Recruitment agencies rely on umbrella companies to simplify contractor payroll, ensure compliance, and deliver a seamless experience for all parties involved.
But what happens if your umbrella company is using a tax avoidance scheme?
The answer could have serious implications. It won’t just affect the umbrella company, but your agency and the contractors you represent too.
We’ve gone over the risks, warning signs, and best practices to ensure your umbrella company is a legitimate partner, not a liability.
The risks of tax avoidance schemes
Tax avoidance schemes are artificial arrangements designed to exploit loopholes in the tax system, enabling individuals or businesses to pay less tax than they should. While tax avoidance is technically legal, it is frowned upon by HMRC and can lead to significant penalties, including:
Financial penalties could be significant. Contractors and agencies involved in schemes could be liable for unpaid taxes, interest, and fines.
Reputational damage is also a concern. Being associated with an unethical umbrella company can tarnish your agency’s brand, leading to a loss of trust among clients and candidates.
And the legal consequences will be unwanted by your agency. HMRC’s crackdown on tax avoidance schemes includes prosecuting those involved under anti-avoidance legislation such as IR35 or the Criminal Finances Act.
How to spot a tax avoidance scheme
Tax avoidance schemes can be sophisticated, but they often have common red flags. Here are some warning signs to watch out for when evaluating umbrella companies:
- Unrealistic take-home pay promisesIf an umbrella company claims contractors can retain 85-90% of their income, it’s too good to be true. Legitimate companies follow PAYE regulations, where deductions for tax, National Insurance Contributions (NICs), and other obligations are unavoidable.
- Complex payment structuresSchemes often use convoluted payment methods, such as loans, offshore trusts, or non-taxable allowances, to disguise income. These structures may look attractive but rarely stand up to HMRC scrutiny.
- Lack of transparencyA reputable umbrella company will clearly explain their processes, fees, and compliance measures. If you’re met with vague answers or overly complex explanations, proceed with caution.
- No accreditation or membershipLook for affiliations with recognised industry bodies, such as APSCo, the Freelancer & Contractor Services Association (FCSA), SafeRec or Professional Passport. Membership signals a commitment to compliance and ethical practices.
Why due diligence matters
As a recruitment agency, you have a duty to perform due diligence when partnering with umbrella companies. Here’s why this responsibility is critical:
- Legal liability: Under the Criminal Finances Act, agencies can be held accountable for facilitating tax evasion, even if unknowingly.
- Contractor relationships: Your contractors trust you to connect them with ethical and reliable umbrella companies. Failing to do so could harm your professional relationships.
- Client expectations: Many end clients now demand agencies demonstrate compliance across their supply chain, including umbrella partners.
How to protect your agency
To avoid falling into the tax avoidance trap, take proactive steps to vet your umbrella company partners:
Request documentation
Ask for proof of compliance, including tax records, accreditation certificates, and audit reports. A legitimate umbrella company will have nothing to hide.
Verify memberships
Check the umbrella company’s status with organisations like APSCo, the FCSA, SafeRec or Professional Passport. Membership requires adherence to stringent compliance standards.
Conduct regular reviews
Periodically review your umbrella partners to ensure ongoing compliance. Changes in tax laws or management could affect their status.
Provide education
Offer training for your staff on spotting avoidance schemes and understanding compliance requirements. This ensures everyone in your agency is equipped to make informed decisions.
The cost of compliance vs. the cost of non-compliance
Some recruitment agencies might be tempted to overlook compliance in favour of higher margins or faster solutions. However, the cost of non-compliance far outweighs any short-term gains.
Partnering with a non-compliant umbrella company puts your agency’s financial health, reputation, and legal standing at risk.
By contrast, working with a compliant umbrella company ensures peace of mind, contractor satisfaction, and sustainable growth for your business.
Choose wisely
When it comes to umbrella companies, compliance isn’t optional. It’s essential. Take the time to vet your partners and avoid tax avoidance schemes. In doing so, you protect your agency, your contractors, and your clients from unnecessary risks.
Remember, the right umbrella company is more than a service provider. It’s a trusted partner in your recruitment business. Don’t settle for shortcuts when compliance and integrity are at stake.