Autumn Budget 2024: Umbrella companies due to get a soaking – London Business News | Londonlovesbusiness.com

Marked by recurring cases of tax evasion and fraudulent schemes that exploit complex payroll mechanisms, the Government is bringing forward legislation to change who has a responsibility to account for Pay As You Earn (PAYE) and national insurance contributions (NICs) where an umbrella company is used in a supply chain.

In a targeted response to widespread non-compliance issues that persist particularly within the labour sector, the Chancellor of the Exchequer, Rachel Reeves, set out in the Autumn Budget that PAYE and NICs will no longer be paid by the umbrella company.

Instead, they will be paid by the company, usually a recruitment agency that supplies the worker to the end-client.  Where there is no recruitment agency in the supply chain, the responsibility will be with the end-client themselves. This will be from April 2026.

An umbrella company is a company that contractors can choose to work through as an alternative to setting up their own limited company.

It acts as their employer and as an intermediary between the contractor and their recruitment agency or end client.  The Government plan to improve standards, particularly within the temporary labour market, by “closing the tax gap” and “making the tax system fairer by reducing the risk of large unexpected tax bills landing with individuals who have been working with a non-compliant umbrella company”.

Current compliance landscape for Umbrella companies

Under current regulations, companies that employ individuals under the umbrella company system must already adhere to a complex array of tax and payroll responsibilities. Notably, the UK’s corporate criminal offence legislation which imposes stringent requirements on companies to prevent tax evasion within their supply chains. This includes the facilitation of PAYE and National Insurance Contributions (NICs) for self-employed contractors.

Despite these regulations, the umbrella market remains problematic, partly due to the blurred lines in accountability for PAYE between umbrella firms and their clients. Some umbrella companies have been implicated in schemes to evade PAYE or NICs by misclassifying employees, using offshore payment methods, or claiming unjustified tax exemptions.

Such tactics not only undermine tax compliance but also expose client businesses to legal risks, as legislation holds companies accountable for tax evasion facilitated by any “associated party”, this includes umbrella companies. The Criminal Finances Act (“CFA”) 2017 extends liability to companies failing to implement preventative measures against tax evasion in their supply chains, highlighting the importance of robust due diligence and internal controls and procedures within businesses working with “associated persons” like umbrella companies.

Under the current regulatory environment, businesses engaging with umbrella companies face significant risk if their due diligence is lacking. The government’s intensified approach aims to close loopholes that previously allowed certain companies to sidestep PAYE responsibilities. Now, with these legislative changes coming into effect sooner than anticipated, businesses need to revisit their compliance strategies to ensure they are not inadvertently liable for tax non-compliance.

Impact on companies with PAYE responsibilities

For businesses that rely on umbrella companies for payroll services, the accelerated changes to PAYE legislation bring with them significant compliance demands. Under the Criminal Finances Act 2017, companies face strict liability if they fail to prevent tax evasion facilitated by any associated entity, including third-party service providers like umbrella companies.

Businesses must therefore exercise due diligence when working with umbrella companies, recognising that any failure in PAYE compliance could result in them having direct liability. This heightened responsibility requires companies to actively audit and monitor their supply chains to ensure they are not inadvertently participating in schemes designed to evade PAYE or NICs, and more generally evade tax. Compliance with PAYE regulations means not only adhering to current laws but also implementing sufficient controls to detect and mitigate potential tax evasion activities by associated umbrella companies and within their own business.

In practical terms, this shift in legislation highlights the necessity for companies to conduct more thorough assessments of their payroll practices and verify that all umbrella company partners meet legal standards for the time being. Firms may need to review existing contracts with umbrella companies, introduce more stringent reporting requirements, and, where necessary, seek legal guidance to verify that payroll procedures fully align with the current and new legislation which will shortly be introduced as part of the Finance Bill 2025. By assuming a proactive stance, companies can better protect themselves from the financial and reputational risks of PAYE non-compliance and the strict liability offence of failure to prevent tax evasion.

Consequences for non-compliance

Companies that fail to meet their PAYE responsibilities when using umbrella companies risk facing significant penalties, ranging from financial sanctions to criminal charges. Specifically, the CFA Act makes businesses criminally liable if their “associated persons” facilitate tax evasion by a taxpayer either in the UK or overseas.

An “associated person” is an employee agent and other person who performs services for or on behalf of the company such as contractors, suppliers, agents and intermediaries. Companies must have “reasonable preventative measures in place” to prevent tax evasion within their supply chain; failure to do so can lead to prosecution. This legislative structure imposes strict liability, meaning that a company can be held accountable even if it did not directly facilitate tax evasion but simply failed to prevent it.

For directors and key stakeholders, the repercussions of non-compliance are substantial.  Although directors and senior officers cannot be found personally liable for failing to prevent tax evasion, HMRC can investigate individuals for tax evasion or fraud.  The stakes are notably high for companies within sectors heavily reliant on contract work, where the use of umbrella companies is common, as these entities are now directly in the spotlight of government enforcement efforts.

Furthermore, companies found in breach of PAYE compliance will likely encounter reputational damage, which could impact their relationships with clients, contractors, and regulatory bodies. The government’s push for transparency and accountability means that organisations must not only adhere to the new regulations but also demonstrate a proactive commitment to maintaining payroll integrity. Firms need to establish and maintain rigorous compliance frameworks because the penalties for even unintentional non-compliance are likely to be enforced with greater frequency and severity.  The full details of how the new measures will operate will be set out by the Government in the coming months, alongside the draft legislation.

Preventative measures and compliance strategies

With the new PAYE compliance standards in place, businesses can mitigate risk by implementing structured preventative measures that demonstrate a commitment to tax compliance. Given the CFA’s strict liability framework, which makes companies accountable for failing to prevent tax evasion by associated parties, businesses must prioritise robust compliance frameworks across their payroll and accounting practices now.

One of the first steps in this preventative strategy is the establishment of a comprehensive due diligence process when selecting or continuing relationships with umbrella companies in the lead up to the new measures. This process should involve verifying the compliance history of any umbrella companies you use, including a risk assessment of their PAYE and NICs practices. Businesses may also consider implementing an internal compliance audit system to regularly review payroll processes and identify any potential vulnerabilities in their engagement with umbrella companies.

Additionally, businesses should establish clear contractual agreements with umbrella companies that include clauses on tax compliance and transparent payroll practices. These agreements may specify reporting obligations and outline the required documentation to prove PAYE adherence. Implementing ongoing training and awareness programmes for key personnel can also reinforce compliance culture within the organisation, equipping employees to recognise and address potential tax evasion risks.

Finally, engaging with legal advisors specialising in Corporate Compliance, Investigations & Prosecution can help businesses stay abreast of regulatory changes. Legal experts can provide tailored guidance on managing PAYE compliance, ensuring businesses fully understand their obligations under both PAYE regulations and in relation to corporate criminal offences. This proactive approach demonstrates a clear commitment to meeting the standards set by the accelerated legislation timeline and reduces the risk of inadvertent non-compliance.

As the government takes a firm stance on PAYE compliance within the umbrella company market, companies now face pressures to ensure their payroll practices meet elevated standards. Although the CFA has been in force for some time, it is clear that the Government’s focused attention on tax evasion, particularly within the labour market, means companies should be reassessing the preventative measures they have in place and how these can be elevated to reduce the risk of non-compliance.

The changes serve as both a challenge and an opportunity for companies in the coming months.  Whilst the changes demand greater attention to detail in tax compliance, they also present a pathway for companies to enhance their operational integrity and build a reputation rooted in accountability and transparency.  Companies should discuss their corporate compliance needs with a specialist solicitor.