Understanding Umbrella Companies: Why They Cause Problems for HR Directors, Supply Chain Directors, and Risk Directors

Why umbrella companies Cause Problems for HR Directors, Supply Chain Directors, and Risk Directors

Umbrella companies have become a common feature in the UK workforce, particularly for contract workers and freelancers. While they offer a convenient solution for managing payroll, taxes, and compliance, they have also raised significant concerns across various business functions, including HR, supply chain management, and risk mitigation.

In recent years, non-compliance and unethical practices within umbrella companies have led to legal challenges and financial penalties for businesses and directors. These cases highlight the need for a deep understanding of how umbrella companies work, and the potential risks involved. This article explores what umbrella companies are, why they pose challenges to HR, supply chain, and risk directors, and provides examples of high-profile legal cases where non-compliance has resulted in severe consequences.

What Is an Umbrella Company?

An umbrella company acts as an intermediary between contractors or freelancers and their end clients (usually companies or recruitment agencies). Contractors become employees of the umbrella company, which then processes their payroll, handles taxes (such as PAYE – Pay as You Earn), and ensures compliance with UK employment laws.

The key selling point of umbrella companies is simplicity for contractors, who do not need to worry about tax administration. They submit timesheets to the umbrella company, which invoices the end client, takes care of taxes, and pays the contractor after deducting fees.

While this arrangement might seem straightforward, the lack of transparency and potential for tax avoidance schemes have created a host of problems for businesses, especially in terms of compliance with tax laws and employment regulations.

Why Umbrella Companies Cause Problems for HR, Supply Chain, and Risk Directors

HR Directors face significant challenges when working with contractors via umbrella companies, mainly around employee misclassification and payroll compliance. Problems arise when umbrella companies do not follow proper employment practices, potentially leading to:

• Incorrect Tax and National Insurance Contributions: Currently the worker is liable if they do not  adhere to PAYE regulations, however HMRC has confirmed that in future agency that employs the contractor will be held liable for unpaid taxes..
• Worker Rights: There have been numerous cases of contractors not receiving statutory entitlements, such as holiday pay or sick leave, because of non-compliant umbrella companies. HR directors must be vigilant about ensuring contractors’ rights are protected, as any legal issues related to worker mistreatment can lead to reputational damage.

Supply Chain Directors, managing large numbers of contractors is a critical aspect of ensuring smooth operations. When contractors are employed through umbrella companies, visibility into the full employment process is often limited, which can result in:

• Lack of Transparency: Many umbrella companies are not fully transparent about their fee structures and tax practices, which can make it difficult for supply chain directors to track costs accurately. This lack of transparency can lead to overpaying for services or being implicated in tax avoidance schemes.
• Unforeseen Liabilities: Labours renewed focus on taxation is highly likely to result in a crackdown on non compliance of tax laws. If an umbrella company is found to be non-compliant the end client—typically a business that uses the contractor’s services could face back payments or fines from HMRC (Her Majesty’s Revenue and Customs). Supply chain directors need to ensure that contractors are sourced and managed through compliant agencies to avoid being caught up in legal issues.

Risk Directors are primarily concerned with mitigating financial and reputational risks. Non-compliant umbrella companies expose businesses to significant risks, including:

• Reputational Damage: When non-compliance issues come to light, the company’s reputation can suffer. High-profile cases of tax avoidance involving umbrella companies have led to severe public backlash and have tarnished the reputations of businesses that engaged with them. Risk directors must work to ensure that all third-party partners, including umbrella companies, adhere to legal and ethical standards.
• Tax Evasion and Legal Challenges: Businesses that use contractors through umbrella companies could unknowingly become involved in tax avoidance schemes. Risk directors need to be aware of the company’s overall compliance with tax laws, including IR35, to avoid costly legal battles with HMRC (see below).

High-Profile Legal Cases Against Non-Compliant Resourcing

Several cases involving umbrella companies have made headlines, illustrating the serious consequences of non-compliance.

• G4S Covid test centres. BBC Radio 4’s File on 4 discovered staff at Covid test centres have been employed by subcontractors failing to comply with TAX regulations. Although G4S claimed they brought this to the attention of the HMRC the publicity caused the business substantial reputational damage.

• HMRC Crackdown on “Mini Umbrella Companies” (2021). Another significant legal development came when HMRC launched a crackdown on “mini umbrella companies” (MUCs). These companies were set up to exploit VAT and employment allowance schemes. They targeted contractors by misclassifying them and benefiting from tax loopholes designed to support small businesses.

• One prominent case involved an NHS trust, which unknowingly engaged contractors through a network of MUCs. HMRC uncovered that the trust’s supply chain included fraudulent practices, resulting in millions of pounds in unpaid taxes. This situation highlighted how businesses can become entangled in non-compliant practices without their direct knowledge, leading to substantial financial risks.

• The Medacs Healthcare Case (2018). Medacs Healthcare, a recruitment agency supplying doctors to the NHS, found itself in legal trouble when it was accused of engaging with non-compliant umbrella companies. Contractors were hired through intermediaries who did not pay the correct amount of tax, leaving Medacs liable for unpaid PAYE and National Insurance contributions. The case resulted in significant fines and served as a wake-up call for recruitment agencies and businesses that rely heavily on contractors.

How HR, Supply Chain, and Risk Directors Can Mitigate These Risks

Given the legal and financial consequences of working with non-compliant umbrella companies, it’s essential for HR, supply chain, and risk directors to take proactive steps to mitigate risks:

Conduct Thorough Due Diligence: Vet umbrella companies rigorously before engaging them. Ensure they are fully compliant with UK tax laws, including IR35, PAYE, and VAT regulations.

Demand Transparency: Work only with umbrella companies that provide full transparency regarding their fee structures, tax deductions, and worker rights. A lack of transparency is often a red flag for non-compliance.

Implement Strong Contracts: Ensure contracts with umbrella companies clearly outline responsibilities, including tax obligations, worker entitlements, and compliance with all applicable laws.

Work with Trusted Agencies: Use recruitment agencies and intermediaries that have a proven track record of compliance and ethical practices. Partnering with established and reputable firms reduces the likelihood of being implicated in non-compliant practices.

Why you need Rockford Resourcing.

The economic climate is improving, and capacity and quality of employees could prevent you from reaching your goals, you need a partner to help you resource ahead of demand.

Labour is committed to making employment fairer for workers and businesses more compliant, your resourcing need to me transparent and compliant to avoid this risk of legal action and reputational damage.

We offer a different approach, a transparent, compliant and easy way to manage resourcing and payroll for your contingent workforce.

We remove misleading employer and agency costs from our advertised and agreed rate.

Our fully compliant supply chain adapts to meet the evolving regulatory landscape.

We can handle large-volume vacancies rapidly, ensuring your resource matches your needs.

Our ‘one stop shop’ services help remove any reliance on umbrella firms, saving you money.

We handle large workforce requirements as well as specialist, niche recruitment.

Our unique recruitment process means we ensure hi quality candidates who are highly engaged because all of their financial concerns are catered for.

Why not add Rockford to your preferred supplier list now?