McDermott Comment | Freelancers Forced into Tax Avoidance by Umbrella Companies


Sarah Gabbai, tax attorney at law firm McDermott Will & Emery, said:

“Any UK company that contemplates hiring contractors on a self-employed basis first needs to consider whether they are within the scope of the new IR35 “off-payroll” legislation, which came into effect on 6 April 2021.This will only be the case if the self-employed contractor wishes to provide services through his or her own personal services company, and if the UK engaging company is “medium or large” as defined under the relevant rules. If the new off-payroll rules apply, and the UK engaging company assesses the contractor to be a deemed employee for tax purposes, it then has to operate PAYE and pay employer’s National Insurance Contributions in respect of the contractor’s services fees.

As an individual’s employment status is a highly contentious area, the risk of getting it wrong is pretty high. UK businesses know this, and consequently have adopted a policy of either operating PAYE by default, or declining to hire self-employed contractors altogether. Because of the obvious labor market distortion that this situation creates, many contractors have resorted to using umbrella companies, a good number of which are non-PAYE compliant. Such non-compliance not only poses a guaranteed risk of HMRC seeking additional income tax from the contractors themselves (whether under the Loan Charge or otherwise), but also creates a risk of criminal sanctions for the UK engaging company under Part 3 Criminal Finances Act 2017 if the non-PAYE compliance involves tax evasion and the engaging company does not have reasonable prevention procedures in place to prevent facilitation of that tax evasion. As such, for both end clients and contractors, this uptick in the use of umbrella companies has merely exchanged one problem for another, albeit for different reasons – and an even greater one at that. Matters might not be helped by the new Health and Social Care Levy either, which could potentially exacerbate the problem of contractors being shunted into non-compliant umbrella companies when the 1.25% NIC increase comes into force on 6 April 2023.”