What is an umbrella company?
An umbrella company serves as an intermediary between independent contractors or freelancers and their clients. It functions by taking care of all the administrative, legal, and financial aspects of self-employment. Contractors effectively become employees of the umbrella company, which takes care of tasks like invoicing, tax calculations, and National Insurance contributions.
The company will charge a fee for its services, typically deducted from the contractor's earnings. This arrangement simplifies the contractor's administrative burden, ensures compliance with UK tax laws for contractors and provides access to employee benefits like pension schemes.
Read on for more about umbrella company compliance specifically for recruitment agencies
Why are umbrella companies important for contract recruitment?
What do umbrella companies need to comply with?
What are the issues in the news with umbrella companies in the UK lately?
What are the risks for recruitment agencies if they don't use compliant umbrellas?
Recruiter Checklist for compliance checking umbrellas
Why consider a Preferred Supplier List of Umbrellas for your recruitment agency?
Placing contractors outside the UK
How to stay up-to-date with the latest developments on umbrella companies
Why are Umbrella companies important for contract recruitment?
Umbrella companies play a crucial role in the world of contract recruitment, helping recruitment agencies meet their legal responsibilities when hiring contractors that are deemed to be inside IR35. When a contractor is engaged through an umbrella company, they effectively become an employee of the umbrella, streamlining administrative tasks.
Recruitment agencies often partner with umbrella companies to manage payroll, taxation, and legal compliance on behalf of contractors. This collaboration allows agencies to focus on matching skilled professionals with appropriate projects, while the umbrella company handles the intricate aspects of employment.
However, contractors are rightfully cautious, as the fees deducted by umbrella companies can impact their earnings. A transparent and well-communicated partnership between recruitment agencies and umbrella companies is vital to ensure a smooth experience for contractors seeking temporary work opportunities.
What do umbrella companies need to comply with?
There are a wide range of legal, tax and regulatory requirements that umbrella companies need to comply with. These include adhering to national employment laws in the country they operate in to ensure proper treatment of the contractors on their payroll, accurately calculating and deducting income tax and National Insurance or social security contributions, maintaining transparent financial records, and submitting the required reports, assessments and payments to local tax authorities.
Umbrella companies also need to follow relevant industry standards and codes of conduct where applicable, ensuring fair practices and transparency in their dealings with both contractors and recruitment agencies.
For example, in the UK there are two main industry associations for contractors: the Freelancer and Contractor Services Association (FCSA) and Professional Passport. Umbrella companies that are accredited by either of these bodies are subject to compliance checks, which offers contractors and recruiters alike more peace of mind when selecting an umbrella company to work with.
There are also regulatory bodies in some countries that govern the conduct of umbrella companies to ensure compliance with employment and tax regulations. In the UK, the regulatory body that oversees umbrella companies is the Employment Agency Standards Inspectorate (EAS), which operates under the Department for Business, Energy & Industrial Strategy (BEIS). The EAS monitors and enforces compliance with employment legislation, including the rights of agency workers and the conduct of umbrella companies.
In other countries, similar regulatory bodies or government agencies might oversee the activities of umbrella companies to ensure fair treatment of contractors, proper tax handling, and adherence to labour laws. It's important for contractors and recruitment agencies to work with the best umbrella companies that are registered and compliant with the relevant regulatory bodies to ensure a legitimate and ethical engagement.
What are the issues in the news with umbrella companies in the UK lately?
An increasing number of umbrella companies have come under HMRC investigation due to fraudulent and illegal practices. HMRC issued a call for evidence, concluding in February 2022, to gather insights on the operation of the umbrella company market from various stakeholders. The findings revealed that the use of umbrella companies was driven by clients offloading contractor responsibilities of the IR35 legislation down the labour chain.
Respondents collectively emphasised the need to tackle non-compliance to safeguard contractors and advocated for standardised regulations. Contractors expressed confusion over pay structures, applicable rights, and employment status. There was also widespread awareness of tax non-compliance in the market, resulting in many recruitment agencies offering a preferred supplier list of accredited umbrellas to address taxation concerns and ensure due diligence.
It is worth noting that even when umbrella companies are accredited by a reputable industry body, this is not always a guarantee of compliance. Many ‘accredited’ umbrella companies have later been found to have engaged in unscrupulous practices. HMRC has published guidance to improve awareness of some of the more common tactics used by non-compliant umbrellas, such as salary skimming, withholding holiday pay and tax avoidance.
Professional Passport has since called for changes to the UK government’s policy on umbrella companies, stating that the umbrella sector harbours some models that purport to be genuine umbrellas but are tax avoidance and disguised remuneration schemes that are duping contractors into signing up for them with the promise of more take-home pay.
In the absence of tougher regulations, both contractors and recruitment agencies in the meantime must be on their guard and do everything they can to ensure they are confident that the company of their mutual choice can be trusted as an intermediary employer.
What are the risks for recruitment agencies if they don’t use compliant umbrellas?
