The umbrella company industry has faced increasing Government scrutiny over tax non-compliance in recent years, with widespread evidence concerning significant non-payment of tax reflected in the growing HMRC defaulters list that highlights the scale of the problem.
HMRC has encountered persistent and seemingly insurmountable challenges in enforcing the correct payment of tax, resulting in a series of consultations which underscored the urgent need for reform.
The Government has now published new draft tax legislation aimed squarely at strengthening accountability: shifting liability for unpaid tax from umbrella entities to the recruitment agencies that engage them.
Dave Chaplin, CEO of ContractorCalculator, says: "HMRC have demonstrably failed for decades to enforce tax compliance in the umbrella sector, so it has chosen to pass the enforcement baton to agencies, by providing them with a brutal incentive to make sure the correct tax is paid.
"From 06 April 2026, if an agency chooses not to run their own payroll and instead passes a worker's gross earnings to an umbrella, the agency will be responsible for any tax shortfalls.
What is the background to the umbrella legislation?
The policy document explained the background to the legislation, stating that whilst many umbrella companies operate responsibly, benefiting agencies and workers, a significant number facilitate tax avoidance and fraud, resulting in financial losses for taxpayers and unexpected tax bills for workers.
The Government asserts that non-compliant companies also harm compliant businesses and the broader market. While HMRC has tried to warn and support workers affected, enforcement has been challenging due to the ease of setting up new umbrella companies.
Despite efforts to raise standards, the Government states that non-compliance persists. Following consultation, the Government announced in the Autumn Budget 2024 that new legislation will shift PAYE tax responsibility in cases of non-compliance, aiming to protect workers better, support honest businesses, and safeguard public funds.
The policy aims to achieve three main goals:
- Reduce tax losses by preventing fraud in the umbrella company sector, protecting taxpayers and limiting the funds available to organised criminal gangs.
- Protect workers from unexpected tax bills resulting from non-compliant umbrella companies.
- Promote fair competition in the temporary labour market by stopping fraudulent operators.
Additionally, the policy supports the Government's broader mission to stimulate economic growth and improve job quality by tackling low standards in the labour supply chain.
The measure may impact approximately 700,000 individuals who work through umbrella companies, as it seeks to clamp down on tax avoidance totalling £2.845 billion from 2025-26 to 2029-30, of which the first year is expected to prevent £895 million of unpaid tax.
Where is the draft umbrella tax legislation?
The draft legislation is published online at the following location:
The Explanatory Note explains that Part 2 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) will be amended to introduce a new Chapter 11, making recruitment agencies jointly and severally liable for any amount payable under the pay-as-you-earn (PAYE) system when they supply workers via umbrella companies. Where there is no agency involved in providing the worker, joint and several liability will apply to the client.
Further legislation will be introduced to amend Section 4A of the Social Security Contributions and Benefits Act 1992, providing HM Treasury with the power to make regulations imposing an equivalent joint and several liability for National Insurance Contributions (NICs) purposes.
What is in the statutory drafting of the umbrella legislation?
The draft umbrella tax legislation will be incorporated into a new Chapter 11 of the Income Tax (Earnings and Pensions) Act 2003, in sections 61Y to 61Z1.
The legislation contains the following sections:
- Section 61Y: Umbrella companies: joint and several liability
- Section 61Z: Relevant parties
- Section 61Z1: Purported umbrella companies
The Explanatory Note explains the purpose of each of the clauses. The statute introduces "the umbrella company" in 61Y(b), which requires "umbrella company arrangements conditions" to be met (defined in 61Y(4). The monies to be correctly taxed are referred to as a "qualifying umbrella company payment" (61Y(3)).
61Y(2) establishes that each "relevant party" (as defined in 61Z) is jointly and severally liable for the tax. A "relevant party" (61Z) is essentially any UK-based party between the client and the worker, for example, any other employment business (such as an agency). [Additional edit: Where there are multiple agencies between the client and the umbrella, current drafting appears to only make the highest agency that contracts with the client to be a 'relevant party' - leaving lower-level agencies without liability.]
Section 61Z1 sets out when joint and several liability will apply in respect of a "purported" umbrella company. This is where it is reasonable to suppose that one or more participants in the arrangements would assume that the purported umbrella company employed the worker but did not in fact do so. It appears to be inserted to prevent new models from being set up to circumvent the new rules.
For completeness, clause 61Y(7) contains definitions such that a business does not meet the definition of umbrella company as a result of being deemed an employer by Chapters 7 to 10 of ITEPA 2003 – or in layman terms, is a sole trader operating via an agency (Chapter 7), is working via a PSC for a small firm and is Inside IR35 (Chapter 8), is working via a Managed Service Company (Chapter 9), or is working via a PSC for a medium or large firm and is "Inside IR35."
How will agencies be liable for the umbrella's unpaid tax bills?
The Explanatory Note states that "Joint and several liability will allow HMRC to pursue an agency in the first instance for any payroll taxes that a non-compliant umbrella company fails to remit to HMRC on their behalf. The end client will be liable if contracting directly with an umbrella company."
Chaplin says: "Whilst this topic is one for payroll experts to confirm, there does not appear to be an issue with the agency paying the tax directly to HMRC even when an umbrella is used. Therefore, the easy way for an agency to eliminate risk when using umbrellas will be to pay the tax bill directly to HMRC simply, and the rest to the umbrella, which will then complete the payroll processing."
Other options for agencies might include creating and running their own umbrella company or bringing payroll in-house.
What happens next with the tax legislation?
The tax legislation will be formally introduced in the next Finance Bill 2025-26 at its first reading, and the law will come into effect from 6 April 2026.
Since the legislation has already undergone a considerable drafting process with policymakers and government lawyers, there is unlikely to be any material changes to the legislation.
Will umbrellas still be available for contractors?
Yes – contractors can still use umbrellas, and they will not be liable for unpaid taxes. The legislation is designed to stamp out egregious abuse of the tax system and should not affect 100% compliant umbrella companies. There will be increased compliance administration for both agencies and umbrella companies, but for contractors, nothing should change.