5 Common Traps of Rogue Umbrella Companies

Umbrella companies aren’t regulated. As such, there are many rogue companies, advertising high take-home rates, which may land you with a hefty tax bill. Even well-known umbrella companies are far from perfect with hidden costs to cover expenses their business models attract. It’s a case of buyer beware, and especially now as companies enforce blanket bans on personal service companies to manage IR35 compliance.

Read the following article to understand some of the common pitfalls of using umbrella companies.

Umbrella companies are nothing new. They have been around for over 20 years. They were designed to give people who didn’t want to run a limited company an alternative option.

However, as the IR35 Reform has come on the scene, the use of umbrellas has evolved and they are now being adopted by end clients as a means of managing the risks of IR35 compliance in the private sector.

In short, rather than take on the administration of assessing roles inside or outside of IR35, companies are selecting to ban personal service companies (PSCs) from the supply chain altogether, and insisting contractors use an intermediary umbrella to do all the PAYE administration. These leave people with a choice – progress the contract using an umbrella, walk away from the contract or go PAYE (in many cases this may not even be offered as an option).

There are times in the cycle of contracting where walking away isn’t an option, and sadly it’s given way to some unscrupulous tax avoidance schemes that can be very hard to detect for both the client and the contractor.

So how can you ensure your efforts to do the right thing and pay the right amount of tax are not in vain and don’t leave you with a hefty tax bill?

We spoke to umbrella founders and experts Robert Sharp at Orca Pay Group and Lucy Smith at Clarity Umbrella Ltd to get their check list for ensuring the umbrellas you trust are all above board. Here are their top tips:

1. First and foremost: speak to the umbrella directly and do your due diligence

“When it comes to umbrellas, ‘due diligence’ is the critical phrase to have in mind,” says Rob. “Don’t just have a ten minute chat. Really drill the umbrella on their processes, the models they use for PAYE, and that they are a true PAYE payment model. If they won’t answer the questions then proceed with caution.”

“I’d suggest looking up company information as part of this reconnaissance too,” adds Lucy. “If you see a company registered outside the UK, more than likely in a tax haven, then it’s a clear sign not to go ahead. But don’t be fooled. Some umbrellas know people will delve a little deeper so will set up the front facing business to look like a UK entity. It’s only when you’ve signed up that you find out there is another business behind it. It’s another reason to make sure you don’t sign up before getting answers or at least sight of a contract.”

2. Ask for an illustration

“Take home rates of 75% or more are a falsehood and the biggest warning sign that you’re dealing with a potential rogue scheme”, adds Robert. “A well-run umbrella will give you a transparent breakdown of all deductions and you should expect a rate of nearer to 54% on average if you are likely to be a 40% tax-payer. Bottom line is that you need to be forensic about the breakdown being given to you – really understand the deductions and the payment model.”

3. Ask for a key information document

Lucy agrees and says there is another way of verifying compliance: “If an umbrella insists you sign something before they will even answer a question or give you a key information document then something is amiss.

“Actually, by law, you are entitled to a key information document, which sets out the take home pay, deductions and administration for both a PAYE rate (or your taxable salary) and the umbrella rate (the invoice or contract value before employment costs are deducted). Umbrella take home shouldn’t vary much from one umbrella to another, other than the margin they charge. HMRC taxes shouldn’t vary other than by a few pounds dependent on that margin, so you should be able to compare like for like and make a decision.

“Your decision should be based on both the margin and the customer service you will receive, so do pick up the phone before you make that decision. Any attempt to prevent a comparison should make you stop and rethink.”

4. Beware the buzz words and promises of low fees

Terms like ‘loans’ should not be coming into the conversation. If you see that in an illustration then be suspicious. Lucy explains new terms are popping up all the time: “Beware of ‘loans’, ‘benefit trusts’ or ‘profit sharing schemes’, or variations on that theme.”

Lucy adds that promises of low fees are another watch out: “It’s just not possible to run an umbrella with a £5 a month margin. The legal expertise to comply with tax, contract and employment legislation is far more complex and onerous than people realise, which is why well-run umbrellas have rates nearer to £100.

“In my experience, tax avoidance schemes will spend huge amounts to attract clients at any cost – from low fees to spending large amounts on Google Adwords. Founders of well-run umbrellas simply can’t afford to spend such huge sums so, as with so many things in life, if the promises seem too good to be true then they will be.”

5. Mini umbrellas are a no go

In the latter part of 2020, the term ‘mini umbrella’ became more pervasive in the press, but not for the right reasons. On the face of it, mini umbrellas look niche and specialised but in actual fact they are part of a complex web of businesses used for tax avoidance. The professionalism with which they are run can also catch out end clients. Top tip – if you smell a rat, then chances are you’re right.

To confirm your hunch, challenge your end client on its due diligence, have they taken reasonable care to ensure the umbrella is being run correctly? In essence, you need to follow steps 1 to 4 above and do your own due diligence of the supply chain.
Be warned: HMRC is watching the development of mini umbrellas closely and has advised against the use in no uncertain terms. They will be after anyone caught up in one.

“It’s tough for those people who really need the work and find they have been duped to go down this route. But as hard as it may be, turning down the role is probably your best option, otherwise you’ll potentially land a hefty tax bill,” warns Rob. “The loan charge scandal is testament to the power HMRC will wield and the devastating impact it can have on families with retrospective taxes currently being applied as far back as 12 years.”

The final three tips on understanding the pitfalls of umbrella companies are available within our brand new IR35 Action Planner.