Recruitment agencies face substantial risks when they fail to use compliant umbrella companies for managing contingent workers. Non-compliance with labour and tax regulations can lead to legal, financial, and reputational consequences. The utilisation of non-compliant umbrella companies might result in the misclassification of workers, leading to potential legal actions and fines for back taxes and penalties. Additionally, agencies might be held liable for unpaid employee benefits, overtime, and other entitlements.
Working with a non-compliant umbrella company can ultimately reflect badly on your reputation as a recruitment agency. For instance, if your contractors don’t get paid on time, or the umbrella company goes into liquidation, it could result in cash flow problems for them or potential loss of earnings completely. Non-compliance can also create complexities in maintaining accurate records and reporting, increasing the risk of audits and legal actions. Worse still, directors of recruitment agencies can be prosecuted under the Criminal Finances Act 2017 if they are found to have been involved in a supply chain containing non-compliant providers. It’s therefore essential to make sure you have done everything you can to ensure that any umbrella company you work with is above board.
Recruiter Checklist for compliance checking umbrellas
So if you want to start assessing the compliance and reputation of umbrella companies, where do you start?
Thoroughly researching and vetting umbrella companies is crucial to safeguard your agency's reputation and ensure compliance with legal requirements. At 3R, we have put together a comprehensive checklist to help you make informed decisions as a recruitment agency partnering with umbrella companies.
Here is a selection of the top three things from the list that will help you perform your umbrella company compliance check:
- Legal and tax compliance
First, start with the basics; you’ll need to make sure the umbrella company is correctly registered, that they adhere to local regulations for employee tax classification such as IR35, and that they have a business bank account registered in their name in the territory they are operating in.
- Employment contracts and documents
Then we suggest you turn your attention to the employment contracts and other documents and review them for transparency and legality. You’ll need to ensure that contracts clearly outline the terms of employment, payment structure, and benefits, so it’s advisable to get legal advice on this.
- Transparent fee structure
Check the fee structure, including any administration or processing fees and ensure that all fees and deductions are clearly communicated to contractors.
These three items are only the tip of the iceberg. Download our complete compliance checklist for umbrella companies here to get the full checklist and make sure you don’t miss any red flags.
Why consider a Preferred Supplier List of Umbrellas for your recruitment agency?
Preferred Supplier Lists (PSLs) are lists of umbrella companies that recruitment agencies can offer to contractors. There has been some criticism of the use of PSLs from contractors and contractor industry associations, mainly because restricting the choice of the contractor to only two or three potential umbrella companies can be considered anti-competitive. Sometimes there are incentives that are offered or expected between the recruitment company and the umbrella company, but incentives are often a catalyst for rogue practices. If an umbrella company offers incentives to a recruitment agency, they may be extracting additional profits from contractors to fund this.
However, given the risks of non-compliance, offering a PSL to contractors can be the only way a recruitment agency can ensure they are offering the best choices to the contractor. As a recruiter, you naturally want to make sure you have the best partners in the business and ultimately you shouldn't be using umbrellas that are throwing up red flags on compliance matters. Preferred suppliers have a higher likelihood of compliance and therefore minimise the risk of contractors being treated incorrectly.
This is why working with 3R’s back-office platform can make life easier for recruitment agencies. 3R already has a list of compliance-checked preferred suppliers for umbrella companies.
Placing contractors outside the UK
When placing contractors outside the UK, recruitment agencies must exercise caution in navigating legal and administrative differences. Understanding local labour laws, tax regulations, and employment practices is crucial to ensure contractors' compliance and mitigate legal risks. Securing comprehensive international contracts that clarify roles, responsibilities, and expectations helps prevent disputes.
UK recruiters need to place more trust in third parties to fill their knowledge gap, so compliance checks are even more critical. In the United States for example, state-by-state complexities require an Employer of Record (EoR) as the third-party service that takes on the responsibility of being the legal employer for a company's workers, handling payroll, taxes, benefits, and compliance with US labour laws.
Similarly, UK recruiters face challenges in compliantly placing contractors in the European Union (EU) due to varying labour laws, tax regulations, and employment practices across EU member states.
Navigating complex legal frameworks, work permits, and compliance requirements while ensuring consistent contractor rights and benefits poses intricate hurdles for seamless cross-border placements. Contact 3R to find out how we can help.
How to stay up to date with the latest developments on umbrella companies
Recruitment agencies can remain current on umbrella company issues by setting up Google News alerts for relevant keywords, monitoring updates from HMRC, and regularly checking the websites of industry associations and trade news outlets such as The Contractor. You can also sign up to email alerts on the Gov.uk guidance on working with umbrella companies page, as this will bring updates directly to your inbox when changes occur.
Keeping up to date via these sources enables recruiters to stay informed about regulatory changes, compliance updates, and industry trends, ensuring effective decision-making and risk management.
3R recognises the requirement for due diligence and as part of our industry-leading back-office software, our contractor payroll solutions include a Preferred Supplier List of Umbrella companies.
For a demonstration of our solutions or if you have more questions about umbrella companies, contact our expert team for advice.
