Why umbrella company regulation proposals will backfire

The UK’s temporary labour market is under threat – and I say this before the chancellor has got to her feet to unleash Spring Statement 2025, writes Chris Bryce, CEO of the Freelancer & Contractor Services Association.

So even before Rachel Reeves’ statement next Wednesday, the current threat comes from the government’s proposed umbrella company regulation shift outlined in its March 4th “outcome” document to the consultation, “Tackling non-compliance in the umbrella company market.”

Shifting payroll tax liability is simply shifting the problem

In broad terms, the government wants to force recruitment agencies to take on payroll tax responsibilities instead of umbrella companies.

That may seem like a crackdown on umbrella company non-compliance, but it is more likely to have the opposite effect.

Far from protecting workers and boosting tax revenues, the proposal -- which isn’t really regulation at all but merely a shifting of the perceived problem -- will:

-          fragment compliance oversight;

-          expose workers to financial insecurity;

-          deprive workers of employment rights.

And crucially for HMRC, this so-called ‘deemed employer’ proposal will cost the exchequer billions.

A misguided umbrella company reform attempt

This still comparatively new Labour government argues that shifting payroll tax liability from what we call Specialist Payroll Intermediaries (SPIs), commonly known as umbrella companies, to recruitment agencies, commonly known as employment businesses or EBs, will close a perceived £2.85 billion tax gap.

However, a new report by us exposes critical flaws in this policy and predicts significant unintended consequences. 

Vast sums for HMRC are already being collected (by umbrellas)

The reality is that well-regulated umbrella companies already collect and remit vast sums to HMRC.

FCSA-accredited providers alone account for £12.5 billion in employment taxes annually.

Dispersing PAYE responsibility across 24,000 employment businesses instead of 600 specialist payroll intermediaries will not improve compliance.

It will simply shift the problem to a larger cohort and create administrative chaos.

Four fundamental problems with 'deemed employer'

There are four major and unwanted consequences to the government’s plan to regulate companies.

1. Increased tax losses

Rather than recovering tax, we calculate that the proposed ‘deemed employer’ measure will cost the Exchequer an estimated £7.53 billion over the reference period.

These losses will arise from four main sources:

• Payroll fraud proliferating among unscrupulous employment businesses.
• A rise in non-compliance due to the difficulties of policing 24,000 recruiters (instead of just 600 SPIs).
• Reductions in National Insurance Contributions (NICs) as workers split earnings across multiple employers.
• A decrease to HMRC in corporation tax and Apprenticeship Levy contributions.

 2. Payroll fraud and compliance risks

Payroll fraud has long been an issue in the labour supply chain, but shifting payroll responsibility to employment businesses will make it even easier for rogue operators to thrive.

Fraudsters will adapt by disguising themselves as recruitment agencies, creating a landscape where illegal schemes become harder to detect.

Unlike umbrella companies, which are subject to industry accreditation standards, we believe the recruitment sector lacks a universal regulatory framework to oversee payroll compliance.

3. Worker rights under threat

One of my major concerns as a former contractor is the risk of depriving workers of key employment rights. Compliant umbrella companies ensure that workers receive statutory benefits such as holiday pay, sick pay, and pension contributions.

Under the umbrella regulation system proposed by Labour, there are three large adverse impacts on workers (and their rights):

1. Workers will lose continuous employment status, potentially adversely affecting mortgage applications and pension stability.
2. Workers may be forced into multiple employment arrangements, leading to NIC miscalculations and tax disputes.
3. Those engaged by multiple employment businesses risk struggling to access statutory maternity or paternity pay, if no single employer takes responsibility.

4. Disrupting a well-functioning market

The recruitment sector is not structured to manage payroll at the scale currently handled by SPIs.

Most recruitment agencies, particularly smaller firms, lack payroll expertise and systems.

Forcing employment businesses to take on PAYE responsibilities has three big drawbacks.

It will:

1. Drive up operational costs for recruiters;
2. Reduce the competitiveness of SMEs that cannot afford the compliance burden;
3. Create delays and errors in worker payments (especially in the short-to-medium term), likely leading to dissatisfaction and even reduced labour market flexibility.

The umbrella regulation model we need: Licensing with targeted enforcement

Like other industry stakeholders, we support regulation but believe there is a smarter alternative.

And we’re arguing that the government is going about umbrella regulation in the wrong way.

Rather than shifting responsibility up the supply chain, the government should introduce a ‘Payroll Intermediary Licensing Regime,’ which could:

• Ensure that only compliant payroll providers operate in the market.
• Strengthen enforcement using digital oversight and data-sharing mechanisms.
• Crackdown directly on tax avoidance promoters rather than penalising compliant businesses.

A licensing regime like PILR would preserve worker protections, maintain tax integrity, and prevent market disruption -- all while ensuring payroll pirates and other bad actors are removed from the supply chain. 

But what about Option 3?

To regulate umbrella companies, the government has plumped for “Option 3” in the original consultation document (of June 2023). This is the plan to shift liability and responsibility for the operation of PAYE to recruitment agencies.

This could be seen as a reasonable approach but, unless it is implemented in just one specific way, it risks introducing all the problems outlined above.

We’ve examined the possible permutations in detail (of course, we have no sight yet of what the final legislation will look like), and the only way “Option 3” can be made to work is if the umbrella retains the ability to operate PAYE on behalf of recruiters by using the umbrella’s own PAYE reference number (the Employer’s Reference Number or ERN).

And even then, I believe further regulation along the lines of what we propose above would still be required. 

Umbrella regulation must target the right problem

The government’s current umbrella regulation proposal is a classic case of ‘throwing the baby out with the bathwater.;

Instead of solving tax avoidance, it will introduce new risks, fragment compliance, and hurt workers.

The government must urgently reconsider its approach and work with industry experts to implement a regulatory framework that tackles non-compliance without disrupting the UK’s flexible labour market.

My call for you to act

If you are a contractor, recruiter, or business affected by these proposals, now is the time to speak up.

The window of opportunity to let your views be known is closing soon, and policymakers need to hear from those of us on the front lines. Support the call for a well-targeted and carefully thought-out licensing regime -- instead of regulatory upheaval -- by writing to your MP and the chancellor (or contact us) to ensure your voice is heard.