Government inaction over tax umbrellas drives avoidance schemes, experts say

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Government delays in delivering on a 2018 promise to regulate umbrella companies — employment arrangements used by hundreds of thousands of freelance workers — is leading people into rule-breaking tax avoidance schemes, industry experts warned.

Umbrella companies typically collect a freelancer’s earnings from their hiring company or recruitment agency, deduct tax and national insurance and then pay the worker.

The unregulated industry has attracted increased scrutiny in recent years. While many companies operate legitimately, some operators have facilitated tax avoidance tools on behalf of workers or, sometimes, solely for the umbrella company’s benefit. Others have skimmed funds from workers’ pay packets or withheld holiday pay.

A report this week by umbrella company compliance specialist PayePass, estimated the number of people working via unregulated arrangements grew from 600,000 in 2018-19 to 700,000 in 2021-22.

Julia Kermode, chief executive of PayePass, said: “[The regulation of the sector] needs to be tackled in the right way, otherwise more and more people will find themselves in these tax avoidance schemes.”

The government launched a consultation on ways to curb tax avoidance and abuses of employment rights by umbrella companies this summer and was analysing the responses.

It first promised to regulate the sector as far back as 2018, in response to a review into modern working practices it had commissioned. But progress has been slow.

The pace of growth in workers using umbrella arrangements since changes to the off-payroll working rules affecting the private sector had been “staggering”, Kermode said.

Since April 2021, the decision about whether contractors are considered self-employed for tax purposes — known as “outside IR35” — or employed was moved from the freelancers to their hirers. Similar rules have been in force in the public sector in 2017.

Hirers affected by the rule changes have increasingly required freelance workers to use umbrella companies, pushing up the numbers using the arrangements. But this resulted in a growth in rogue operators, Kermode said.

She added she had seen “many instances” of umbrella workers’ earnings being diverted into tax avoidance schemes. Some workers only found out when they were hit by large, unexpected tax bills from HM Revenue & Customs.

“This is simply unacceptable. The government is well aware of the issues and must step in to protect people’s livelihoods,” Kermode added. “The tax avoidance taking place means that tens of billions of pounds in uncollected tax are likely slipping through HMRC’s fingers.”

But HMRC estimated that only handful of avoidance promoters remained active and it said it was determined to drive them out of business. It has published details of 50 promoters, 14 directors, and 54 tax avoidance schemes. HMRC has also issued 15 stop notices between August 2022 and the end of August 2023, requiring a promoter to stop marketing a tax avoidance scheme.

The government said it was reviewing feedback to the consultation and would respond “in due course”. It added: “Many umbrella companies are compliant with the tax rules — however, we recognise the risk posed by those who abuse the model and will take action against these bad actors.”

However, industry practitioners want more rapid action. Crawford Temple, chief executive of Professional Passport, an independent assessor of payment intermediary compliance, also said he was seeing “high levels” of tax avoidance schemes, and this was “reaching levels of an industrial scale”.

“HMRC is simply not stamping down on the schemes concertedly enough and persists in chasing the victims of the schemes rather than the architects of those schemes. The lack of enforcement is simply allowing the perpetrators to thrive,” he said.

The government consultation suggested various options for regulating the industry. These included a new requirement for recruiters, or their clients, to conduct due diligence on umbrella companies, with penalties for failing to do so. Another option was the transfer of unpaid tax from an umbrella company to another party in the labour supply chain.