UK Budget: new rules to combat umbrella company tax avoidance ‘should prompt due diligence’

Penny Simmons, an employment tax expert at Pinsent Masons, was commenting following an announcement by Rachel Reeves, chancellor of the exchequer during the UK Budget that new rules would be introduced to tackle non-compliance involving umbrella companies from April 2026.

According to a policy paper published by HM Revenue & Customs (HMRC), where a recruitment agency uses an umbrella company to engage with workers, the agency will become legally responsible for ensuring that the umbrella company operates PAYE properly and that the correct amounts of tax and National Insurance contributions (NICs)  – including employer NICs – are paid to HMRC.

Recruitment agencies will still be able to outsource payroll functions to umbrella companies or other payroll providers but will remain legally responsible for operating PAYE – and will therefore retain ultimate responsibility for any PAYE errors and unpaid taxes. For more complex supply chains, where there are multiple agencies involved in engaging a worker, the agency that has the contractual relationship with the business receiving the services of the worker will be legally responsible for accounting for PAYE.

Read more of our UK Budget coverage

• UK Budget: national minimum wage sees biggest boost on record
• UK Budget: carbon border adjustment mechanism set for 2027 start date
• UK Budget: tech barriers review to inform industrial strategy
• UK Budget: no change for corporate taxes but employers’ NICs increased to 15%
• UK Budget: role for private finance in infrastructure delivery remains unclear
• UK Budget: carried interest tax rate increased to 32% with further increases expected from 2026
• UK Budget: CCUS and tax relief measures may soften oil and gas energy profits levy blow

Simmons said: “The new rules will shift the risk of unpaid taxes, penalties and interest from the umbrella company to the agency engaging the umbrella. The risks could be extensive where an agency uses large numbers of umbrella companies. Recruitment agencies should consider increasing and reviewing due diligence controls and contractual safeguards before engaging with umbrellas, since without rigorous onboarding controls, agencies could be exposed to significant tax risks of non-compliance.”

Where a business engages directly with an umbrella company rather than involving an agency, the business will be legally responsible for operating PAYE and the tax risks of non-compliance will sit directly with the business.

“This will likely create a powerful incentive for businesses to review their labour supply chains and route dealings with umbrella companies through recruitment agencies and employment businesses. Businesses should also ensure that contractual arrangements with both agencies and umbrella companies are reviewed to ensure they contain adequate safeguards,” said Simmons.

Broadly, the term 'umbrella company' describes an arrangement under which contractors and temporary workers are supplied by an umbrella company to a recruitment agency, which then supplies the workers to a business – the client – that receives the services of the workers. The client is invoiced for the work that those workers undertake. The workers are then paid as employees or self-employed contractors by the umbrella company.

Labour supply expert Rami Labib of Pinsent Masons said: "The proposed new rules are likely to make the use of umbrella companies less attractive. I anticipate that agencies may respond by reducing the number of umbrella companies that they are prepared to work with".

The announcement of the new rules follow a consultation on tackling tax avoidance by umbrella companies by the previous government in June 2023. The Treasury has been concerned about tax avoidance in the umbrella company market for some time and the government considers that the new rules will safeguard significant amounts of tax revenue currently being lost due to non-compliance. The government believes that recruitment agencies can decide which businesses enter their labour supply chains, and therefore have the power to prevent non-compliant umbrella companies from entering the market. The government considers that making businesses controlling labour supply chains legally responsible for PAYE is the most effective way of improving compliance in the market.

Draft legislation is expected next year, and the government has said it will engage with stakeholders for feedback before the proposals are finalised.