Umbrella Tax Liability Rules Put Agencies on the Hook for Unpaid PAYE
New joint and several liability rules allowed HMRC to recover umbrella company payroll shortfalls from recruitment agencies or end clients, changing the risk behind thousands of contractor engagements.
The balance of risk in the umbrella company market changed on 6 April when new tax rules took effect across both new and existing labour supply chains.
Under Chapter 11 of Part 2 of the Income Tax (Earnings and Pensions) Act 2003, an agency that contracts with an end client to supply workers can be held jointly and severally liable when an umbrella company fails to operate PAYE correctly. Where no agency is involved, the liability can fall upon the end client.
The rules apply to qualifying payments made on or after 6 April 2026, including payments under arrangements that began earlier. They cover PAYE Income Tax, student loan deductions and employee and employer National Insurance contributions.
Liability moved up the supply chain
The umbrella remains the worker’s employer and remains responsible for running payroll. The crucial change is that it is no longer the only business from which HM Revenue and Customs can recover a shortfall.
HMRC guidance states: “If we find an umbrella company has not paid the correct amount of PAYE to us, we’ll recover it from you.”
In a standard chain, that warning is directed to the agency holding the contract with the client. If an umbrella fails, becomes insolvent or has used a non compliant payment model, the agency may have to pay tax that it believed had already been included in the money transferred down the chain.
Dave Chaplin, chief executive of IR35 Shield, described the change as “the most brutal piece of tax legislation I’ve seen in 25 years”. His concern was that the agency could inherit liability caused by another company’s conduct.
Unlike the off payroll rules, the legislation does not provide an equivalent statutory reasonable care defence. Due diligence remains commercially essential, but extensive checks do not automatically remove liability if the tax remains unpaid.
A market affecting about 700,000 workers
The government estimated that approximately 700,000 people worked through umbrella companies. It expected the measure to have a significant effect on about 30,000 agencies and 400 umbrella businesses.
The forecast Exchequer benefit was £715 million in 2026 to 2027, followed by £635 million in 2027 to 2028. Government estimates put one time business compliance costs at £9.9 million and continuing administrative costs at £21.7 million a year.
For recruiters, the immediate response was likely to include shorter preferred supplier lists, more payroll evidence, stronger contractual protections and closer monitoring of Real Time Information submissions. Some agencies or clients were expected to move workers onto their own payroll rather than retain an umbrella in the chain.
Contractors could still feel the disruption
The legislation did not make umbrella employees responsible for the agency’s new liability, and it did not turn umbrella work into an IR35 engagement. An umbrella employee is already taxed through PAYE, whereas IR35 determines the tax treatment of a worker supplying services through an intermediary such as a personal service company.
The two systems nevertheless interact in the market. Risk averse clients pushed many contractors towards umbrellas after the public and private sector off payroll reforms. Agencies now faced a distinct tax risk in the same model they had often presented as the safer alternative.
Contractors could therefore encounter fewer permitted umbrellas, additional onboarding checks, a change of employer or a move onto agency payroll. Changing umbrellas could also create practical issues involving tax codes, starter and leaver documents, pension arrangements and continuity of employment.
The strongest protection for workers remained transparency. Contractors needed to compare the assignment rate with gross taxable pay, understand employer costs and the umbrella margin, check deductions against the Key Information Document and retain payslips and reconciliation statements.
The reform was designed to protect workers and the Exchequer from non compliance. Its wider significance was that umbrella engagement had ceased to be a simple way for agencies and clients to transfer payroll risk. From April, the businesses controlling the supply chain had a direct financial reason to examine who was paying contractors and what happened to every pound deducted.