IR35 Reforms Encourage Tax Fraud by Umbrellas

Recently, there has been a spate of complaints by contractors about umbrella companies and employment businesses who are deducting employer’s national insurance contributions where the client is a public authority and the new ‘off-payroll’ (i.e. Income Tax (Earnings and Pensions) Act 2003 Chapter 10) rules apply. 

In other words, the public authority client has decided that the engagement constitutes deemed employment and the party below the public authority client in the payment chain, usually an employment business, has wrongly deducted employer’s national insurance contributions from the ‘deemed direct payment’ owing to the contractor.

This despicable practice is prohibited by statute and evidence suggests that employment businesses and umbrella companies are ‘skimming off’ employer’s national insurance contributions resulting in significantly less income payable to contractors. Where the off-payroll rules apply a public authority client must account to HM Revenue & Customs for employer’s national insurance contributions separately and not as a deduction from the fees owing to the contractor. 

This is precisely the same as for any employee; after all, if you’re an employee and notice on your payslip that a deduction has been made for employer’s national insurance contributions your response is likely to be unprintable. The warning signs for contractors include ambiguous statements concerning ‘deductions’ in the contract of employment with an umbrella company and payments for odd amounts.

The consequences for an employment business or umbrella company unlawfully deducting employment contributions are dire. HM Revenue & Customs in the first instance will claim any underpayment in national insurance contributions plus interest and penalties. Further, if the off-payroll rules genuinely apply then the contractor is likely to succeed in a claim for unlawful deductions from wages against the umbrella company in the employment tribunal. This is likely where ‘services’ description in the contract simply refers to a job title such as speech therapist. It is predicted that in the next 3-6 months a large proportion of umbrella companies will have been liquidated. 

As the recent case of Elbourn demonstrates, the employment tribunal can effectively reverse an incorrect status decision caused by using the much-maligned CEST tool (or otherwise) where the contractor claiming unlawful deductions from wages is truly self-employed for the engagement in question and, therefore, does not fall within the tribunal’s jurisdiction (s.230 Employment Rights Act 1996). The only defence for an umbrella company facing a claim for unlawful deduction from wages is to show that the public authority client is a customer of a business carried on by the individual and therefore the off-payroll rules don’t apply. The contractor would then be entitled to payment gross of tax under s.44 Income Tax (Earnings and Pensions) Act 2003 from the outset of the engagement. This is clearly invidious for umbrella companies.

Where a contractor has been told by a public authority client that the off-payroll rules apply the best option is to insist on being supplied by the employment business as an Agency Worker and not to sign an opt-out of the Conduct of Employment Agencies and Employment Businesses Regulations 2003. This avoids any misunderstanding as to a contractor’s rights under the Agency Worker Regulations 2010.

Let’s be clear, there is no legal basis for using an umbrella company and it is unlawful for an employment business to insist or otherwise make a condition of providing work-finding services that a contractor uses a particular umbrella company which involves any form of payment or deduction from wages. In fact, a contractor in this unfortunate position would be entitled to compensation and the employment business would be investigated by the Employment Agencies Standards Inspectorate. Where financial inducements have been offered by an umbrella company to an employment business criminal penalties under the Bribery Act 2010 may apply.

Since 2003 employment businesses have been prohibited from adopting this practice. Where an employment business has attempted to force a contractor to sign an opt-out notice where there is no advantage for the contractor and the employment business wants to use a particular umbrella company it is open for the courts to strike down such a notice.

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