Gross Payment Model, the clear and present risk for contractors’ agencies and end-clients

The so-called ‘Gross Payment Model’ has become increasingly prevalent in the contractor and recruitment sectors. Understanding and mitigating against this practice is crucial for end-users and recruiters, as it involves potential tax avoidance and therefore has significant implications.

Here, exclusively for ContractorUK, I will divulge what the gross payment model entails, why it's attractive to some workers, and the significant HMRC risks it poses to clients and agencies, writes Sebastian Sauca, chief executive of SafeRec.

What is the Gross Payment Model?

The Gross Payment Model (GPM) is a method by which payments are made to contractors with a limited company in a manner that circumvents the payment processes required under off-payroll working (OPW) legislation (Chapter 10 of ITEPA 2023) if the contract falls inside IR35, and where the end-client is in the public sector or a large/medium-sized private sector company.

How does the GPM work?

End-users or agencies make payments to an umbrella company expecting that these funds will be processed as regular payments of remuneration, and expecting that the worker will be paid in accordance with the PAYE regulations, with appropriate deductions having been made and accounted for to HMRC.

But instead, the umbrella company pays the contractor’s limited company directly!

In essence, funds are received ‘gross’ into the limited company bank account, without deduction. This may represent all of the payment or a portion of it (with the rest being administered in accordance with the correct tax treatment). 

Perversity, valid SDS, and without an SDS…

The perversity of this practice is that it is totally invisible to agencies and end-hirers who mainly tend to only conduct yearly checks on their umbrella companies.

This is discussed further, below.

When payments are made directly to a contractor's limited company without a valid Status Determination Statement (SDS) issued by the end-client, the end-client is the ‘deemed employer.’ So with no valid SDS, it is the client who is liable to HMRC for any unpaid income tax and NIC.

If there is a valid SDS, which is passed down to the umbrella company, they become the ‘deemed employer’ under the Chapter 10/ OPW legislation. However, if they default on their obligations, or the umbrella is based offshore, the agency can become liable for unpaid income tax and NIC (although there are some safeguards in place).

In short, the Gross Payment Model is bad news, regardless of how you look at it!

What type of HMRC liability arises from the Gross Payment Model?

Understanding the potential financial liability is crucial.

The term ‘tax liability’ can often seem abstract to companies but breaking it down into concrete numbers illustrates the true scale of the issue and why the senior leadership of any organisation should actively review and audit their umbrella PSL.

Below is an example of the HMRC tax liability for one single worker over the course of a year, across four different assignment rates:

Calculation Assumption: Employer Pension 3% of Qualifying Earnings, £18 Umbrella Margin, 37 hours worked per week, Apprenticeship Levy calculated, NI Category letter A, Income Tax calculated W1M1, Tax Code: 1257L.

As seen in the table, the liability that comes with not checking if umbrella companies are paying workers under PAYE when they should, represents a significant and serious risk. A potentially £21,000 risk!

And for these assignment rates, here is the yearly liability projected per recruitment agency size, per number of workers:

How can agencies, and end-clients avoid the risk posed by the Gross Payment Model?

Managing liability risk posed by the Gross Payment Model requires more than just the usual annual ‘due diligence.’

The yearly check, however it is done, will not suffice for agencies and end-clients to protect their business from potentially hefty HMRC liabilities. It is important to recognise that some umbrella companies might use this model for only a portion of their workers -- often those parties in supply chains who don’t run continuous checks throughout the year.

The only effective way to identify if an umbrella company is operating a Gross Payment Model for some or all its contractors is by auditing the only consistent piece of evidence that proves accurate PAYE calculations and deductions -- their payslips and the subsequent payment to HMRC.

The payslip is of paramount importance (cont.)

Fortunately, a new strain of umbrella company is taking shape and these voluntarily audit in real-time all the payslips they process.

If compliance matters to you as an agency or end-client, this is an option worth exploring.

Being specialists in the payslip space, we would argue that a rigorous payslip auditing process is the most efficient and reliable method to protect from big HMRC liabilities. There are also provisions to protect businesses should fraudulent documents be provided.

Potentially lethal consequences if you’ve got GPM contractors in the supply chain

Regardless of which specific umbrella company is engaged, it is crucial that compliance is clearly demonstrated by agency and end-user businesses, assuming either of those wish to avoid HMRC penalties, interest and, in turn, potentially worse -- commercial failure.

Indeed, we believe the financial and reputational health of agencies and end-users is at stake.

And for business owners considering an exit strategy, valuation could be adversely affected too.

Final thought – ‘due diligence’ of umbrella companies needs to evolve

Increasing regulatory pressure -- as the government seems to be doing -- is likely to compel supply chains to ensure their umbrella company partners and ‘due diligence’ strategies are solid and a lot more thorough, respectively. The urgency to act is difficult to overstate, and the ‘due diligence’ process must evolve beyond a mere tick-box exercise if you’re a contractor recruitment agency or an end-user of contractors and want to safeguard your business effectively in the future.