Umbrella Company Consultation – the government’s response and the need for clarification

Earlier this month, the Labour government issued its response to the Conservative-led consultation into umbrella company compliance with the objective of regulating the sector.

While clarity around the preferred route to this is unclear (Option 3), recruitment agencies must ensure that only compliant umbrella companies are used within their supply chain because the risks of engaging with tax avoidance schemes (even by mistake) could, and will, be greater than ever.

In this article, Andrew Trodden, Senior Marketing Manager at Stonebridge Pay, explains why clarity is urgently needed, as business reputations are at stake, as well as the prospect of crippling tax bills.

You can access the full government response here.

Remember why compliant umbrella companies are important and the value they provide

Compliant umbrella companies provide an essential and valuable service within the supply chain of temporary workers. With recruitment agencies placing hundreds, often thousands, of temporary workers monthly, having these on the in-house payroll would require enormous administration and countless hours of work. There is also far more to payroll than just processing payments – there is serious legislation and regulations to abide by!

As payroll specialists, umbrella companies provide much-needed support to recruitment agencies looking for third-party assistance with the payroll of temporary candidates. As employers, they also help the workers who register with them in many ways – more than just sending their pay to the correct bank account on the right day!

When registering with an umbrella, contractors and freelancers get access to many benefits, including employee rights, insurance coverage and continuity of employment. Continuity of employment is often overlooked, but it allows temporary workers to accept multiple assignments through different agencies while having the same employer for payroll purposes (the umbrella) – providing stability and making it easier to obtain finance such as a competitive mortgage or bank loan (challenges often faced by non-employees).

From the government’s perspective, compliant umbrella companies help ensure that temporary workers pay their fair share of tax and National Insurance. Therefore, in a ‘dream world’ where every umbrella follows the rules, it’s reasonable to suggest that the government would be the sector’s most prominent advocate. However, this certainly isn’t the case.

Avoid putting all umbrellas in one basket

Non-compliant umbrella companies have seriously tarnished the positive impact that ethical umbrellas bring to the supply chain.

HMRC analysis shows that umbrella companies were used to engage at least 700,000 workers in 2022-23. This analysis also shows that at least 275,000 of these workers, and likely significantly more, were engaged at some point in 2022-23 by umbrella companies that failed to comply with their tax obligations.

The quote above has been taken from point 3.128 in the ‘Government response to questions 34-41’ (page 51) in the umbrella consultation response document. It highlights the significant number of workers using umbrellas and the alarmingly high proportion of those workers who may have fallen short of their tax and NI obligations (potentially impacting 40% of umbrella employees).

Undeniably, the industry’s reputation is almost beyond the state of repair. You only have to read a paragraph or two in a recent Sky News article to realise how many temporary workers have been negatively impacted on the back of using non-compliant tax avoidance schemes. And with a news outlet as influential and with such an expansive audience as Sky News – the word is most certainly out there that serious risks apply when an umbrella is in the supply chain.

With the above said, hundreds of compliance-driven umbrella companies in the UK provide ethical and transparent services to ensure the contingent workforce is paid compliantly, and agencies can continue to place temporary candidates without worries of non-compliance. To reiterate the point – without umbrella companies, handling payroll for short-term assignments would place unimaginable pressure on agencies (even the major players with large budgets and vast resources).

More clarity regarding Option 3 is required urgently

In the consultation response, the government has picked Option 3 as their preferred route to regulate the sector, with the introduction of a legal umbrella company definition and amendments to the Employment Rights Bill.

To summarise, from April 2026, the “responsibility to account for PAYE where an umbrella company is used” will move “to the recruitment agency that supplies the worker to the end client.” In scenarios where there is no agency in the supply chain, this new responsibly will fall on the end-hirer.

How Option 3 will work leaves plenty to the imagination, and clarity is urgently required to allow businesses enough time to prepare.

A report published by the Temp Labour Initiative, a group of industry stakeholders including umbrella companies and recruitment agencies, explains the two ways to interpret Option 3, and the challenges posed.

One interpretation of Option 3 is that agencies must use their PAYE reference numbers for candidates using an umbrella company. This outcome would pose “a severe risk to the stability of the labour supply chain”. The report states that a “more measured and targeted approach is needed—one that focuses on bolstering enforcement against non-compliance rather than penalising those who adhere to the rules.”

Should agencies be forced to engage workers directly without umbrella companies, workers face losing employee status – reducing their rights (including loss of redundancy pay and statutory pay). And if workers are paid by a new agency every time they accept a temporary assignment, continuity of employment evaporates. It’s also worth re-highlighting the sheer amount of administration agencies would be required to plan and implement in the build-up to (and especially beyond) April 2026. All these key discussion points need clarity and careful consideration.

