An Umbrella Company Warning from HMRC

HMRC’s recent Spotlight 71 announcement was made as a clear warning to agency workers and contractors about the growing risks of being moved between umbrella companies. If you’re a business operating under the Construction Industry Scheme (CIS) and for independent contractors themselves, understanding what this warning means is essential.

Non-compliance may mean you are illegally avoiding tax, and this can lead to unexpected bills and hefty penalties. Here at Contractwise, we’re payroll specialists who are experts in CIS compliance. Spotlight 71 reinforces the importance of transparent payroll practices and accurate worker classification. In this article, we’ll take a closer look at the warning and explain how to avoid getting caught out.

Read on for more information…

What is an umbrella company?

An umbrella company is a third-party business that typically employs agency workers, temporary workers and contractors and processes their payroll. Instead of being paid directly by a recruitment agency or the end client, the worker becomes an employee of the umbrella company. This means the umbrella company invoices the agency, deducts income tax and National Insurance contributions through PAYE and is responsible for paying the worker’s salary.

When the arrangement is legitimate, umbrella companies offer significant benefits, as they simplify payroll, ensure statutory rights such as sick pay and annual leave, and reduce administrative tasks for agencies and contractors. However, problems sometimes arise when umbrella companies are used nefariously to disguise tax avoidance, which is the whole point of Spotlight 71.

What is Spotlight 71?

Spotlight 71 is a recent HMRC guidance note that was released to warn workers who are being repeatedly moved between umbrella companies. HMRC points out that these frequent moves are often a red flag for tax avoidance, especially if they seem to be occurring without any reason. In many cases, these are disguised remuneration schemes.

The guidance in Spotlight 71 makes it clear that responsibility does not only sit with agencies. Workers themselves can be held liable for unpaid tax if they are benefiting from avoidance arrangements, even if they are unaware and were told the scheme was compliant.

As a result, HMRC has encouraged workers to check contracts and payslips carefully if they are under an umbrella company and to speak out if arrangements seem unusual or too good to be true.  

How do some people use umbrella companies to avoid tax? 

Usually, a tax avoidance scheme that involves an umbrella company will promise higher take-home pay than standard PAYE arrangements. A worker will be paid a small amount as taxable salary, with the rest given to them in a non-taxable payment. The payments will be presented as being outside of PAYE, even though they are still earnings. One common way to do this involves deliberately rotating workers through different umbrella companies to try and confuse HMRC. This is highly illegal and is something HMRC are clamping down on.

Workers caught in these schemes will face significant, and in some cases life-changing, tax bills in later years, even if they believed the arrangement was legitimate. With this in mind, it is vital not to get caught out and to recognise the signs of this kind of tax avoidance.

Signs of umbrella company tax avoidance

HMRC has provided several key warning signs that workers and businesses should keep an eye out for to ensure they are not inadvertently avoiding tax through umbrella companies.

Employment contract

A legitimate umbrella company will provide you with a clear employment contract setting out pay, deductions and your employment rights. Warning signs include:

You are unexpectedly moved to a new umbrella company with no paperwork or at short notice
You have signed a contract with one company but are being paid by another. Sometimes they may have similar names or be based overseas.
You are asked to sign a different employment contract or a different type of agreement (such as an annuity agreement), as well as your initial contract

At Contractwise, we offer payroll audits that will ensure contracts are always legitimate.  

Payslip information

Payslips should clearly show your gross pay, National Insurance, income tax and any other lawful deductions. Warning signs on your payslip can include:

• Your PAYE reference, employer name or the way you are paid has changed unexpectedly
• Your payslip shows less pay than you expect
• Your payslip shows less than how much you are actually paid
• Incorrect income tax and National Insurance deductions
• Your payslips are changed from digital to paper versions
• You are moved to a payroll system you can’t access

Salary payments

Salaries should mostly be paid through PAYE. If a significant portion is paid outside of this, especially if it comes from an overseas company, this is a big warning sign. HMRC will likely view this as an attempt to hide taxable income. Again, if you are unexpectedly moved to a new payroll system, it might be a sign that the umbrella company is attempting to avoid tax.

Schemes known for tax avoidance

HMRC has helpfully identified a range of schemes and organisations that have been involved with this kind of tax avoidance. You can view this list on the HMRC website, but it may not be exhaustive. This is why it’s important to recognise the main red flags outlined above. Promoters of such schemes will likely downplay the risks or pretend they have HMRC approval.

What to do if you notice red flags

If you notice any red flags with your umbrella company, the first thing to do is reach out to them directly with your concerns. If they do not respond, refuse to give you further information or ask you not to contact HMRC, this is further evidence of potential wrongdoing.

At this stage, you should seek professional tax advice and report tax avoidance to HMRC.

At Contractwise, we help protect contractors and subcontractors with a wide range of CIS services, including eliminating the risk of HMRC reclassification. We will ensure workers are properly classified as contractors or subcontractors so you are not hit with a costly fine. For more information, contact our team today.