How debt transfer rules will hit umbrella companies in 2026

Following Autumn Budget 2024, it's prudent to evaluate its impact on the recruitment industry, partly by clearing up some misconceptions circulating about freshly proposed debt transfer legislation, writes Martyn Valentine, director of The Law Place Limited.

When was debt transfer legislation announced?

On Wednesday October 30th 2024, the chancellor announced debt transfer legislation, which will follow the example set by section 688AA of the Income Tax (Earnings and Pensions) Act 2003 (workers' services provided through intermediaries: recovery of PAYE).

The intention of Rachel Reeves’ announcement is to recover £500 million in tax revenues lost to disguised remuneration tax avoidance schemes.

What are the main aims of the April 2026 debt transfer legislation?

To be introduced from April 6th 2026, the legislation’s main aim is to transfer responsibility for accounting for PAYE income tax from umbrella companies to employment businesses. If an employment business continues to use an umbrella company that subsequently operates a tax avoidance scheme, the employment business will be liable if it is immediately below the end-client in the supply chain.

The contractor sector should be aware that the new legislation is expected to transfer the tax debt to the end-client if there is no reasonable prospect of recovering the debt from the employment business or its directors' personal assets.

In direct engagements where no employment business is involved, the end-client will be responsible for tax.

The secondary aim of the legislation is to protect workers from the compulsory use of umbrella companies and the risk of liability for underpayment of tax, as happened with appalling, tragic consequences of the Loan Charge scandal.

Increase in employer NICs: the risks of passing it onto the worker

Typically, umbrella workers are paid the National Minimum Wage plus a commission, which is agreed upon prior to the start of an assignment. Sometimes this is called the “Assignment Rate.”

But the Autumn Budget’s proposed increase in employer’s National Insurance Contributions potentially leaves umbrella companies vulnerable to claims for breach of contract if the loss is passed to umbrella workers. In such cases, successful claimants would have enforcement options, possibly including a company winding-up order.

My forecast...

My forecast is that umbrella companies will no longer be viable in their current form, and market forces will compel their transition to conventional payroll providers, who will act as sub-contractors for employment businesses -- not employment intermediaries.

Be aware, Chapter 7, Part 2 of the Income Tax (Earnings and Pensions) Act 2003 requires an employment business to treat agency workers as employees for tax purposes. However, an exception (section 44(2)(b)) applies where the income is derived from employment.

Changing contracts with associates

If an umbrella company merely changes its contracts with its "associates" (formerly "employees") so that it simply acts as a payroll provider who contracts on behalf of an associate/agency worker, an employment business is likely to lose this statutory protection and will be at risk of litigation from HMRC to recover an underpayment of tax.

Our consultancy has seen firsthand this unscrupulous practice.

No change in the law is required for HMRC to recover tax in these circumstances, so employment businesses are already at existential risk of tax debts when working with umbrella companies.

What about Professional Employment Organisations (PEOs)?

For the April 6th 2026 debt transfer legislation, it is likely that government will adopt a broad definition of “employer” (as seen in the Employment Rights Bill 2024).

I anticipate that the definition of “employer” will capture any and all legal persons who directly or jointly employ individuals, whether for their own benefit or another, and remit tax to HMRC.

Using PEOs will mean added costs for employment businesses and end-clients, but PEOs also fail to circumvent the government's intention of increasing tax revenues and limiting risk for agency workers.

In an industry where relevant qualifications are anathema to the purported ability of an ‘expert’ to provide HR and legal advice, the relevancy of PEOs may be short-lived.

Debt transfer rules won’t outlaw umbrella companies but…

While the incoming debt transfer legislation does not expressly outlaw umbrella companies, the government has suggested using indemnities and due diligence so that employment businesses can in future use umbrella companies in a more rigorous way.

However, unscrupulous umbrella companies directors often exploit insolvency legislation to avoid judgment debts, so an indemnity provided by a limited company is of limited value. A further option may be personal undertakings given by the directors of umbrella companies. However, any competently advised person will strenuously avoid giving a personal undertaking, due to the risk of personal bankruptcy.

What needs to go hand-in-hand with debt transfer

As to the government’s future role in a regulated umbrella market, due diligence requires further and more timely warnings of unlawful behaviour by umbrella companies from HMRC. Even more importantly, it requires a statutory body equivalent to the Solicitors' Regulation Authority to aggressively police the recruitment industry and ban errant individuals from operating umbrella companies.

The secretary of state already has powers to prohibit a person from carrying on an employment business. Self-regulation has neither avoided the sceptre of the debt transfer legislation nor prevented the horrors of the Loan Charge. So hopefully the Fair Work Agency will be up to the task.

A boon for outside IR35 contractors

There’s a further ‘issue’ for end-clients and parliamentary counsel to consider. If the proposed legislation allows for a tax debt to transfer to an end-client if an employment business cannot pay it, no end-client will breach its fiduciary duty to its shareholders by needlessly incurring risk of a greater magnitude than engaging contractors on an outside IR35 basis.

Drafting the debt transfer legislation along these lines will provide a civil remedy to work alongside section 45 of the Criminal Finances Act 2017.

Has the rot already set in?

Whereas employment businesses claim that umbrella companies help reduce administrative costs by passing the costs of payroll to agency workers (essentially by charging for work-finding services), the truth is that umbrella companies often provide a passive income to employment businesses by way of payments to be on a Preferred Supplier List.

To protect this ‘arrangement,’ employment businesses require umbrella company workers to opt out of the Conduct of Employment Agencies and Employment Businesses Regulations 2003 ("Conduct Regulations"), so that umbrella workers can be prevented from working directly for an end-client and suffer delays in payment.

The Ryan Air-Lutz case

In Ryan Air v Lutz 3201452/2020, the employment tribunal held that a notice to opt out of the Conduct Regulations was ineffective because the claimant was not properly informed of the consequences of doing so.

As disapplying the Conduct Regulations provides no benefit for an umbrella worker, no lawyer acting in good faith can advise such a client to sign an opt-out notice.

An umbrella worker who has signed an opt-out notice without the benefit of professional legal advice can bypass any restriction clause and claim for damages if she/he suffers any "detriment", such as vexatious litigation to enforce a bogus restriction clause.

Referring a candidate to an accountant, or other expert lacking legal qualifications, won't save an employment business. A candidate who suffers the withdrawal of an offer of an assignment due to a refusal to sign an opt-out notice as part of an arrangement involving an umbrella company can commence litigation in the county court against an employment business to recover loss of earnings.

The future (includes the toxification of umbrellas)

The bottom line that I don’t think can be escaped from is that the debt transfer legislation will toxify umbrella companies from the perspective of both employment businesses and end-clients. It is surely anticipated that rigour mortis will set into the umbrella industry before April 6th 2026 occurs; potentially the point of death for umbrella companies as we know them today. In addition, expect end-clients' behaviour to change in anticipation of the debt transfer legislation.

How? Well, engaging contractors outside IR35 avoids employment rights challenges in an employment tribunal and will therefore be less risky than using umbrella companies. Managing IR35, in that sense at least, is straightforward, on the basis that HMRC’s unreliable CEST tool is never used, and that end-clients obtain competent legal advice.

Finally, prepare for protest

In due course, stakeholders in the contractor recruitment industry will invariably protest about the necessity of using umbrella companies to provide outsourced payroll services. However, the administrative cost of using payroll providers that are not part of the supply chain can be passed up the supply chain -- instead of down, providing a real benefit for agency workers while preserving flexibility in the supply of labour.