The other interpretation is that umbrellas will continue to operate normally using their own PAYE reference, but agencies would bear the liability for PAYE and National Insurance Contributions. While a lot of further guidance is needed for stakeholders, this interpretation is perhaps more straightforward in principle than agencies needing to use their own PAYE reference.

For more information about the potential shortcomings of Option 3, please read: Labour Market Compliance: Challenges, Myths, and Sustainable Solutions.

The government will not be mandating due diligence, but…

Despite the decision to move forward with Option 3, it’s worth noting the overlooked Option 1 and Option 2.

Option 1 would have seen a mandated due diligence requirement for businesses (including recruitment agencies) involved in a supply chain featuring umbrella companies. On the other hand, Option 2 proposed a transfer of debt to other supply-chain members where an umbrella company cannot settle any owed taxes or NI.

Regarding due diligence, the government’s decision against Option 1 does not give agencies more leeway to take risks when referring to umbrellas.

…whilst a due diligence requirement might encourage businesses to take greater accountability for the umbrella companies they contract with, the Government does not believe that such a requirement alone would be sufficient to achieve the behavioural change in the market necessary to significantly reduce the widespread non-compliance.

Considering the above quote from the government, recruitment agencies must ensure that they have exceptional due diligence procedures in place and, where necessary, engage with third-party experts (e.g. insurance providers, legal specialists) to ensure that there are zero risks associated with any umbrella companies or payroll providers within the supply chain.

Referring to non-compliant umbrellas before, and after April 2026, is not an option for responsible recruitment agencies. Not only could the potential tax and NI bills be catastrophic, but the reputational damage could leave agencies with no route back into market.

Keeping up to date with the industry’s views

Following the government’s response to the Umbrella Company Consultation, several online webinars have already been hosted by well-respected professionals at established payroll providers, insurers, and accreditation-body representatives.

At such a time of uncertainty, it’s important to tune in to important discussions amongst industry stakeholders. Not only may you discover new insights into April 2026 and beyond, but it’s a good opportunity to ask questions, voice concerns and learn from experts.

Several well-respected online sources of information, including IT Contracting, regularly post new content about the future landscape of the umbrella company marketplace. Be sure to check these sites regularly for the latest news.

What should recruitment agencies be doing now, before April 2026?

Compliance-led recruitment agencies will already have strict policies and procedures to ensure that every organisation within their supply chain abides to UK tax and employment law. When it comes to referring to umbrella companies, the following should be considered by recruitment agencies to ensure supply chain compliance:

• Understand the value provided by compliant umbrella companies and the benefits they offer recruitment agencies and temporary workers. Ethical umbrellas operate PAYE, but many offer additional benefits for partnered agencies, including credit, insurance, compliance expertise and access to time-saving software platforms (allowing easy candidate tracking).
• Ensure that a strict Preferred Supplier List (PSL) is in place, consisting of companies that have proven they operate to the highest compliance standards.
• Regularly review every company on the PSL and ensure they undergo regular audits (either by agencies or approved third parties). Once a PSL is collated – maintaining it and ensuring temporary candidates exclusively use the umbrellas on it is not enough. Ongoing checks are essential.
• Always conduct thorough audits of umbrella companies, including their trading history. For example, this will help identify mini umbrella companies, as they typically have not been established long.
• Keep up to date with the latest government announcements regarding regulating the umbrella company sector, as more information about Option 3 is needed for agencies to ensure they’re truly prepared. Also, regularly monitor the latest companies named and shamed on HMRC’s list of tax avoidance schemes, promoters, enablers and suppliers.
• Educate temporary workers about umbrella companies and how the compliant ones operate. Provide justification as to why each umbrella is worthy of being on the PSL.
• Warn candidates about the key signs of tax avoidance schemes. Temporary workers need more support from recruitment agencies than ever before, and there is an opportunity to provide added value to candidates by educating them about non-compliance and the dangers of tax avoidance.
• Identify professional bodies that offer accreditations to umbrella companies (and the specific standards the umbrellas have adhered to obtain accreditation). While every umbrella on a PSL must undergo strict audits and assessments, referring to umbrellas with ‘seals of approval’ may improve the efficiency of PSL management.
• Engage with stakeholders, discuss the changes/challenges and seek answers that’ll benefit the whole supply chain. Reducing non-compliance is essential, but it’s crucial that hard-working, ethically-ran businesses are not punished in the process.