As a result of the April 2021 Off Payroll changes, more individuals than ever are using umbrella companies. In an unregulated industry, the consequences of choosing an unscrupulous provider can be severe.
Choosing the wrong umbrella company can lead to serious tax risks. Non-compliant schemes may promise higher take-home pay, but can result in HMRC investigations, unexpected tax bills, and penalties. Always ensure your umbrella operates standard PAYE.
In this article, we explain how to spot the worst umbrella companies, and why you should steer well clear of dodgy operators. You should only ever use a legitimate UK-based payroll operation, without exceptions.
If you’re unsure whether an umbrella is the right route, see our guide to umbrella vs limited company, or read more about the IR35 rules which often determine how contractors are paid.
Examples of non-compliant payroll arrangements
Over the years, many non-compliant umbrella company models and payroll arrangements have come to light. Keep reading and we’ll summarise the most common models that contractors have come across while seeking an umbrella company.
Mini umbrella companies
Mini umbrella companies (MUC) have been in the news recently after a BBC investigation found that unethical mini umbrella companies were paying G4S workers against their knowledge.
The BBC’s report uncovered that recruitment agencies deliberately referred candidates to non-compliant mini umbrella companies to reduce their business tax and National Insurance Contributions.
The unscrupulous arrangement was only brought to light when a worker noticed they were being paid by an unknown third party – a mini umbrella company.
If you are being paid by a company you do not recognise, this is a major warning sign.
Loan schemes
Loan schemes have been around for many years and epitomise an unethical payroll arrangement.
Rather than pay workers with PAYE, loan schemes process their clients’ pay with a combination of national minimum wage (NMW) and a loan.
The scheme provider will issue loans on the basis they’re not required to be repaid. Doing this makes the loan free from tax.
And by combining loan payments with the NMW – the scheme provider helps workers avoid paying the right amount of tax by claiming the payment options they are using are non-taxable.
However, these payments are no different to normal income, and therefore tax and National Insurance Contributions still apply.
HMRC treats these arrangements as tax avoidance, and contractors can face significant retrospective tax bills.
Elective Deduction Models
In an Elective Deduction Model (EDM) arrangement, workers keep their self-employed status to reduce their tax and National Insurance Contributions.
Also, as workers are self-employed, holiday pay doesn’t apply and consequently, pay retention is likely to be inflated. If you notice a company promising to reduce or remove your NI contributions or boost pay retention, do not use them.
Any arrangement that artificially increases take-home pay should be treated with extreme caution.
Other unusual arrangements
Criminals are always looking to create new tax avoidance arrangements. Over the years, all kinds of dodgy umbrella company arrangements and disguised remuneration schemes (arrangements involving loans) have come to light, including those above.
Another scheme that is worth mentioning was the job board arrangement. Workers were paid with a combination of the NMW and then issued credits for a job board which were then immediately transferred into cash – eliminating the tax. At least with this kind of arrangement, it instantly sounds suspicious. PAYE isn’t glamorous, but it’s how compliant umbrella companies will process their employees’ payroll.
In a recent article on Umbrella Companies, a contractor was faced with an unusual pay calculation from an obvious tax avoidance scheme. The company was promising inflated take-home pay by issuing the contractor with NMW and shares in the company. The shares would instantly be sold and converted into tax-free cash. Just like the job board arrangement – this sounds extremely dodgy and should be avoided at all costs!
Obvious signs of a non-compliant umbrella company
High take home pay retention
Compliant umbrella companies in the UK will process their employees’ payroll with Pay As You Earn (PAYE) – HMRC’s tax system.
Therefore, you should expect to be taxed accordingly and make the required National Insurance Contributions.
Everybody’s circumstances are different, and many factors will impact pay retention, but usually, contractors should expect to retain between 55 and 65 percent of their pay with a compliant umbrella.
Therefore, if you come across a company promising noticeably higher pay retention (sometimes upwards of 90%) – you should avoid them at all costs. It’s a tax avoidance scheme.
Located outside the UK
Companies House is a powerful tool that’s extremely useful when researching umbrella companies. Have a look and see where the umbrella company you’re interested in is registered.
If they’re UK-based – that’s a great sign. However, if there is no indication they’re in the UK, or you discover their HQ is in a known tax haven such as the Isle of Man or the Cayman Islands – alarm bells should be ringing. Only use a UK-based umbrella company.
Unethical language such as “HMRC approved”
HMRC acknowledge umbrella companies, and proof of this is in the recent guidance ‘Working through an umbrella company’. However, HMRC does not actively approve or endorse specific umbrella companies.
Therefore, if you come across an umbrella company claiming to be “approved by HMRC” or “HMRC friendly”, you should be wary. These claims are not legitimate and may be a deliberate attempt to lure you into an unethical arrangement.
No history and a lack of reviews
When conducting due diligence on umbrella companies, check out their online reviews and overall reputation within the sector.
Have a browse on the website of an umbrella you’re interested in and study their on-site page. Then, take a look at Google and Trustpilot reviews. The Contractor UK forum is also a useful place to read about other workers’ experiences.
Usually, tax avoidance schemes and unethical umbrella companies will not have much history. These types of businesses often operate for a short period before shutting down.
Untrustworthy directors
Search the Companies House database and see who the directors are of the umbrella company you’re interested in using.
The company has been issued a Scheme Reference Number (SRN)
If HMRC is made aware of a potentially unethical umbrella company or payroll scheme, they’ll issue it with a Scheme Reference Number (SRN).
An SRN does not automatically mean the scheme is unlawful, but it is a clear warning that HMRC is monitoring it closely.
Extremely basic website with a lack of company information
A lot of unethical umbrella companies have very basic websites with limited information.
Make sure the umbrella companies you’re considering using clearly explain how they operate and what deductions are made.
How to pick a compliant umbrella company
Choose an accredited provider
The government does not currently regulate the umbrella company sector, although this may change in future.
There are two recognised industry bodies: the Freelancer and Contractor Services Association (FCSA) and Professional Passport.
Both require umbrella companies to undergo audits and ongoing compliance checks.
Request a take home pay calculation
When you’re deciding which umbrella company to join, request a calculation from each provider.
Make sure they’re operating PAYE, and that the figures are realistic.
Sneaky umbrella companies may use incorrect tax codes, include expenses you are not entitled to, or manipulate working hours to inflate net pay.
Key Information Documents (KID)
If you’re working via a recruitment agency, you should be issued with a Key Information Document (KID) before registering.
This document provides an estimate of your pay and deductions based on your circumstances.
Conclusion
There are a lot of umbrella companies in the UK. While most are compliant, some are operating unethically and engaging with them could land you in serious trouble with HMRC.
There are plenty of ways to spot a dodgy umbrella company – some are obvious, and others are not.
For starters, make sure the company is UK-based, operates PAYE, and has an established reputation. If anything seems unclear or overly complex, take a step back and seek advice before proceeding.
This article was kindly written for ITContracting by Andrew Trodden.