Umbrella tax legislation: What recruitment businesses need to know

New laws aimed at cutting tax fraud and non-compliance in the umbrella company sector are due to come into effect April 2026. 

The draft legislation – part of the Finance Bill 2026 – is contained in a new Chapter 11 of Part 2 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA 2003). While the Bill hasn’t received Royal Assent yet, it will do in due course. 

As a recruitment agency, you may wonder what any of it has to do with you. After all, you’re not an umbrella company.  

But agencies that operate in labour supply chains alongside umbrella companies could be caught out by the new legislation. Chapter 11 makes recruitment agencies “jointly and severally liable (JSL)” for unpaid tax/PAYE. In other words, if an umbrella business fails to pay what it owes, you could be on the hook.  

Chapter 11 also interacts with Chapter 7 ITEPA 2003, commonly known as agency legislation, in one or two ways you need to know about. 

In the rest of this article, we’ll look at what Chapter 11 aims to achieve, and what recruitment businesses need to do to remain compliant. 

Chapter 7: a timely recap 

To understand and distinguish between the new umbrella legislation (Chapter 11) and Chapter 7, you first need a firm grasp on what Chapter 7 means.  

For recruitment agencies, Chapter 7 outlines which agency-supplied workers are considered self-employed for tax purposes, and which aren’t. It’s an important distinction that aims to stop self-employment being exploited in cases where it isn’t genuine. 

Central to that is the supervision, direction and control (SDC) test. If there is even a hint of SDC in the relationship between the end client and the worker (even if it’s not exercised), self-employed status doesn’t apply. In which case, the agency has to treat the worker as being employed and take responsibility for the worker’s PAYE and National Insurance (NI). 

That might sound straightforward enough, but there’s a hitch. SDC is not defined in law, so what is it? HMRC’s definitions of SDC are (perhaps deliberately) vague and therefore open to challenge. In brief: 

• Supervision means that someone is overseeing a person doing work (to ensure work is completed and to a required standard) 

• Direction means making someone work in a certain way  

• Control means dictating what work a person does and how they do it 

The problem here, as you can probably see, is that the definition of SDC applies to a lot of temporary or contract workers.  

Clarity is crucial 

With that in mind, the important bit for agencies to remember is that HMRC will assume SDC applies unless you can prove otherwise.  

In a PAYE compliance check, you’ll be asked for evidence that workers treated as self-employed are not subject to SDC. You’ll need to provide a robust audit trail of relevant documents, and your paperwork needs to be spot on.  

Specifically, make sure self-employed status (particularly an absence of a right of control), is addressed in all contracts. That means contracts between the agency and worker and contracts between the agency and end client.  

It’s even more important that the end client provides you with documents showing the worker isn’t subject to SDC. After all, the client knows better than anyone what happens at the coalface. 

You might be reluctant to ask for this information because you’re worried about bothering a client. At the same time, end clients are sometimes reluctant to provide it, worried about HMRC viewing documentation as fraudulent and being unwittingly drawn into a compliance investigation. 

These objections are understandable, but they carry no weight with HMRC, so both sides need to play ball. Ask your end client for the evidence you need. Reassure them that fraud provisions don’t apply if they provide an honest assessment of the SDC status of agency workers.  

HMRC knows that mistakes happen and has a lot on its plate. It only presses the fraud investigation button when it suspects deliberate misinformation or fabrication.  

Chapter 11: closing umbrella firm loopholes 

So that’s Chapter 7, but what about Chapter 11? At one point, Chapter 11 legislation was floated as an amendment to Chapter 7. That hasn’t happened, for good reason. The two pieces of legislation do very different jobs.  

While Chapter 7 closes loopholes around self-employment, Chapter 11 aims to do the same around workers employed by umbrella companies.  

What’s an umbrella company? In short, it’s when a worker personally provides services to an end client via a third-party company that employs him. The third party is the umbrella company. The difference with a personal service company (PSC) is that the worker has no stake in an umbrella company. 

