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In October 2024, the UK government unveiled its latest measure aimed at addressing the rampant non-compliance within the umbrella company sector. This initiative, set for implementation in April 2026, shifts the responsibility for Pay As You Earn (PAYE) compliance from umbrella companies to recruitment agencies or, in certain cases, the end clients. The implications of this policy ripple across the temporary labour market, signalling a marked departure from current practices.

Context: The Current State of Umbrella Companies

Umbrella companies have long been fixtures in the UK labour market, acting as intermediaries that provide payroll services for temporary workers. While many operate within compliance boundaries, others exploit regulatory gaps, engaging in schemes that facilitate tax avoidance and fraud. According to HMRC, £500 million was lost to disguised remuneration tax schemes in the 2022-2023 period, nearly all linked to non-compliant umbrella companies. This does not include further losses attributed to mini umbrella company fraud.

Non-compliance not only drains the Exchequer but also undermines compliant businesses and exposes workers to unexpected tax liabilities. For the government, reforming this sector is a step toward a fairer tax system and a more equitable labour market.

Proposed Measures: PAYE Responsibility Shift

The core of the government’s proposal involves reassigning the obligation to ensure PAYE compliance. Under the new scheme, recruitment agencies, those directly supplying workers to end clients, will bear responsibility for accounting for PAYE. Should an agency outsource payroll operations to an umbrella company, it will remain liable for any discrepancies.

Where no agency exists, the responsibility will rest with the end client. This alignment brings PAYE obligations for umbrella company workers in line with those for other agency workers, closing loopholes that have long been exploited.

Impacts Across the Labour Supply Chain

Recruitment Agencies:

Recruitment agencies stand at the forefront of this reform. By placing PAYE accountability on their shoulders, the government aims to foster greater scrutiny in labour supply chains. Agencies will be required to ensure that payroll practices align with legal obligations, likely necessitating due diligence processes and legal safeguards.

This shift will particularly impact smaller agencies that rely on outsourcing payroll operations to umbrella companies. For these businesses, the new measures introduce both administrative burdens and financial risks, as they remain liable for non-compliance by their chosen intermediaries.

End Clients:

In scenarios where end clients deal directly with umbrella companies, they will assume the role of PAYE operator. This adjustment compels end clients to evaluate their relationships with umbrella companies and consider internalising payroll functions or establishing stringent compliance checks.

Umbrella Companies:

The proposed legislation significantly alters the role of umbrella companies. No longer responsible for PAYE compliance, they will likely face increased scrutiny from agencies and end clients. While compliant firms like Payme welcome the chance to further distinguish themselves from rogue operators, the overall sector faces heightened pressure to professionalise and operate transparently.

Workers:

Workers employed via umbrella companies will notice minimal direct changes, as their pay will continue to reflect deductions for income tax and National Insurance contributions. However, the reforms aim to shield workers from the fallout of non-compliant tax arrangements, reducing the risk of unexpected liabilities.

Motivations Behind the Reform

This initiative is part of a broader governmental strategy to rectify shortcomings in the temporary labour market. By tackling non-compliance, the government hopes to recover an estimated £2.8 billion over the next six years while safeguarding workers and enabling a competitive environment for compliant businesses.

Moreover, these changes complement the government’s wider agenda to enhance economic performance by promoting fair labour practices. The consultation is not merely about tax compliance but a wider effort to stabilise and improve the functioning of the temporary workforce ecosystem.

Challenges and Considerations

While the intent behind the consultation is clear, its implementation presents several challenges:

1. Administrative Complexity: Recruitment agencies, particularly smaller ones, may struggle to adapt to the new framework. The requirement to oversee PAYE compliance introduces additional layers of responsibility and potential costs.

2. Compliance Monitoring: Ensuring that agencies and end clients meet their new obligations will require robust oversight. The government must consider how it will monitor compliance effectively without creating excessive red tape.

3. Umbrella Company Viability: The measures could disrupt the umbrella company market, potentially leading to a contraction in the number of firms operating in this space. While this might weed out non-compliant entities, it could also reduce options for businesses seeking payroll outsourcing solutions.

4. Stakeholder Engagement: The success of this reform hinges on constructive dialogue between the government, businesses, and other stakeholders. Agencies and umbrella companies alike will need clear guidance and support during the transition.

Next Steps and Future Outlook

The government plans to release draft legislation as part of the Finance Bill 2025, accompanied by a Tax Information and Impact Note. This process will include stakeholder consultations to refine the proposal and address business concerns.

In the meantime, HMRC will provide guidance and tools to support affected entities. For instance, an online resource is expected to clarify PAYE obligations for agencies and workers, helping them navigate the new situation.

Redefining Norms in the Temporary Labour Market

The 2026 consultation represents a key moment for the umbrella company sector. By recalibrating accountability, the government seeks to restore fairness and integrity to a market plagued by exploitation and non-compliance.

While the road to implementation will not be without challenges, this measure offers an opportunity to rebuild the sector on firmer, more equitable foundations. Whether it succeeds in delivering its promises will depend on the collaboration and commitment of all parties involved.