Will the current umbrella company model continue?

With all the other legislative changes of late affecting umbrella contractors and their companies, it would be easy to miss one coming into force in April 2016: the new National Living Wage, writes Lisa Keeble, director of Contractor Umbrella. And yet ironically, it could be the most significant one of them all for umbrella working.

For me to spell out why, the status quo needs first to be clarified. Most umbrella companies operate an overarching contract of employment which will be split between minimum wage and a profit-related bonus. The reason for that is that umbrella companies have to maintain continuity of employment across assignments for the contractors’ workplaces to be considered ‘temporary.’

Also to comply with HMRC, specifically the Revenue’s definitions of what constitutes an overarching contract, the brolly has an obligation to pay contractors when they’re not working or on holiday; this is referred to as ‘pay between assignments.’

But with contractors earning up to £1,000 per day, and umbrella companies’ margins averaging about £30 per week, even the worst mathematician in the world could see that the figures just don’t stack up. Therefore, currently, minimum wage is paid each month, regardless of whether or not funds have been received from the agency or client, with the bonus being payable upon receipt of those funds. Then in order to comply with the minimum wage legislation, it is calculated after the umbrella company has paid Employer’s NICs and after they have deducted their margin i.e. the worker’s gross income for tax is minimum wage and no less.

Some companies in the industry, unfortunately, do not play by these rules and will contravene the legislation by taking on workers whose contracts are too low in value for the umbrella company to comply. To illustrate:

Contract Value of £7 per hour: 37 hours per week = £259

Expenses are taken into account when calculating taxable pay and an umbrella company that allows expenses against a low contract value will also be flouting the rules. So, with the example above, the rate may be £7.50 per hour but, if expenses of £50 were allowed, the worker’s taxable pay would, once again, fall below minimum wage.

Well here’s the incoming rub. From April 2016, the minimum wage of £6.50 per hour becomes the living wage of £7.20 per hour and the government is determined that the new rules will not be flouted. So much so that under new powers, company directors (such as those running umbrellas) can be disqualified for up to 15 years, and 200% of the underpayment will be payable with a maximum fine of £20,000.

A difference of 70p per hour may not seem very much but for umbrella companies that may have several thousand workers on their books, it will make a significant difference. In practice, it will instantly (from April) become more expensive to operate compliantly, as the liability for pay between assignments becomes higher and employment contacts will have to be rewritten.

This does then beg the question that if this new legislation is considered alongside the proposed changes to Travel and Subsistence expenses, whether or not the current umbrella company model will continue? The new rules on T&S mean that end clients will be unlikely to give confirmation that they have no right of supervision or direction or control over contractors and that they relinquish any right that they could have. In turn, contractors - whether umbrella or PSC - will have no right to claim tax relief on Travel and Subsistence. Consequently, it won’t matter whether or not umbrella companies operate an overarching contract as there will no longer be a need for them to demonstrate that contractors are working on a series of temporary assignments. This will mean that contractors could end up being employed for tax purposes only; costs for umbrella companies will reduce considerably as, depending on how the model is structured, they may no longer have to make a stack of payments that they do currently, including pay between assignments and Statutory Payments, among others. In short, the umbrella company business model could return to what it was 15 years ago – an alternative to a PSC with no employment rights afforded to the contractors.

Meanwhile, although the new penalties imposed for contravention of the minimum wage will be of no interest to PSC contractors, they will need to factor in the Living Wage to their PAYE calculations.