HMRC worries that the growing use of umbrella companies increases the chances of fraud or non-compliance, because it adds new levels of complexity and new places for tax fraud to hide. That’s especially true when multiple umbrella companies work on the same project. 

Against that background, Chapter 11 aims to: 

• Close the tax gap caused by umbrella fraud 

• Protect workers from large and unexpected tax and NICs bills caused by umbrella companies that fail to pay up 

• Ensure the temporary labour market operates on a level playing field by eliminating fraud 

Chapter 11 and recruitment businesses 

So what does this mean for you? Most importantly, the legislation introduces the concept of joint and several liability (JSL) for any unpaid tax. 

Put simply, JSL means that, as the agency supplying the worker, you could end up with the bill for any PAYE liabilities the umbrella company doesn’t pay. This will usually apply to the “top agency” in any chain, which is the agency that has the contract with the end client. 

This is a major shift in approach by HMRC. From next April, recruitment agencies in a complex labour supply chain will be on the hook for umbrella companies’ non-compliance.  

And you won’t be able to plead ignorance or rely on a defence of ‘reasonable care’. As the legislation currently stands, taking steps to ensure the umbrella is compliant won’t be enough if it turns out not to be. Your “absolute liability” for unpaid PAYE remains.  

In other words, it’s up to you to make sure the umbrella companies you work with pay what they owe.  

Due diligence needs to be watertight 

The most important message for recruitment businesses in all this is that due diligence has never been more crucial.  

You need to have complete clarity on the complexity of your labour supply chain and your position in it. Chapter 11 is all about driving better self-policing of these convoluted supply chain solutions. 

Don’t be shy about checking the compliance of the umbrella companies you work with in detail. Then check again – frequently. Up-to-date information is especially important if workers are being placed for significant periods of time. Your due diligence should include: 

• Checking umbrella companies have processes in place to prevent or spot mistakes 

• Checking they are financially robust 

• Checking they include PAYE reference numbers on payslips 

• Checking the umbrella company makes the necessary PAYE deductions 

This is unlikely to be the last word on Chapter 11 – HMRC has already addressed some of the more confusing areas in a recent webinar. For the moment it’s possible that some recruitment agencies may unwittingly fall within the definition of an umbrella company. But we hope for more improved and clearer guidance over the coming months before HMRC rolls out the legislation next year. We’ll keep you posted. 

The crossover between Chapter 7 and Chapter 11 

In summary, Chapter 7 addresses situations where workers are placed by intermediary companies (agencies, umbrellas) but aren’t directly employed by those intermediaries.  

Chapter 11 concerns itself with workers who may be placed by an agency but are directly employed by an umbrella company. 

They’re different areas, so any crossover between the two will only likely occur in rare cases where there might be some confusion over which regime applies.  

For example, some models, like the Elective Deduction Model (EDM), may fall between these two stools. EDM is a very grey area and is probably best avoided (HMRC has confirmed they believe this doesn’t work) but umbrella companies may try to use it to circumvent Chapter 11 JSL. In which case, tax liability should get picked up by Chapter 7 anyway. 

One other area of potential crossover is around fraudulent documents. In agency legislation, recruitment agencies can claim to have been genuinely misled by fraudulent documents from a client.  

Not anymore. There will now be no such defence where fraudulent documents from an umbrella company are concerned. It’s up to you to check their validity. 

Again, the message here is to prioritise comprehensive, and continuing, due diligence.    

The takeaway 

In practice, there should be little crossover between Chapter 7 and Chapter 11, which have very different aims. 

But recruitment agencies need to understand both and have a clear sense of the labour supply chains they are part of.  

The simple fact is that Chapter 11 is likely to make it a bit more burdensome to work with umbrella companies. Some agencies may prefer to take functions like payroll in-house to avoid the risks of JSL. 

For now, with six months to go before new laws take effect, the best advice is to take guidance and start communicating with any umbrella businesses you work with. Put your heads together to develop robust processes that will ensure full compliance and keep HMRC happy. 

Chapter 11 may seem a bit of a pain, especially at first but it will be much easier to navigate if all parties accept the need for honesty, transparency and a commitment to the smooth flow of accurate information.

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