The new Chancellor of the Exchequer, Rt Hon Rachel Reeves MP, announced the Budget with potentially unforeseen and far-reaching consequences for contractors, recruiters and end-clients.
In this article, Martyn Valentine LLB (Hons), director and founder of The Law Place Limited, outlines the impact of the Budget, including:
- A 1.2% increase in employer’s National Insurance contributions to 15% from April 2025
- Reduction in the Secondary Threshold (the level at which employers must start paying national insurance on each employee’s salary) from £9,100 per year to £5,000
- Dividend tax not affected
- Crackdown on umbrella companies (paragraph 5.26 of the Autumn Budget 2024)
- Increasing the Employment Allowance from £5,000 to £10,500 – unlikely to affect most agency workers
What does this mean for contractors and end-clients?
The rise in employer’s National Insurance contributions will significantly increase the cost of engaging contractors on an inside IR35 basis, i.e., where a client has made a policy decision to determine that all engagements involving limited company contractors are inside IR35.
The cost of the increased employer’s National Insurance contributions will, in our view, exceed the cost of setting aside funds to defend an IR35 enquiry. End-clients will now face the choice between implementing robust assessment processes to manage outside IR35 engagements or paying increased fees to recruiters and umbrella companies to offset the increase in employer’s National Insurance contributions.
Where umbrella companies are used, end-clients will face an increased risk of liability for underpayments of tax and National Insurance contributions once the forthcoming debt transfer legislation is implemented by April 2026. Contrary to the views of trade bodies such as the REC, debt transfer is not unprecedented, for example, the Managed Service Companies legislation.
In all cases where a recruiter supplies agency workers to end-clients, recruitment costs will correspondingly increase. This increase will not affect contractors engaged on an outside IR35 basis, subject to the comments below.
End-clients will note that the previous government introduced legislation to offset any tax paid by a contractor against any liability for tax incurred by a ‘deemed employer’ if the off-payroll legislation is found to apply to an engagement, therefore dramatically reducing the risk of engaging contractors on an outside IR35 basis.
How are umbrella companies affected by the increase in employer’s National Insurance contributions?
Umbrella companies charge an ‘assignment rate’ including the costs of employment (tax and employer’s National Insurance contributions) to a recruiter. The gross rate (less employment costs constituting the assignment rate) is then subject to deductions for employee’s National Insurance contributions and income tax then paid to the employee.
In theory, umbrella companies must remit tax and National Insurance contributions to HM Revenue & Customs. However, it is normal practice for recruiters to make the offer of an engagement conditional on an agency worker signing up to an umbrella company in a joint venture or partnership with the recruiter. Unfortunately, many such arrangements involve a candidate accepting pay on the basis of an unlawful loan charge arrangement (or similar scheme) and then becoming liable at a later date for underpaying tax, with disastrous personal consequences. Arrangements requiring the use of a connected service are a breach of the Conduct of Employment Agencies and Employment Businesses Regulations 2003. Similarly, a requirement to use an umbrella company involving payment by an agency worker for invoices is a criminal offence, being an indirect charge for work-finding services.
The Chancellor announced a crackdown on unlawful practices by umbrella companies to ensure that the correct tax is paid. Once the new legislation is introduced, ‘umbrella companies will no longer be legally responsible for operating PAYE on payments to the workers that they employ’ (https://www.gov.uk/government/publications/tackling-tax-non-compliance-umbrella-company-market/tackling-non-compliance-in-the-umbrella-company-market–3).
All umbrella companies will now face rising costs as the increased assignment rate cannot cause the agreed gross rate payable to an umbrella employee to be correspondingly reduced. Umbrella employees can issue a claim for breach of contract in court where pay has been reduced without agreement.
The Conduct of Employment Agencies and Employment Businesses Regulations 2003 prohibit a recruiter (an ’employment business’) from withholding fees owed to an agency worker, so any reduction in fees owing to an umbrella employee may result in litigation. Opt-out notices in the context of agency workers are void unless the agency worker is properly informed of the consequences (Exchequer Solutions Limited).
Once the debt transfer legislation is implemented by April 2026, it is anticipated that the umbrella industry will be replaced by regulated payroll providers who merely act as sub-contractors for recruiters or end-clients.
How is this good news for contractors?
As the costs of engaging contractors inside IR35 will increase and the recruitment industry is facing headwinds such as the Employment Rights Bill 2024 (which proposes to eliminate zero-hours contracts in all cases except for task-based and temporary requirements), engaging contractors on an outside IR35 basis will be the preferential option for risk-averse end-clients. As a contractor’s limited company is the employer, all risks under the Employment Rights Act 1996 (as amended) can be avoided. If limited company contractors are used, there is no risk of liability for additional tax if the engagement is legitimately outside IR35.
Let’s remember that paying a contractor on an outside IR35 basis means paying without deduction of tax and National Insurance contributions and incurring a risk of debt transfer where an umbrella company is unable to pay its debts.
The Chancellor did not announce any changes to dividend tax, thereby retaining an advantage for contracting via a limited company.
What can end-clients do?
Having reviewed thousands of purportedly ‘outside IR35’ contracts produced by trade bodies, legal information services, tax advisers and accountants, we conclude that the vast majority of these contracts are not fit for purpose and needlessly expose end-clients to litigation risk.
End-clients would be well advised to replace their contractual documents and ensure that all status determination statements contain an explanation (ideally drafted by a lawyer skilled in employment status law) as to why the terms on which the services are provided support the conclusion. Either relying on HM Revenue & Customs’ CEST tool or referring to the contract holistically instead of the individual terms is an invitation for HM Revenue & Customs to impose penalties for failing to take reasonable care.
End-clients can manage the changing market conditions by implementing processes for undertaking status determination statements prior to a formal offer of an engagement, proactively monitoring changes in working practices, and expressly requiring a recruiter (i.e., in a written contract) to disclose a copy of the terms as may be offered to a limited company contractor candidate.
The proposed debt transfer legislation will expose end-clients to the unconscionable risk of tax liability where umbrella companies are used. For the purposes of agency workers, the risk can be mitigated by insisting recruiters either process payroll internally or use payroll providers supported by approved insurance policies. There is nothing to be gained in waiting until April 2026, so end-clients and recruiters may choose to transition to life without umbrellas.
End-clients must balance the manageable risk posed by the off-payroll legislation against the increased costs of engaging contractors inside IR35 or as agency workers. The curious addiction to umbrella companies risks reputational harm and financial loss for recruiters and end-clients alike. It’s time to rethink misconceived blanket bans on limited company contractors who merely wish to work in a genuinely self-employed capacity. By April 2026, the risk for recruiters and end-clients in using umbrella companies will be unacceptable, and the umbrella industry as we know it will end.
A further article on the measures to crack down on umbrella companies not correctly paying tax will be published once the Treasury has published full details.
How can The Law Place help?
Contact Martyn Valentine LLB (Hons) for legal advice about how you can minimise risk for all parties in the supply chain. We offer legal status determination statements, IR35 Contract Reviews, industry-leading contract packages and general legal advice.
Our expertise is based on legal qualifications, specific IR35 training, and 20 years of experience in providing employment status and IR35 advice, all backed by legal professional indemnity insurance.
We offer a free 15-minute consultation to new clients –call 07788 773871 or email martyn@thelawplace.co.uk.
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