For many years, so-called umbrella companies have featured heavily in the world of recruitment. This is soon to end, as from 6th April 2016 contractors will no longer be able to claim travel and subsistence allowances as tax rebates from HMRC. The impact on both contractors and on recruiters is likely to be dramatic, and underlines the reasons why at First Base we have never used umbrella companies.

How do Umbrella companies work?
Essentially, umbrella companies provide PAYE services to recruiters who provide fixed term contract workers on behalf of their clients. The recruiter sources, interviews and manages the contractors, but once taken on board, the contractors are employed by the umbrella company rather than the recruiter.

This arrangement has proven attractive to recruiters for a number of reasons. Firstly, it takes away all the costs and responsibilities involved with employing temps directly, allowing recruiters to cut down drastically on administrative expenses. Secondly, the umbrella companies help recruiters keep the costs of temporary contractors down by allowing them to supplement minimum wage with travel and subsistence allowances claimed on their behalf. The recruiter can therefore offer an attractive proposition to their clients based on reduced overheads and lower staff costs.
On paper at least, the contractor also benefits from this arrangement, as their minimum wage take-home pay is often supplemented by 20-30% in reclaim taxes. The umbrella company handles this paperwork on their behalf without the contractor having to access HMRC directly.

The client wins by having access to minimum wage staff without any employment responsibilities and at the same time avoiding their HMRC obligations under IR35.

How does it work?

The client pays the recruiter for their fixed term contractors in the same way as if the recruiter employed them directly. The recruiter then pays the umbrella company, who is then responsible for paying the contractors. The contractors are paid minimum wage under the condition that they walk to work. The Umbrella Company then claims various travel and subsistence tax reliefs on their behalf, based on travel costs, food, accommodation etc. Some or all of these reimbursements are then passed on to the contractor, boosting their earnings by 20% or more in some cases.

What’s wrong with this?

Despite this arrangement having worked for several years, certain things about it are fundamentally wrong. From our perspective, these are also the factors that make it unstable:
Wages are kept artificially low through the promise of supposed tax incentives. This is obviously a negative thing for contractors, but clients are also affected. It makes clients ill-prepared for changes in legislation, such as the increase in the national living wage and the abolition of travel and subsistence allowances this coming year.

Recruiters put their margins at severe risk. This is likely to be a problem for some agencies over the coming year. Umbrellas have allowed some recruitment companies to make impressive savings on their fixed term contract employees. Some of these savings have been passed on to clients, and some have been transformed into high margins. With the end of travel and subsistence benefits and the likely collapse of umbrella companies, employment expenses are expected to leap by up to 30%. Where are these additional costs likely to fall? A recruiter in this position can attempt to pass the cost onto their client but at the risk of becoming uncompetitive. Or they can accept the loss of nearly all their profits by absorbing the cost themselves. Or they pass the cost onto candidates through reduced wage incentives. It is not an attractive proposition whichever way you look at it.

Umbrella companies exploit contractors: the majority of contractors who benefit from this arrangement do not go into it with their eyes open. As temporary workers, they are often not made aware of their employment situation. Many of them are registered by the company as self-employed without them fully realising the implications of this. This makes them ultimately responsible for paying their own national insurance and tax, and removes them from the protection of working legislation, such a statutory sick pay, maternity pay and company pension provision.

What does the future hold?

These changes in legislation, we feel, will ultimately be positive for recruiters, clients and contractors. However, in the short term, we do worry that some of our partners in the recruitment industry will struggle to come to terms with the changes. At First Base, we have never used umbrella companies for the reasons listed above. We do not believe they provide a fair deal to contractors, to clients or ultimately to recruiters either. So our rates and conditions for fixed term contractors will remain unchanged.

If you are a client who is worried about increasing staff costs as a result about this, please get in touch to talk about how you can reduce overheads while still offering a fair deal to your contractors.

Tricia Hay

Tricia Hay is Owner, Director of First Base Employment Limited