Potentially unlawful practices among certain recruiters and umbrella companies, in response to the public sector IR35 reforms, have left many contractors unjustly funding the tax obligations of their recruiters and clients, including employer’s national insurance (NI) contributions.
Since the April 2017 legislative changes, recruiters have increasingly been encouraging contractors to work through umbrella companies. Many of these recruiters are deceptively advertising contracts to contractors at the rate that they pay the umbrella company.
While the contractor rightly expects to receive the quoted rate, the employment costs, including employer’s NI, must first be funded from the sum paid to the umbrella, leaving the contractor far short of their expected income. This could be construed as a legal misrepresentation, rendering the consequent deduction of the client’s or recruiter’s employment costs unlawful
The problem with non-compliant umbrellas
We’re seeing this all the time, and it’s the reason why all umbrella companies are being tarred with the same brush. Recruiters aren’t accounting for the full uplift – also known as a limited rate – when they quote rates to contractors, and neither they nor the umbrella companies are making this clear, meaning contractors are being misled.
When a recruiter engages a contractor via an umbrella, it is required to uplift (increase) the Pay As You Earn (PAYE) rate, accounting for all of the employers tax obligations and costs:
Holiday pay at 12.07%
Employer’s NI at 13.8%
Apprenticeship levy at 0.5% (where applicable)
Contributions into a pension scheme
Umbrella company margin.
The remaining sum, not including the uplift, would then be treated as the contractor’s earnings and subject to income tax and employee’s NI. Unfortunately, in addition to quoting contractors the umbrella’s invoice value, many recruiters are also pocketing a portion of the umbrella fee. This is known as a ‘kick back’, which many non-compliant umbrella companies with lower operating costs accept to avoid being frozen out by recruiters.
Why are contractors being forced into umbrella companies?
Following the public sector IR35 reforms, recruiters are often liable for employer’s NI where a contractor is deemed caught by IR35. With many public-sector organisations imposing unlawful blanket rules, whereby all contractors are automatically deemed caught by IR35 and recruiters are often left to pick up a significant NI bill. To pass the buck, many organisations are encouraging contractors to use umbrella companies.
Recruiters are pretty much unanimously shifting contractors into umbrella companies, because they are being told by their clients that everyone is inside IR35. Unfortunately, what the client says, goes.
What does HMRC guidance say about employer’s NI?
Section 7 of HMRC guidance published online in March 2017 states the following concerning NI payments: ‘They [the fee payer] cannot lawfully deduct the secondary NICs from a fee that has been agreed, but could, depending on the contractual terms, negotiate a lower fee [with the intermediary].’
This appears to simultaneously prohibit unlawful NI deductions while providing recruiters with an opportunity to circumvent the rule. In truth, HMRC intended the first part of the sentence to apply to fee payers negotiating new contracts with contractors.
The freedom to renegotiate a lower fee was only supposed to apply to existing contracts when the Off-Payroll rules came into play, with this stipulation providing fee payers with the chance to alleviate unforeseen employer’s NI costs. However, a lack of clarification from HMRC appears to have caused unlawful activity on a broad scale.
Can umbrella companies deduct employer’s NI lawfully?
Amendments to the Income Tax (Earnings and Pensions) Act 2003 following the Finance Acto of 2017 suggest that the recruiter may be responsible for paying employer’s NI irrespective of the presence of an umbrella company:
Section 61N centres around ‘fee payer’, who is responsible for making a ‘deemed direct payment’ to the worker, which is to be treated as earnings from an employment.
S61N(2) of the legislation states that the fee payer is the party in the chain immediately above the lowest. According to s61N(1), the lowest party in the chain is not the worker but the intermediary. Given that the contractor no longer engages via a limited company, the umbrella company is deemed to be the intermediary, meaning the recruiter is, by law, the fee payer.
Valentine points out that, as the payment is to be treated as earnings from employment, the fee payer is responsible for paying employer’s NI, and issuing gross payments to the umbrella intermediary. By paying gross to the umbrella, the recruiter is in breach of s61N of the ITEPA 2003.
Any contractor affected could claim that they suffered an unlawful deduction with reference to this. Recruiters who have acted in this manner may find themselves liable to the contractor in respect of damages for misrepresentation. They also risk ruinous tax investigations and claims in the High Court for damages.
Examples of malpractice of this nature underscore yet again the need for regular auditing of a recruiter’s practices and actual supervision by a competent professional body. The present, virtually laissez-faire, regulatory environment is overdue for reform.