Contractors beware: HMRC targeting umbrella corps

Umbrella firms threatened with deregistration, taxes and arrests

The UK's tax authority, HM Revenue and Customs (HMRC), is cracking down on umbrella companies that contractors use to pay their taxes.

According to multinational law firm Pinsent Masons, the number of First Tier tax tribunal cases awaiting hearing has surged more than sevenfold since the same quarter last year.

At the end of June 2022, there were 10,000 cases backlogged, up from 1,200 at the end of June 2021.

The main reason behind the rapid increase is the large number of cases HMRC that is pursuing against umbrella firms it believes have underpaid VAT.

"With a large number of umbrella companies suspected of VAT avoidance, the tax tribunal backlog has grown massively in a very short time," said Steven Porter, a partner at the law firm.

"Contractors looking to sign up with an umbrella company should be aware that it is likely the umbrella company will be required to pay VAT. HMRC will view any claims to the contrary with suspicion."

The changes to the off-payroll working (OPW) rules, commonly known as IR35, came into effect on 6th April 2021, making medium and large-sized private and public sector organisations responsible for determining the employment status of the contractors they engage, for tax purposes. In other words, organisations now have to decide whether the contractors they use should be taxed as off-payroll workers or permanent employees.

Under previous IR35 rules, which were in place for nearly 20 years, contractors were allowed to self-declare their tax liabilities; that is, whether they should be taxed in the same way as salaried workers or as off-payroll employees.

HMRC says that system was open to abuse because contractors could intentionally mis-classify their working arrangements with their employers to curtail their tax liabilities.

The change to IR35 has led to a sharp rise in contractors' use of umbrella firms, especially in the tech industry.

Contractors who use an umbrella firm have the choice of working on a contractual basis while still having an employer handle things like tax returns, etc.

"HMRC...and the tribunal are aiming to clear the backlog of tribunal cases quickly - HMRC are confident that they will win and move on to collecting the VAT it believes it is owed," said Porter.

"HMRC sees the tax affairs of contractors as an area where it is missing out on a lot of unpaid tax. Umbrella companies are firmly in its crosshairs."

A spokesperson at HMRC said: "We are using our civil and criminal powers to challenge those involved in Mini Umbrella Company (MUC) fraud, including deregistering tens of thousands of MUCs who we believe were exploiting the VAT Flat Rate Scheme and removing their access to the Employment Allowance."

"We have made a number of arrests in relation to MUC fraud and also taken steps to recover input tax in cases where it is established that a business in the supply chain knew, or should have known, there was fraud."

Some government departments have struggled to implement the new IR35 rules correctly.

Last month, NHS Digital and Defra were among those that were required to settle bills for unpaid taxes.