The government's extension of off-payroll working rules to the private sector in April 2021 has resulted in an increased use of umbrella companies, Lords warn.

In a letter to the Treasury, members of the House of Lords Economic Affairs Finance Bill Sub-Committee expressed serious concerns that the extension of the off-payroll rules to the private sector is resulting in greater numbers of people using umbrella companies; and increasing the risk that some individuals, particularly those on low incomes, will become involved with rogue umbrella companies associated with tax avoidance. ‘Paradoxically, this appears to substitute one form of tax avoidance for another,’ the Lords warned.

‘This is highly regrettable, given that the purpose of the off-payroll rules is to curb tax avoidance,’ the Lords’ letter said. ‘While we welcome the call for evidence on umbrella companies, and the work HMRC has done to counter rogue umbrella companies, we believe that this work needs greater urgency.’

The government needs to commit to a date for bringing forward legislation to create the proposed single enforcement body to regulate umbrella companies.

Members of the committee also criticised HMRC’s CEST tool, which assesses whether contractors fall under IR35 rules or should be hired and paid as employees.

The Lords stated that they ‘believe it is critical CEST’s limits are clearly acknowledged by HMRC. It cannot and should not be a substitute for law. HMRC needs to ensure that, in its compliance work, it recognises that the use of other means to assess employment status is both legitimate and reasonable’.

The 20% ‘undetermined’ rate means a significant number of people need additional support to identify their status to determine whether the off-payroll working rules apply. ‘We consider that more must be done to improve the advice and support available for those who receive a CEST “unable to determine” outcome,’ the Lords said.

The continued absence of questions on mutuality of obligation within CEST means that many of those impacted by the off-payroll working rules do not have confidence in the accuracy of its results. The letter stated: ‘We recommend that HMRC work with stakeholders through the IR35 Forum to agree modifications to CEST to reflect the test of mutuality of obligation properly.’

While a light-touch approach is ‘admirable’ where engagers are making honest mistakes, the Lords suggested tougher compliance action is needed where engagers are effectively evading their obligations under the rules to make individual determinations, including the use of blanket bans.

The government must take a more coherent approach to the issue of employment status, which considers both tax and employment rights, the Lords said, adding that 'it is unfair that individuals are treated as employees for tax purposes but without the rights which are normally associated with employment'. To address this, the government should press ahead with implementing the proposals set out in the Taylor Review of Modern Working Practices.

Lord Bridges of Headley, chair of the House of Lords Economic Affairs Finance Bill Sub-Committee, said: 'The whole point of the off-payroll reforms was to crack down on tax avoidance. Yet, as we warned the government in our Sub-Committee’s report in 2020, it risks giving rise to a new wave of tax avoidance, as people — many of them on low incomes — end up in rogue umbrella companies. The government must take action to protect workers from "rogue" operators as a matter of urgency.

'It is right that HMRC commissions external research into the impact of these off-payroll rules. But by only focusing on engagers, it will only get half the story. Its scope needs to be widened to include contractors — and needs to be carried out more quickly.

'The Government has said it is committed to fairness in the workplace. However, it is unfair for individuals to be treated as employees for tax purposes without having employment rights. Our Sub-Committee reiterates the call we made in our 2020 report for the government to press ahead with implementing the proposals set out in the Taylor Review.'