Following the ongoing storm surrounding the implementation of IR35 reform in the private sector, a significant number of freelancers have been forced into the supposed safety and shelter of umbrella companies, writes Andy Chamberlain, director of Policy at the Association of Independent Professionals and the Self-Employed (IPSE).

As many freelancers know, umbrella companies act as an intermediary between them -- as temporary workers -- and labour suppliers, like recruitment agencies. Umbrellas shield clients and agencies from IR35-related risks by taking on the responsibility to tax the worker at source.

Some end-clients use umbrella companies to avoid notoriously difficult employment status decisions altogether – the ‘blanket ban’ approach we’ve seen from many hirers in the financial services sector. While other organisations defer to them once they have come to an ‘inside IR35’ determination. Either way, umbrella companies provide a simple and risk-averse solution to the IR35 ‘problem’ and that benefits the whole supply chain. Except perhaps, the worker.

For self-employed workers, the trend towards umbrella companies, over the past year has replaced one storm with another. In other words, rather than dealing with HMRC and the complications surrounding IR35, freelance contractors are increasingly having to deal with umbrella companies and the no-man’s land between full-time employment and the independence of self-employment.

In legal and technical terms, umbrella companies employ their workers, and they provide them with employee benefits. But it is a strange sort of employment. The chances are that no one in the umbrella company will have any kind of relationship with the ‘employee’. The umbrella will not know what its employee is doing on a day-to-day basis, nor where he or she is doing it, or even why.

Further, the umbrella will not be seeking to promote the ‘employee’, nor provide him or her with work to do, nor invite him or her to team meetings with any of its other ‘employees’. The umbrella certainly won’t be spending money on things like training, well-being, team-building exercises, and Christmas parties!

In return, the ‘employee’ does not feel like an employee and even if they did, it is doubtful they would say the umbrella company feels like their ‘employer.’ To most of their ‘users’ (perhaps a more accurate term), the umbrella is often a faceless organisation. Yes, the umbrella pays them, after tax has been deducted,  but the worker’s day rate gets reduced to cover Employer NI and (where applicable), the Apprenticeship Levy. This is a highly contentious part of the model – the ‘employees’ may expect to have to pay Employee NI, but if anyone is paying Employer’ NI, shouldn’t it be – well, the employer?

Some economists like to argue that in fact, all employees pay Employer NI through reduced wages, so umbrella workers are no different.

There are two problems with this argument. One, I don’t think it’s true – if it were, salaries across the board would have been reduced by 1.25% last month when the employer NI rate was hiked (which didn’t happen). Two, even though it is at least partially true that employees suffer lower wages as a result of Employer NI, most employees don’t realise it. If you ask a traditional employee who pays the Employer NI, they will say ‘their employer’. If you ask the same question of an umbrella employee, they will say ‘I pay it.’

The argument is even clearer when it comes to Apprenticeship Levy (AL). No employee believes they pay AL; because they don’t -- except umbrella employees; because they do. At least in effect.

Aside from the seemingly irreconcilable problem of NI and AL, umbrellas are also increasingly controversial, as over the past year, individuals working via them have made a number of allegations against these quasi-employers. For avoiding potentially up to millions of pounds worth of tax; for manipulating rules so that workers can’t receive the holiday pay that they are entitled to; for doing other underhanded things with other statutory benefits which employees ought not to expect from any decent employer.

Moreover, there are difficulties for self-employed workers, when it comes to IR35. While businesses use umbrella companies to avoid running into difficulty with the flawed reform of the Intermediaries legislation, there are signs that recruiters are being over cautious - and therefore damaging the financial wellbeing of freelance workers unnecessarily. According to our research, over half of umbrella company workers (57%) believe that their role is outside IR35 but that the supply chain simply won’t allow them to take the risk of working through their own limited company. 

Following these complaints, there has been significant anger towards umbrella companies over the past year. For example, seven in 10 umbrella company workers believe that they lack the same (full) employment benefits as an employee. Worryingly, we also found that more than three in five individuals believe that there are no advantages to working through an umbrella company.

Solving the issues around umbrella companies is paramount to their success and the long growth of the self-employed sector. If more and more workers are forced into umbrella companies, then freelancers will increasingly lose out on their independence and control and will have to pay additional costs like umbrella company admin fees.

While some umbrella companies admittedly do remove businesses’ worries around IR35 – and many do deliver a valuable service for workers and companies alike, too many provide workers with little to no benefits. With many self-employed workers being forced into umbrella companies -- often without even a choice over which umbrella company they use due to a Preferred Supplier List being in place -- it is clear that action needs to be taken by the government to stop people from entering into pseudo-employment relationships. And these are relationships that a significant number of individuals do not want.

With the government recently launching a call for evidence around umbrella companies, we hope that policy-makers listen to the thousands of umbrella company workers who have failed to see the benefits of working via an umbrella company. In particular, we hope that the government legislates to standardise holiday pay rules and increase transparency. What can they do about the employer NI and AL problem? Probably nothing – they’d have to fix the whole tax system for that.