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IR35: How to tell if your umbrella company is compliant

How to avoid non-compliant umbrella companies – and how to spot a good one

Male Inspection Engineering holding tablet assessing pipework

Finding STEM skills is a top priority for many pioneering companies. According to our latest insights report 70% of clients want specialist candidates, 45% are looking for more adaptable people and 58% want to fill roles quickly.

That demand for staffing solutions is set to continue and offers the flexible workforce a chance to ignite new opportunities. There are a few ways to work with these customers but the most common are by using a Limited Company or an Umbrella Company.

With the reform to off-payroll working rules, there is an anticipated increase in the number of contractors looking to use an Umbrella Company. In some cases, end hirers will have decided it’s a way to mitigate risk. In others, where a client decides that the new off-payroll working rules will apply to the assignment, it could be the best choice for the worker – ensuring they are treated as, and receive the benefits of, being employed by the Umbrella Company. This also allows the contractor to maintain flexibility to move between assignments for different agencies and end clients under an overarching contract of employment.

“With the reform to off-payroll working rules, there is an anticipated increase in the number of contractors looking to use an Umbrella Company” 

There are lots of reasons to provide services through an Umbrella Company and there are some great examples of Umbrella Companies on the market. Unfortunately, as we saw in 2017 when the same off-payroll working rules were applied to the public sector, lots of non-compliant companies formed under the guise of an Umbrella Company. With the private sector reform on the immediate horizon, it feels like a good time to talk about what an Umbrella Company is, how to spot a good one and how to ensure you avoid falling into the trap of operating through a non-compliant provider. To do this, it’s best to start with the basics.

What is an umbrella company?

An Umbrella Company is an employer of both contractors and freelance professionals. These professionals will usually complete multiple assignments either via recruitment agencies or directly with end hirers. In a common supply chain, the Umbrella Company enters an employment contract with the worker and then holds a contract for services with the recruitment company.

How is umbrella company pay calculated?

If we use the above example of a common supply chain, the recruitment agency will agree an assignment rate with the Umbrella Company via its contract for services.

As with any normal employer, the Umbrella Company has costs to cover. These include employer’s National Insurance, holiday pay, apprenticeship levy and pension contributions. The umbrella also retains a small margin for the services it provides. It is important to note that the PAYE rate is the rate that should be discussed with the worker, all the additional costs will be added on top of that rate.
As with any normal employee, statutory deductions would be taken from that pay rate depending on the tax band.

Assignment rate and PAYE rate

A common concern or misconception in the market is that employer’s National Insurance is deducted from workers’ pay. This deduction is not from the gross pay to the worker; it is deducted from the assignment rate paid to the umbrella by the agency or end client.

How the Key Information Document helps with this

In 2020, the Key Information Document (KID) was introduced. This puts a legal obligation on the agency in the supply chain to provide a breakdown of what rate will be paid to the Umbrella Company, the ‘assignment rate’ which deductions will then be made by them, an example of the PAYE rate and then the likely statutory deductions from there.

Over and above the KID, Umbrella Companies then provide an illustration to the worker, showing a full breakdown of costs and calculations to provide clarity.

At SThree, we started providing Key Information Documents earlier than legally required and have a very clear process in place, for example Key Information Documents on our brand websites and provided to every worker, as they should be. This gives the clarification required to any workers who engage with us, or our Umbrella Companies, who make up our Approved Supplier List (ASL).

Any additional benefits to using a compliant umbrella company?

Compliant Umbrella Companies offer all the statutory elements that any employer must, employment rights, sick leave, pension, holiday and maternity pay etc. Over and above that, most will also offer additional benefits packages, discount schemes, digital GP appointments etc.

One of the key benefits of using an Umbrella Company where you are moving from assignment to assignment or end client to end client is the employment continuity with one employer. This can be especially helpful in building up employment history and supports applications for mortgages etc.

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Overview of compliant providers

A compliant Umbrella Company is a great way for a worker to provide services to multiple end customers or agencies, build up employment history, obtain all statutory employment rights as well as additional benefits.

