Contractors, don’t get caught in the National Insurance Employment Allowance pyramid scheme

As if contractors hadn’t seen it all when it comes to tax avoidance schemes and blatantly non-compliant arrangements, the latest scheme is a sort of evolution of Mini-Umbrella Companies which uses a pyramid structure.

And similar to those fraudulent operators which we know as ‘MUCs,’ the fear is the taxman won’t catch this new ruse in time to prevent a dent in the Treasury’s coffers, writes Lucy Smith, founder of Clarity Umbrella.

How did we get here?

In May 2024, we saw HMRC hand updated guidance to individuals on what to look out for with the latest activities from MUCs. 

As the HMRC update sought to make clear, Mini-Umbrella Companies or MUCs are effectively schemes which set out to deliberately defraud the exchequer, through abuse of the Flat Rate VAT scheme and the National Insurance Employment Allowance.

Mini-Umbrella Companies 2.0

But just as we all might think HMRC are on top of things by dishing out advice on MUCs, we have discovered that the fraudsters are already one step ahead. In this sense, the MUC - as a model - is now old hat and in reflection of scams often getting more sophisticated as they mature, this time the new ruse – MUC version 2.0, if you will -- are even harder to detect than MUCs themselves.

What’s the same however is the attempt to defraud through abusing the NI Employment Allowance. In all fairness to the devisers and advisers of this pyramid-structured scheme (the ‘KC-approved’ mob and all that), it is clever. There’s no denying that.

How does Employment Allowance pyramid fraud work?

Here’s a breakdown of how the ruse works.

Let’s start with, say, 10 companies -- imagine them at the bottom of a pyramid structure, tier 1.

Each of the 10 employs contractors and makes legitimate payments -- across to both the individual contractors and HMRC. So far; so legitimate, and in most circumstances the 10 companies even have UK-based directors, too.

At this stage, other than the word ‘pyramid’ (which I’ve inserted as I know in hindsight how the ruse works), no immediate red flags and no unhappy HMRC.

Each business then ensures they have Employer’s Class 1 National Insurance liabilities under £100,000 (a condition of the NI EA), but they then inform HMRC that they made a mistake -- and didn’t realise they were entitled to the allowance. On cue, HMRC responds by issuing a tax credit for £5,000 (the allowance for the 2024/25), to each individual business for making an overpayment.

Know your ABCs – so you can steer clear

In the background, our 10 businesses are ensuring that the £100,000 liability is never reached, and prior to ever reaching the threshold, each business is put up for sale.

Then, business ‘A’ -- one of our original 10 from the bottom tier (tier one) -- gets purchased by another business – business ‘B,’ which sits on tier two of the pyramid, and crucially, the purchase by ‘B’ includes the transfer of the tax credit (which ‘A’ received from HMRC).

Then, the new business (‘B’) also purchases a second business (‘C’ – another one of the original 10 on tier one of the pyramid), and ‘C’ also obtained from HMRC the same £5k tax credit. All of a sudden, the purchasing business (‘B’) has £10k’s worth of HMRC credit on its books!

And unfortunately for us taxpayers, this cycle continues, whereby each company in tier one of the pyramid gets sold on, and sold on with the tax credits to companies in the second tier. This continues again -- let’s say with a business on tier three -- which actually snaps up the two companies with £5k each from tier one, and the company which bought them on tier two, which itself claimed the £5k allowance from HMRC. Hey presto, £15k in credits it’s not due.

In the end, the company at the very top of the pyramid -- let’s say tier four (but it could be as high as tier seven) -- then has enough tax credits to pay the PAYE tax bill with all the inherited credits and then pockets leftover cash!

If done cleverly, successively, this could amount to a substantial amount of cash not being paid over to HMRC, dependent on the amount of businesses in the pyramid.

Is this fraud?

So where does the scheme fall down and how do we know that it constitutes fraudulent practice?

Well, we know that there is no such thing as a defined list of businesses for sale with details of their ‘tax credit’ status available. So, for each one of the purchasing business to be buying up specified businesses, they must be aware of the tax credit that sits within said-businesses. More than that, there must be links between these businesses, especially with each business closing prior to reaching the £100k threshold. Or perhaps there’s at least one individual looking down over the whole pyramid of businesses, to see that the entire fraud runs smoothly!

How to avoid National Insurance Employment Allowance pyramid schemes

In reality, it’s going to be tricky for the average, hard-working contractor to spot this scheme.

But probably the biggest red flag would be a movement of one business to another business, part way through an assignment due to a sale.

If there are frequent sales, well that’s an even bigger red flag!

Where do contractors caught in this pyramid scheme stand?

At this early stage, we really do not know where contractors stand or how they could be affected by this shady operation. The consequences are opaque.

But be in no doubt, this is abuse of the NI Employment Allowance, and as such the fraud is being committed based on the employer’s responsibilities. We know that HMRC has a habit of determining things on a case-by-case basis, or looking through arrangements or the chain of a single test case, so my best advice is if you think something isn’t quite right, is -- Run A Mile.

And finally, our playing catch-up taxman…

We can be pretty sure that HMRC is already aware of this ruse yet by the time any action is taken, who’s to say there won’t already be the next iteration of NI EA abuse already up and running, undoubtedly one step ahead of the taxman once again.