Slow government progress on umbrella regulation exposes IT contractors to tax risks

by Joseph K. Clark

The UK government stands accused of failing to act quickly enough to push through legislation to ensure IT contractors receive the correct pay and benefits when working through umbrella companies. As previously detailed by Computer Weekly, thousands of contractors could be in line to receive compensatory payouts from umbrella companies and employment agencies after having employers’ national insurance contributions (NICs) unlawfully deducted from their pay since the onset of the public sector IR35 reforms in April 2017.

The reforms, set to be extended to the private sector from 6 April 2021, introduce changes that mean limited company and personal service company (PSC) contractors are no longer required to cover the cost of employers’ NI on assignments deemed in-scope of the IR35 rules. The umbrella company or employment agency that pays the contractor’s PSC should cover the cost of employers’ NI at 13.8%. Still, mounting evidence suggests that many are side-stepping this requirement by unlawfully deducting it from the gross pay of the contractors on their books.

A series of group litigations are being prepared to reimburse contractors that have fallen victim to this practice since the onset of the public sector IR35 reforms. Experts predict that thousands more could join them once the changes are rolled out to the private sector. Various contracting market stakeholders have told Computer Weekly that the issue of unlawful deductions (and the group litigations these are on course to give rise to) could have been avoided if the government had acted more quickly to push through regulation to eradicate non-compliant umbrella companies from the market.

IT contractors

These include umbrella companies that withheld holiday pay from contractors, subjected them to unlawful employers’ NI deductions, and firms claiming contractors can remain compliant with UK tax laws while achieving take-home pay rates over 85%. Dave Chaplin, CEO of contracting authority ContractorCalculator, said there had been “widespread calls” for “many years” for umbrella companies to be regulated and rid the sector of the poor practices that have tarnished its reputation. “We are still hearing about hard-working people being duped of their entitlements,” he said. “I would urge HM Revenue & Customs [HMRC] and the government to take immediate steps to address the bad practice and regulate.” This is not only to protect contractors but also to show support to the umbrella companies that operate compliantly, said Chaplin. “Although the industry is unregulated, most umbrella firms are honest, but they do get tarnished by the bad behavior of the few.”

Slow to act on umbrella regulation

So why has the government seemingly been so slow to regulate umbrella companies? Andy Chamberlain, director of policy at the Association of Independent Professionals and the Self-Employed (IPSE), said it could be partly attributed to the government’s inability to appreciate the impact the IR35 reforms would have on the working relationships between contractors and their end clients. The onset of the public sector IR35 reforms led to a surge in the number of end clients introducing hiring policies that banned limited company contractors and favored individuals who worked through umbrella companies. The same now appears to be happening in the private sector as well.

“The government never really acknowledged that the IR35 [reforms] in the private sector and indeed the public sector would result in more people working via umbrella companies,” said Chamberlain. “It’s pretty obvious that it was going to result in that… and we were saying to the government [beforehand]: you’ve got to sort out regulation for umbrella companies before you put this legislation through because you’re putting people – in the worst case – at risk of [joining] non-compliant umbrella companies that won’t deduct tax properly. There will be more tax avoidance – not less.” Chamberlain said that contractors and compliant umbrella companies are now dealing with the fall-out from the government’s decision not to heed these warnings. “What we’re seeing now are other problems around holiday pay [being withheld from contractors], arguments over employers’ NI liabilities, so it’s causing many problems,” he added.

The long and winding road to regulation

That is not to say the government has been entirely inactive in regulating umbrella companies, but progress has been slow. The government-commissioned 2017 “gig economy” review by Matthew Taylor, former interim director of labor market enforcement, made a case for umbrella companies to be regulated more tightly. It also called for their activities to be covered by the Employment Agency Standards (EAS) legislation, which protects employment agency workers’ rights.

In its response to the Taylor Review, the government agreed in December 2018 to expand the remit of the EAS inspectorate to include umbrella companies. “In line with our enhanced approach to enforcement, we will increase state enforcement protections for agency workers where they have pay withheld or unclear deductions made by an umbrella company,” the government stated. Several years have passed since the Taylor Review’s recommendations were made public. Despite parliamentary pressure on the government to act on them, umbrella companies remain out of the scope of the EAS legislation.

Julia Kermode, the founder of independent worker consultancy, said the “lack of visible progress” on extending the remit of EAS to include umbrella firms was concerning, given how relatively simple a change would be. “The plan will have required a small amount of primary legislation, so the reason [for the delay] is likely to be a lack of parliamentary time, which Brexit will have dominated. Of course, we had the pandemic to contend with,” she told Computer Weekly.

That said, simply including umbrella companies in the list of firms covered by the EAS’s remit would not be enough on its own to protect contractors from issues such as unlawful deductions, said Kermode. “The proposed regulation was never going to be fit for purpose because many of the agency regulations do not apply to umbrellas, and crucially there was no planned provision for ensuring appropriate tax and NICs treatment,” she said. “The only good thing about the plan was the simplicity and, for that reason, I had hoped it would be in place before the IR35 reforms are extended to the private sector in April 2021, and therefore giving anyone poorly treated by an umbrella a route for redress.”

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