Regulation of umbrella firms under Employment Rights Bill Part 1

Umbrella companies will soon be regulated in the UK for the first time. The Employment Rights Bill is set to introduce a new level of regulation and oversight which could make these businesses a less attractive link in the temporary labour supply chain.

In this 2-part article, we firstly consider the effect that the provisions under the ERB will have on umbrella companies and then look at what this means in practice for those businesses that are impacted by the changes.

Expanding the definition of “employment business”

As it stands, employment agencies and employment businesses are regulated by the Employment Agencies Act 1973 (EAA 1973) and Conduct of Employment Agencies and Employment Businesses Regulations 2003 (Conduct Regulations).

An “employment business” has traditionally meant a business supplying its own employees or workers to work under the control of someone else – in other words, typical temporary staffing agencies that employ temps and send them to client companies. This narrow definition left a gap into which intermediary companies which are part of the supply chain, but do not place workers into assignments, did not fit.

Those intermediaries have colloquially been referred to as “umbrella companies”, a term which has not historically been defined by statute. Umbrella companies have generally fallen outside the scope of the Conduct Regulations’ and have consequently developed a reputation for having ‘low regulation’ and a convenient structure for the provision of casual workers.

The ERB closes that loophole. Section 34 proposes to expand the definition of “employment business” to include umbrella arrangements. Instead of focusing only on “supplying persons” as per the old definition, the new definition covers “participating in employment arrangements”. Practically, this means any business involved in employing or paying individuals who are supplied to work under someone else’s direction will count as an employment business.

An umbrella company, which employs a worker and then supplies that worker’s labour to an end client via an agency, will fall under this broadened description. The ERB’s language (“participating in” employment arrangements) is deliberately wide to capture various intermediaries in the supply chain.

How umbrella companies operate

The term “umbrella company” is most often used to refer to a third-party employer in the temp hiring supply chain. Typically, a recruitment agency finds a temporary role with a client, but instead of putting the worker on the agency’s payroll, the worker is employed and paid by an umbrella company.

The umbrella company signs a contract with the worker and handles all payroll, tax arrangements (PAYE), and benefits such as holiday pay and SSP. It then invoices the recruitment agency or end client for the worker’s services (including the worker’s pay, plus the umbrella company’s fee and any employment costs). In short, the umbrella company sits between the worker and the agency, acting as the employer for the worker and as a service provider to the agency.

This model became popular for various reasons: recruitment agencies can pass on administrative burdens and liability (since the umbrella company is the employer), end clients get the workers they need without extra headcount, and workers may gain continuity of employment even as they move between assignments (since they stay employed by the same umbrella company).

However, the lack of specific regulation left space for some companies to adopt practices that would not otherwise be permitted under the Conduct Regulations. For example, there have been cases of umbrella companies making opaque deductions from pay (for supposed administrative fees or salary sacrifices) that workers did not understand and withholding holiday pay unless specifically claimed. The UK’s Employment Agency Standards Inspectorate (EASI) had limited oversight of these arrangements and could only step in if an umbrella’s activities inadvertently fell within scope of the Conduct Regulations.

By bringing umbrellas into the regulatory framework, the ERB aims to address these issues. It is worth noting that the umbrella sector is significant – by recent government estimates, around 700,000 workers are paid through umbrella companies in the UK, via roughly 500 different umbrella providers. Therefore, this reform will directly affect a large segment of the contingent workforce and the businesses that rely on it.

In the second article we will look at what businesses must do to comply with the Conduct Regulations.