When the UK’s furlough scheme was announced near the start of the pandemic, Paul Stephenson thought he would be eligible. He was working via a temp agency in a small manufacturing company where other staff were being furloughed. But he wasn’t employed by either the manufacturer or the agency.

Instead, his employer was an “umbrella company” which he couldn’t contact directly and was, according to its Companies House filings, run by one person in the Philippines. Even stranger, he soon received a notification that his employer had changed. This company was apparently run by someone in the Philippines too.

“This is crazy,” he wrote to me. “Any chance I had of getting my furlough organised has presumably been lost and my employment data is being passed around like a plate of biscuits.”

Umbrella companies are intermediaries: they employ people on behalf of clients or agencies which don’t want to employ those workers directly. When they appeared about 20 years ago, they catered mostly to white-collar contractors who wanted to be employed through an umbrella rather than to operate as sole traders or limited companies. Changes to IR35 tax rules by HM Revenue & Customs have pushed more contractors in this direction.

Temp agencies also use umbrellas as a way to “outsource the administrative costs and responsibilities of meeting tax and employment rights law”, as the government puts it. This leaves them free to focus on recruitment.

In the 2007/8 tax year, HMRC estimated roughly 100,000 people were working through umbrella companies. By 2020/21, the number was “at least” 500,000. The Low Incomes Tax Reform Group estimates that half of all agency workers work through umbrella companies.

Plenty of umbrellas comply fully with tax and employment rules. But the government has identified a number of scams which suck money out of the pockets of workers or taxpayers. These include skimming money from people’s wages or depriving them of holiday pay, paying workers part of their salaries in a “loan” to avoid tax, and setting up “mini-umbrellas” to claim tax reliefs aimed at small employers.

While HMRC has tried to crack down on tax scams, the sector remains deeply under-regulated. Unlike agencies, umbrellas are not regulated by the Employment Agency Standards Inspectorate. And by accident or design, the fragmented employment relationship means workers can struggle to hold anyone to account if something goes wrong.

Legitimate umbrella companies are desperate for the government to regulate the sector so they are not undercut by unfair competition. The Freelancer & Contractor Services Association, a body for umbrella companies, declared last year the sector was “rife” with “truly terrible practices” which the government had “failed to, in any way, effectively police”. The Recruitment & Employment Confederation, which represents agencies, has also called repeatedly for regulation.

Yet the government has been slow to act. In 2018, it consulted on the recommendation to bring umbrella companies “into scope for state enforcement” and later published a plan to that effect. Last June it “reaffirmed its commitment” when it promised to create a single enforcement body for workers’ rights. In November, it issued a “call for evidence” with the aim of bringing umbrellas into the scope of the EAS, which regulates agencies. To date, none of these things has happened.

Even if the government makes the EAS responsible for umbrellas, it’s hard to see how the regulator would cope without additional resources. It employs fewer than 20 frontline inspectors, according to its latest annual report.

A better solution would be to hold companies jointly responsible for tax or employment rights breaches that happen down their labour supply chains. You might not employ a worker directly, but if they are performing labour for you, then don’t you have some responsibility to make sure they are not underpaid or exploited?

This would remove the incentive for companies to choose the cheapest agency or umbrella without paying attention to the details. Kevin Barrow, a partner at law firm Osborne Clarke, believes decent companies would welcome this. “They see competitors getting a competitive edge by using supply chains they haven’t properly checked out and it makes them fed up,” he says.

Britain’s flexible labour market got through the pandemic in better shape than many economists feared, but there is rot below that damages workers, taxpayers and decent businesses alike. The longer we leave it, the worse it will get.

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