How using agency PAYE reference numbers will hit contractors

In September 2024, HMRC published a policy paper with a sentence that sent ripples through the contracting world.

It was the strongest hint yet that the government might adopt ‘Option 3’ from the 2023 call for evidence on umbrella companies.

While it wasn’t explicitly spelled out, the message was clear enough -- making recruitment agencies the employer for tax purposes was on the table.

What will happen to the umbrella company worker from April 6th 2026?

While the final legislation is still pending (as of June 2025), this direction would represent a significant shift in how payroll and compliance operate in the temporary labour market.

And while much of the discussion so far has focused on tax and supply chains, writes Sam Amos, a director at real-time tax compliance firm SafeRec, it’s time we ask a more pertinent question for ContractorUK readers. What will happen to the umbrella company worker from April 6th 2026?

What is Option 3?

But to begin to answer that key questions, we must first ask another question; What is Option 3?

At its core, Option 3 proposes that recruitment agencies, not umbrella companies, should process tax and National Insurance.

HMRC’s goal is to tighten tax compliance, especially where complex or non-compliant schemes have been used in the past.

Assumption, idea, and fundamental change

The assumption is that putting tax responsibility in the hands of agencies -- which are often closer to the end-client -- will close loopholes.

And the idea is simple in theory: instead of the umbrella company processing payroll, they will do it using the agency PAYE reference.

However,  ‘just’ switching the PAYE reference isn’t a small tweak -- it fundamentally changes how payroll is delivered and how transparent it is for the worker -- the umbrella contractor.

We break this down in detail, below, as to what this could mean in practice. But broadly speaking, we anticipate five adverse consequences for contractors from processing tax using agency PAYE reference numbers, as the government currently proposes from April 6th 2026.

Five fallouts for contractors from using agency PAYE reference numbers

1. Loss of transparency in pay calculations

For years, contractors have negotiated their work based on the assignment rate -- a headline figure that reflects the total value of their labour.

But converting that figure into a PAYE salary isn’t straightforward. It includes employer’s National Insurance, holiday pay, pension contributions, and more.

Where payroll is processed by umbrella companies, workers receive a detailed ‘reconciliation statement’ showing exactly how their pay was calculated --pound by pound. This breakdown includes:

• Employer NICs
• Apprenticeship Levy
• Pension Contributions
• Holiday Pay
• Margin Deductions

When agencies process payroll directly, they operate a more basic PAYE model that, in our experience, does not offer the same transparency.

Workers typically receive only a standard payslip, which doesn’t explain how their net pay was calculated from the original ‘assignment rate’ they agreed to.

If agencies take on this responsibility, workers risk losing visibility into how their agreed rate translates into take-home pay -- making it harder to spot errors or understand deductions.

2. More lost pension pots

Another practical issue from processing tax using the agency’s PAYE reference number arises with pensions.

If each agency that a contractor works through uses a different payroll setup, there’s a risk of being auto-enrolled into multiple pension schemes, particularly if payroll is processed separately for each contract.

Already, the UK has 3.3 million lost pension pots, with an estimated value of £31.1 billion, according to the Pensions Policy Institute. In addition, the PPI says the average lost pot is worth £9,470, and that number jumps to £13,620 for workers approaching retirement. 

Frequent changes in the employer for tax purposes increase the likelihood that contractors will lose track of their pension savings, especially if contact details go out of date or contractors are unaware of where each pot sits. A system that creates a new pension pot for each engagement only makes this worse.

3. Fewer tools, fewer benefits

When payroll is centralised and consistent, workers often get access to added services, like salary sacrifice arrangements, ‘perks’ platforms, IR35 assessment tools, and tailored advice. Many of these have been developed to enhance the contractor experience and offer more than just payslips.

If agencies take over tax processing, there’s a real risk that these enhancements could fall away. With agencies focused on client fulfilment rather than contractor services, workers could see a drop in the kind of added value they’ve come to rely on over the years.

4. Tax avoidance won’t disappear -- it will just shift…

There’s also a flawed assumption behind Option 3 -- that tax avoidance only happens in umbrella companies. In reality, any organisation processing payroll can engage in non-compliant practices.

Recruitment agencies, just like any other intermediary, could hypothetically run disguised remuneration schemes, use incorrect tax codes, or even set up multiple limited companies to reduce liabilities!

Simply moving tax responsibility from one part of the chain to another doesn’t eliminate risk; it just relocates it.

According to our calculations, the problem isn’t about who holds the PAYE reference. It’s about how they use it. Compliance-risk is tied to the payroll function, not the name on the payslip.

5. Greater confusion for contractors

Even now, there’s often confusion about who employs a contractor --particularly when the tax and legal responsibilities are split. If Option 3 becomes reality, this confusion could deepen.

Workers may find themselves with two separate employers: one for employment rights (like holiday pay and sick leave), and another for tax processing. This grey area is problematic -- and the Trades Union Congress (TUC) has voiced concerns about it in their response to the consultation in 2023.

The TUC said: "This proposal risks placing workers in an unreasonable position -- where one party handles pay and another is responsible for employment rights. Umbrella arrangements are already complicated. This could make them worse."

A taxman (currently) in listening mode…

If there’s one thing we can say with confidence, it’s this: HMRC has been listening.

It’s always tempting to point fingers or assume the worst when change is on the horizon. But it’s important to recognise the role HMRC plays -- translating the government’s decision on umbrella company tax compliance into workable reality is no easy task. And behind those consultations and policy papers we’re seeing smart, committed people genuinely trying to make things better.

At SafeRec, we’ve had the opportunity to engage constructively throughout this process -- alongside other industry voices -- and we truly felt that the feedback from across the supply chain has been heard.

The future

For contractors, and other parties, there’s still uncertainty ahead of course.

But based on the conversations we’ve had, we’re hopeful that what emerges will reflect a more balanced and workable approach. An approach that considers not just tax flow and risk, but the day-to-day experience of agencies, umbrella companies and contractors alike.

If we keep pushing HMRC for transparency, accountability, and clarity, there’s a good chance we’ll land on a solution that actually works -- for everyone.