Choosing an umbrella company from a recruitment agency PSL amid IR35 reform

Having to pick an umbrella company from a recruitment agency’s Preferred Supplier List is an increasingly likely task facing many a limited company contractor and more often than not, it’ll be their first time doing so, writes Marc Scott, director of Liberty Bishop.

Why? Well, IR35 reform in the private sector of course! No, it’s not that literally everything in the world can eventually be traced back to IR35 reform, but yes, it is the case that the new off-payroll working rules from April 6th this year are one of the biggest disruptions to hit the contracting market in living memory.

And ‘disruption’ is definitely the right word – only yesterday I heard reminiscing about contractors protesting outside parliament, which they did after a march through Westminster earlier this month.

Less the new IR35 legislation, more its ripple effect

In my view, a big part of the disruption is not so much the legislation itself, but rather the behavioural affect that it is having on stakeholders. What I’m referring to here are the strategies that supply chains are adopting to deal with the reforms; strategies that do not necessarily follow from the requirements of the legislation itself.

The proposed legislation states that in instances where a PSC is determined by the end-client to be inside IR35, then the “fee-payer” to that PSC has the responsibility to account for PAYE taxes before making payment to it. What’s clear from the legislation itself, then, is that there’s an underlying assumption that, post-determination, the PSC will continue to be utilised in the supply chain, even when that determination was one of inside IR35.

It’s notable, therefore, that the general trend of what we are seeing in practice is not one in favour of continued PSC engagement irrespective of the determination, but rather one which favours movement away from PSC engagement altogether. At the extreme end of this approach are those hiring organisations that have simply put a blanket ban on PSCs being utilised in their supply chains, with some even going as far as requiring the recruitment agency to employ the workers directly under their own (largely non-existent up until that point) in-house PAYE schemes. The less extreme version of this approach is the proactive encouragement of contractors engaged via their own PSC and deemed to be inside of IR35 to switch to umbrella company engagement.

Now let’s be clear: switching from PSC engagement to umbrella company engagement as a result of an inside of IR35 determination is not necessarily a bad thing, not even for the contractor themselves. In fact, it can often be a beneficial and sensible step -- greater simplicity and reduced costs being the primary plus points. However, this sudden change in direction by supply chains does throw up some interesting conundrums, especially in scenarios where the agency and hiring organisation have had little previous exposure to umbrella companies.    

Whose PSL is it anyway?

In the push for umbrella company engagement, who decides which umbrella companies can be utilised; is it the client that should create a ‘Preferred Supplier List’ (PSL) of umbrellas? Or perhaps it should be the recruitment agency that does that and has its own PSL of umbrella companies? Or maybe there shouldn’t even be a PSL of umbrella companies?! After all, there are hundreds of umbrella companies out there, why shouldn’t the contractor be given free rein to choose who they want to go with?

There’s quite a lot to unpack in all of that, so let’s run through each of those point-by-point.

For a start, when you come to being engaged by an umbrella company, there usually is going to be a PSL in place. There’s simply too much risk involved these days for contractors to be given total freedom to use whatever provider pops up from a Google search. Having a PSL simply makes it easier for supply chains to ensure compliance among their suppliers; it’s easier to vet and monitor a shortlist of providers on an ongoing basis than it is to stay on top of the whole market.

Most PSLs also tend to be held by the recruitment agency rather than the hiring organisation (although we’re now starting to see some of the larger hiring organisations voice an opinion on what umbrellas can be utilised in their supply chains, but this tends not to be anything more restrictive than a requirement for the umbrella to hold FCSA Accreditation). And generally a PSL will have between 3-6 providers on it (sometimes more but rarely less).

The practical reality, then, is that PSC contractors found to be deemed inside IR35 under the off-payroll reforms are not only more than likely to be steered towards umbrella company engagement as opposed to being given the opportunity for continued PSC engagement, but they are also likely to find that their choice of umbrella company is somewhat restricted.

Further PSL questions (and answers)

So, to what extent do such restrictions impinge upon the contractors’ freedoms? Is it unfair to restrict a contractor’s choice in this way, or is that freedom of choice actually a bit of an illusion anyway? And can we even go as far as to say that these restrictions actually work in favour of the contractor?!

A fundamental part of any PSL process is ‘due diligence’ in order to ensure that the engagement option being offered is fully compliant with UK tax and employment law requirements. The very raison d'être of a PSL is to ensure compliance in the supply chain. So, if we assume that all suppliers on a PSL are necessarily operating in a fully compliant fashion, then we can reasonably assume that the mechanics of each engagement option is the same. To put it bluntly, PAYE is PAYE is PAYE. So, does it really matter how many suppliers are on the PSL if they are all treating the contract income in the same way?

Actually, it probably does. But only in the sense that the bigger the PSL, the less commercially attractive being on the PSL is for each preferred supplier. Umbrella margins are negotiable, but the negotiation usually takes place between the umbrella company and the agency at the point of the PSL tender, not between the umbrella and the contractor at the point of registration.

It’ll come as no surprise that an umbrella company offered the opportunity to be on a very small PSL – where they can expect a larger percentage share of the overall opportunity – will be more inclined to offer a more attractive margin, which in turn will improve the final net retention received by the employee.

Inevitability, opportunity, monopoly

Off-payroll reform will have an adverse financial impact on most contractors engaged via PSCs, but in the scenario where a PSC has been deemed to be inside IR35, then we know that employment levels of tax and NICs must be applied to the earnings regardless of whether the contractor elects to continue to engage via their PSC or switch to an umbrella company.

PAYE applies, so from an umbrella PSL perspective, having multiple providers all offering the same thing adds little value for anyone. There are marginal gains to be had, but these come primarily from the differences between umbrella margins -- and umbrella margins are at their lowest only when the umbrella in question has the maximum possible opportunity. There’s a lot to be said for a PSL containing just one provider, even though contractors may dislike the lack of choice, especially at a time in the professional temporary labour market when options already seem so few and far between.

Friday 21st Feb 2020