Umbrella contractors must act now

A couple of weeks ago I heard whispers of an imminent HMRC initiative to crack down on umbrellas who are (in their view) abusing dispensations.

Well, this is it: it is a declaration of war by HMRC on umbrella companies who they believe are abusing their dispensations.

To an umbrella, its dispensation is its life blood; without a suitable dispensation, it is wholly unable to compete in the marketplace with those companies that have one.

But to an umbrella company, the one thing worse than a dispensation being withdrawn would be for that dispensation to be withdrawn retrospectively.

Why? Because the umbrella can then expect to be hit with a demand for all the tax and NI that it would have had to deduct from all the expense payments that it made in the past without deducting tax, before the dispensation was retrospectively withdrawn.

Even in the case of a medium sized umbrella company, such a demand could easily hit 7 figures - millions. Even in the case of the most substantial umbrella, it would almost certainly result in insolvency.

The umbrella would be unable to pay its debts as and when they fall due - and going 'bust', possibly also with serious personal consequences for the directors (whose trading decisions may have been responsible for the retrospective withdrawal of the dispensation.)

Moreover, it's possible any money due to contractors may go into the insolvency 'pot' and be taken by HMRC as a preferential creditor instead. Imagine that - the end of the week/month comes, you are expecting your pay cheque - and instead are told that your umbrella has ceased trading and can't pay you, you'll have to contact the company's receiver.

So, in what circumstances might an umbrella be regarded as abusing its dispensation, so as to make HMRC feel justified in withdrawing it retrospectively?

The most obvious relates to payment of travel and subsistence. These can only legitimately be paid tax-free where, firstly, there is a dispensation in place, and secondly, the workplace satisfies the definition of a temporary workplace.

Now, a workplace can only be a temporary workplace if, in the course of the individual's employment by that employer, the individual will be working at more than one workplace.

This means that for there to be a temporary workplace, there are two more conditions that have to be satisfied: Firstly, the employment contract with the umbrella needs to be for more than just the one engagement, and secondly, but perhaps less obviously, the contract itself must have a degree of continuity between engagements; it needs to amount to what HMRC regard as an 'overarching' contract.

On the face of it, those two conditions may look the same - but they're not. There have to be real employment-like obligations between engagements, including at the least, a guarantee of some payment by the umbrella during this period, or a guaranteed minimum amount of work over the course of a year.

HMRC find it difficult to see a contract based on 'no work - no pay' as satisfying their definition of an 'overarching' contract. This creates real challenges in a marketplace where the main thrust of the competition between providers is maximising the returns to contractors, week by week and month by month.

But umbrella companies whose employment contracts don't contain such provisions, and which don't fit with what HMRC regard as 'overarching' contracts, are likely to be vulnerable to this new HMRC initiative; so are their contractors.

Umbrella companies need to review their employment contracts as a matter of urgency; if they don't know or understand what HRMC expect to see in an 'overarching' contract, then their contracts almost certainly won't qualify.

Umbrellas whose contracts are at present being considered by HMRC may be right to be particularly concerned - they certainly need to act now.

Contractors could ask their umbrellas when their contracts were last looked at by HMRC - and what the result was. They should also look themselves at the terms of their employment contracts, and see exactly what there is in there that will remain in place once the current engagement ends. If in doubt, again, they should ask their umbrella - and if still in doubt, maybe they should think about changing.

Article written and supplied by Roger Sinclair, legal consultant at Egos Ltd , an advisory to the IT contractor industry .

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