Non-compliant providers

You should now have a good overview of what an Umbrella Company is, how they operate, calculate pay and the benefits are of working with a compliant company. Unfortunately, they aren’t all like this.
There have always been non-compliant payroll providers on the market. Changes in legislation often creates opportunity for non-compliant firms to take advantage. That is exactly what happened in 2017 when the reform to the public sector off-payroll working rules were implemented.

Contractors who had historically been using a Limited Company, in some cases were forced to switch to an Umbrella Company setup. Unfortunately, lots of companies were created and started offering non-compliant schemes to attract new clientele. These schemes usually start by offering illegal levels of take-home pay, for example some providers offered over 80% take-home pay. They achieved this through a number of setups, most commonly known as loan schemes.

A traditional loan scheme setup would see the company put a contract of employment in place with the worker but then loan them the money in the form of a ‘tax-free loan’ with no intention of it ever being paid back. This practice removes any employee or employer National Insurance contributions needing to be made on the loan amount. The provider in these cases makes their money through charging a percentage of the loan.

Contractors who fall into the trap of using a set up like this will likely have HMRC knocking on the door at some point in the future, and this has already happened in several cases. These providers, if found or investigated tend to shut down, taking funds due to the contractor with them meaning HMRC will be looking to recoup the unpaid tax from the contractor.

“Changes in legislation often creates opportunity for non-compliant firms to take advantage.” Charlie Cox, Commercial Director

Any risk to the agency?

Yes. Directors of the agency can be prosecuted under the Criminal Finance Act 2017 where they have been involved in a supply chain containing non-compliant providers operating in the manner described above. This is why many agencies will have an Approved Supplier List (ASL) of Umbrella Companies they trade with to ensure a compliant, safe supply chain.

If the market isn’t regulated, how can a worker or agency find a compliant provider?

There is a body called Freelancer and Contractor Services Association (FCSA). They are the UK’s leading membership body dedicated to raising standards and promoting supply chain compliance across the temporary labour market.

The FCSA accreditation is recognised as the industry’s compliance gold standard. Accredited members are able to demonstrate the highest standard of compliance in the professional employment services sector. Not only are they required to adhere to FCSA’s Charter, they are also tested for compliance with FCSA’s standards. Accredited Members have been independently audited by leading accountancy and legal professionals to confirm that they adhere to the rigorous FCSA Codes of Compliance. This stringent test of their business operations is a clear commercial differentiator for Umbrella Companies, contractor accountants and CIS payroll providers, and minimises the risk.

FCSA have put together some great guides recently as well which you can access here:

Phil Pluck, Chief Executive of the FCSA said: “Choosing compliant supply chains is vital in protecting the interests of contractors and unfortunately, as the sector grows, more and more non-compliant umbrellas are emerging whose only interest is to exploit both the contractor and supply chains. Reputable and compliant agencies, like SThree, only work with other parts of the supply chain that meet the highest compliance standards; hence their choice to use FCSA partners.

“Income as a contractor must be protected and administered in a fully compliant manner. Ask agencies like SThree and FCSA companies what due diligence they undertake to protect you and your income before making a choice and I am confident that the response will give you the assurance you need to see.”

Final thoughts

Here at SThree, we take compliance very seriously, and measure our success in this area as going beyond what is expected – including being years ahead of legislative requirements.

Staffing compliance is a core pillar of the business and we have operated an approved Umbrella Company supply chain for many years that has been made up only of FCSA accredited members. At SThree and across our family of brands we run a very tight, small ASL. This ensures we give contractors a choice of Umbrella Companies to work with, who we know are compliant. This protects the worker, our end customers and anyone else in the supply chain. We review the ASL every two years going through a strict tender process.

If you would like any help or support on this topic, please get in touch and we will be happy to discuss.

Find your next role

Discover which of our specialist brands can find your next contract in engineering, life sciences and technology

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