How contractors can spot and avoid a non-compliant umbrella company

If a contractor is considering working through an umbrella company, the obvious follow-up question is; ‘Which umbrella company?’

Previously on ContractorUK, the factors to look out for when entering into a contract of employment with an umbrella company were explored, on top of a consideration of the employment benefits of using an umbrella company.

However, not all umbrella companies are equal. And unfortunately there are scammers operating in the market, who may leave contractors out-of-pocket and potentially facing liabilities to HMRC.

So let’s now flag some of the tell-tale signs of a non-compliant umbrella company to help contractors choose a legitimate umbrella to work through, thereby avoiding nasty surprises later down the line, writes Hannah Morrison, senior associate at law firm Brabners LLP.

1. The umbrella isn’t keen on giving you a written statement of employment particulars

As the umbrella company will be the contractor’s employer, the umbrella company must comply with Section 1 of the Employment Rights Act 1996, which requires employers to give certain minimum information to employees -- in writing -- about their employment.

This information is often provided within a contract of employment and a company handbook. Contractors should expect to receive the following information as a bare minimum:

• name of employer
• start date of employment
• rate of pay
• holiday pay entitlement; and
• statutory sick pay entitlement.

If the employment contract which is presented to you seems light on information, then ask the umbrella company to amend it to include the information which is required by Section 1 of the Employment Rights Act 1996. If they refuse, or tell you that you don’t need to worry about adding that information to the contract, consider walking away from the umbrella company.

2. The umbrella offers take-home pay that’s just too high to be HMRC-compliant

A common sign of a non-compliant umbrella company is that it offers take-home pay which appears to be significantly higher than what other umbrellas are offering.

Umbrella companies should be deducting income tax and employee National Insurance contributions from contractors’ pay at source, and paying employer National Insurance contributions to HMRC. But tax avoidance schemes exist that deliberately avoid or underpay the tax due.

In these avoidance schemes to be avoided, the ‘umbrella company’ will generally still operate a PAYE model, but it will split the pay of the worker so that some is taxed, and some isn’t (i.e. they offer to pay you part of your pay gross). This increases the worker’s take-home pay but leaves a tax liability behind that may ultimately fall on the contractor. These organisations disguise these ‘non-taxable payments’ by claiming that they are not salary but loans, grants, credit facilities or advances when, in practice, it is income that should be subject to tax.

For further information on this, the government issued guidance in 2021.

But in short, if the rate of take-home pay seems too good to be true, it probably is. 

3. The umbrella has signs of MUC -- Mini Umbrella Company

Mini Umbrella Companies (MUCs) take advantage and abuse two government tax reliefs aimed at assisting small businesses, namely the Employment Allowance and the VAT Flat Rate Scheme.

MUCs do this by operating multiple umbrella limited companies (sometimes hundreds or even thousands), yet only employing a small number of contractors in each.

This ensures the mini-umbrella company remains eligible for the small business tax reliefs and in practice, means their tax bill is much lower. As set out in government guidance, contractors should look out for the following red flags:

• where there is a different company named on the payslip than the umbrella company the contractor is working through;
• the company named on the payslip changes regularly and/or is newly incorporated (a 'Companies House' search can be undertaken to get this information);
• there are foreign nationals named as directors of the company; and
• the business activity listed on Companies House is incorrect

Working through one of the fraudulent operators that are MUCs may result in the loss of some of your employment rights, because they often move workers between different mini-umbrella companies on a regular basis, unbeknown to the worker, in order to maximise profits from the fraud, meaning that you may not accrue a sufficient period of continuous employment with one umbrella company to be eligible for certain employment benefits! With signs of a MUC detected, withdraw.

4. No accreditation; no externally-imposed standards whatsoever?!

It should be an encouraging sign for contractors that the umbrella company they are proposing to choose is registered with a trade body or compliance assessor, such as FCSA or Professional Passport. And so the opposite is true -- be cautious if there is no accreditation, or affiliation with established bodies that strive for compliance.   

However, it is worth noting that HMRC will never ‘endorse’ or ‘approve’ an umbrella company as being legitimate. So contractors should be alert to bogus umbrella companies stating that they are ‘HMRC-approved.’ This claim can never be true and as such, this is a red flag.  

Finally, short-term gain risks coming back to bite you later on

Overall, contractors should be alert to the signs of a non-compliant umbrella company and the risks of using one.

Although the offer of comparatively higher take-home pay may initially seem appealing, this could result in you being stung later down the line by potentially being required to pay underpaid tax over to HMRC, and could mean that you don’t get all the employment benefits you are entitled to.