How recruitment companies can engage with umbrella companies compliantly

In our recent IR35 survey, an overwhelming 80% of recruiters said they engaged with umbrella companies. But with some horror stories circulating about contractors being recruited into tax avoidance schemes, being scammed out of large chunks of their pay and not receiving the pay and leave they are entitled to – how do recruitment companies manage the risks of using umbrella companies? Can recruiters engage with umbrella companies compliantly?

In this blog, we take a look at the benefits and risks of using umbrella companies, and explore some simple steps that recruitment agencies can take to ensure that they are using legitimate and legal umbrella companies to pay their contractors.

What is an umbrella company?

An umbrella company is an optional extra party in the contractor supply chain that acts as a payroll service. Rather than working through their own limited PSC, a contractor could choose to work for an umbrella company instead. The umbrella company then is another layer in the supply chain, between the contractor and the recruiter.

Client → Agency → Umbrella Company → Contractor

A typical umbrella working arrangement might look like:

• The contractor becomes employed by the umbrella company for the duration of their contracts
• The umbrella company bills the recruiter or end client for the contractor’s services.
• The umbrella company pays the contractor as an employee, deducting any relevant taxes through PAYE.
• Contractors working for umbrella companies are eligible for the same employment rights as other employees, including the right to holiday pay, maternity and paternity leave, and sick pay.

3 out of 4 recruiters told us that they have seen an increase in umbrella companies since the IR35 reforms. Because a contractor working for an umbrella company is classed as an employee and their pay is taxed through PAYE, they are not subject to IR35 rules – which may be making umbrella companies a more attractive way of working.

What are the problems with umbrella companies?

Umbrella companies operating compliantly – deducting the right amounts of tax – are completely legal and can be a useful way for contractors to take on roles where they might otherwise have to work inside IR35 or where they want to be entitled to employee benefits.

However, there are many horror stories out there about umbrella companies. In particular, recruitment agencies should be aware of the risks engaging with umbrella companies acting as tax avoidance schemes or breaching employment laws.  These concerns were reflected in the results of our IR35 survey.

We asked recruiters if they felt that self-employed umbrella companies were sufficiently regulated. 30% of respondents said no, and 38% answered neutrally. This suggests that there is a general lack of confidence around umbrella companies in the recruitment sector. So, what can recruiters do to ensure that they are engaging with legitimate umbrella companies in a compliant way?

Here are Kingsbridge’s top tips:

Do your research

Don’t blindly enter into relationships with umbrella companies without thoroughly researching the business first. Google searches, Companies House, online reviews, and checking for a website or presence on LinkedIn can be good sources of information on umbrella companies. The Government website offers some red flags to look out for when engaging with umbrella companies. These include:

• Unusual company names, or lots of companies set up around the same time with similar unusual names.
• Inappropriate business address.
• Business activity listed on Companies House seems unrelated to the services being provided by contractors.
• Foreign nationals with no previous relevant experience listed as directors.
• Workers are often moved from one umbrella company to another after short periods.
• Businesses are short-lived and close after less than 18 months – beware of umbrella companies that cannot show an established track record.
• Check they are based in the UK – not a known tax haven like Jersey or the Isle of Man.

Advise your contractors to do their own research and due diligence as well – umbrella companies have been known to recruit contractors into tax avoidance schemes without their knowledge, or they may find themselves faced with unexpected deductions from their pay if they aren’t fully aware of the way the umbrella company operates.

Ask for more information

If you’ve done your research and the company looks legit, the next step is to have a conversation with the umbrella company. Make sure you get full information about how they operate, including things like fees, payment terms for contractors and how they take responsibility for tax affairs.

Any legitimate business should be happy to answer these simple queries so beware if answers are hard to come by or the response is cagey. Trust your instincts and if anything feels off, back away!

Don’t believe everything you hear

Always follow the golden rule: if it sounds too good to be true, it probably is! Umbrella contractors should expect their take home pay to reflect the fact that they will be taxed as employees – so anyone promising anything else should be viewed with extreme suspicion.

Do seek professional advice

Before you and your contractors sign on the dotted line with any umbrella company, seek professional advice from a solicitor or accountant. Get them to review the contractual information provided and double check your research. The last thing you want is to become embroiled with an illegitimate company – and having an expert pair of eyes will help provide reassurance and demonstrate due diligence in the event that things go awry down the line.

Kingsbridge have years of experience supporting contractors, so we’re uniquely placed to understand the contracting supply chain. For our recruitment partners, this means we can offer support with IR35 compliance, including the Kingsbridge Status Tool, staff training and IR35 consultancy services. Recruiters can also team up with us to give your contractors access to our comprehensive, compliant insurance packages – and earn rewards at the same time. Find out more about how you can partner with Kingsbridge on our Partners & Affiliates page.