UK umbrella company sector ‘responsible for 700,000 umbrella contractors, and £11.8bn in tax and NICs’
Off-payroll reform ‘swelled’ the pool of umbrella company contractors by 100,000, taking the total size of the UK’s umbrella workforce to 700,000.
In tax terms, this “conservative” estimate of 100,000 extra contractors on umbrella payrolls due to private sector IR35 reform yielded HMRC an additional £7.7billion in 2021/22.
That is part of the Revenue’s total haul -- from brollies for that entire tax year -- of £11.8billion.
'Large umbrella companies were key beneficiaries of IR35 reform'
But the April 6th 2021 reform hasn’t enriched just the taxman, whose extra £4.7bn in income tax and extra £3bn in NICs, is offset against fewer PSCs paying him corporation tax.
In fact, big umbrella companies were the reform’s “key beneficiaries”, unlike small umbrellas which couldn’t quickly absorb large volumes of workers or afford juicy agency kickbacks.
“It is clear to us that the financial incentivisation of recruitment companies to recommend umbrellas is spiralling out of control,” says PayePass, which is behind all these new findings.
Having analysed both ONS data from 2019-2023 and 20 big brollies’ accounts, the audit firm warns that the kickback model “is simply not sustainable for compliant umbrellas.”
Even the big brollies, whose turnover rose by 214% to £8.1bn between 2018/19 and 2021/22, saw their gross profit margin sliced into two over the same period -- from 3% to 1.4%.
Potentially galling for these ‘Top 20’ brollies (turnover over £100m), the average wage of contractors on their books over the same period more than doubled, from £31,300 to £61,600.
“This change is of notable significance, as the profile of the umbrella worker pool has fundamentally changed,” PayePass says in ‘Shifting Sands,’ a 34-page report on its findings.
“Now, [the profile] clearly captures higher wage workers -- many of whom previously worked through their [own] personal service company.
“[Before IR35 reform these workers were] paying corporation tax on profits…[not] PAYE and NICs on gross earnings [as they do now].”
'Off-payroll rules, a key driving force of umbrella sector growth'
So the off-payroll legislation, including the public sector’s effective since April 6th 2017, has been a “key driving force behind the growth of the umbrella sector”.
But the report adds, standing too close to a former PSC contractor to ask how it feels to be one of the 100,000 probably isn’t a good idea.
“[The OPW rules are] effectively forcing people who were previously working for themselves into a payrolled arrangement…at the behest of their end-client.
“This lack of choice about how they are engaged has made self-employed people reluctant to work through umbrellas, and their displeasure is subsequently fuelled by the perception that they must pay employers NICs as well as their own PAYE and NICs.”
'Mis-advertising by agencies'
Shifting Sands says this misunderstanding is exacerbated by two key factors.
First, the tax and NICs coming out of the ‘assignment rate’ which previously would have been paid gross to that contractor.
Second, agencies “mis-advertising rates of pay, deliberately or otherwise, omitting that the assignment rate is not workers' gross pay, but includes all the overheads such as employers' NICs, pension, and umbrella overheads.”
PayePass says enforcement “action” should therefore be taken against recruitment businesses that “deliberately mis-advertise pay rates.”
'Autumn Statement 2023 unlikely to even mention umbrella companies'
But the audit firm’s Julia Kermode admits she isn’t pinning her hopes on Autumn Statement 2023 for a fix, not for contractors nor for umbrella companies.
“The now endemic payment of incentives to agencies is certainly a major factor behind the decrease in umbrella margins”, Kermode, the firm’s CEO began in a statement to ContractorUK.
“[But] I don’t think that umbrellas will even get a mention in the Autumn Statement, let alone any progress made towards the government finally regulating the sector.
“It is too soon after the recent consultation for there to be any meaningful proposals, and I for one would prefer that the resulting regulation is properly thought out, rather than rushed. It's much better to do something once and do it well, even if that takes longer.”
'Reasonable for the Revenue to part-fund umbrella company regulation'
And to ‘properly think it out’ should include looking at HMRC apportioning some of the £7.7bn in additional tax revenue generated by IR35 reform to fund umbrella regulation.
Sir Mathew Taylor tabled the idea in 2017 and the government committed to it in the Good Work Plan of 2018, much to Kermode’s approval.
“[Our] report clearly demonstrates the important role that umbrellas play in collecting tax for HMRC [approximately £11.8bn in revenue for HMRC in 2021/22], so it certainly is reasonable for some of this to be apportioned towards the costs of regulating the sector."
She continued: “The government needs to be mindful that it could be collecting even more money if tax avoidance schemes were stamped out once and for all, and regulating the sector will go some way toward achieving that.”
'It's remarkable government hasn't regulated'
PayePass’s report describes the absence of regulation for umbrella companies as “remarkable.”
Shifting Sands also calls regulation “crucial,” especially in light of the two breeds of brolly worker likely to (wrongly) shop around for an offer they can’t refuse.
“In 2023, we now have two cohorts of umbrella workers who potentially need or want to maximise take-home pay,” the report says.
“[Firstly] those at the bottom end of the pay spectrum, most notably impacted by the cost-of-living crisis; and [second]; high earners who are used to retaining more of their gross pay.”
'Larger umbrellas taking contractors away from smaller umbrellas'
To guard against losing their users, Kermode believes small or mid-sized brollies “need to focus their strategy on how best to retain their workers and minimise churn.”
And that’s even following IR35 reform which already “likely [will] have resulted in these [larger umbrella] companies taking umbrella employees away from [the] smaller companies.”
The report continues: “Worryingly, the stark downward trend in umbrella company gross profit margins (decreased by 50% since 2018/19) leaves little headroom for investment or innovation.
“Additionally, the money is simply not available within compliant umbrella companies to sustain the current levels of financial incentives paid to recruitment companies in exchange for referring workers to them, nor paying large sums to be included on preferred supplier lists.
“[And] the omnipresence of commissions makes it difficult for smaller umbrella companies to compete with larger businesses because they simply do not have the financial bandwidth to be able to do so.”
'Balance of power too far in the hands of recruitment agencies'
The report stops short of issuing recommendations, but on PSLs in particular, PayePass sounds hopeful that regulation will remove them.
“We understand the need for preferred supplier lists [but] the balance of power is now too far in the hands of recruitment agencies which is being abused in some instances,” the audit firm states.
“We regularly hear of workers required to move umbrella at the behest of a recruitment agency, purely because the new umbrella offers a higher financial incentive to the agency.
“We urgently need a culture change to bring more choice to workers and stop corruptive practices, which is why we believe that workers should be able to use any umbrella that can prove it is compliant.”
'Holiday pay misconduct, and skimming, make regulation desperately needed'
To example non-compliance and poor practice, Shifting Sands declines to name specific umbrellas, but speaks of “holiday pay misconduct” and “systematic skimming of monies.”
“There have long been concerns about the compliance of the umbrella sector, and given the volume of tax that should be collected from the sector, it is remarkable that the government has still not imposed statutory regulation,” PayePass reflects. “Fortunately, there are now positive moves in this direction, however no projected timeframe for change.”
Or, as its CEO Kermode more informally puts it: “Regulations are so desperately needed to protect those who work with umbrella companies. And the government [is] finally taking strides towards protecting contractors from tax schemes and dubious practices…though [these are still] somewhat short.”