Umbrella Companies Explained | Umbrella company guide for contractors

What everybody ought to know about umbrella companies

Contractor umbrella companies have been around for almost 20 years. Before they existed, most freelancers and contractors either worked through their own limited company or as a PAYE employee of a recruitment agency (or the end-client).

Nowadays, it’s believed that over 400,000 contractors and freelancers in the UK are paid through umbrella companies – a colossal amount! The number significantly rose when changes to off-payroll in the public sector came into effect in April 2017. And, with changes to off-payroll in the private sector set to come into effect in April 2021, this figure is likely to rise again.

We’re not here to tell you that using an umbrella company is the best option to maximise your pay retention – it’s not. It’s no secret that the most tax-efficient way to operate as a contractor is working outside of IR35 legislation and through a limited company (PSC). However, if you find that you’re contracting inside IR35, or you’re not interested in being the Director of your own limited company, using an umbrella company may well suit you perfectly.

Sure, getting paid by an umbrella isn’t as tax efficient as limited company contracting, but there are plenty of other benefits. Keep reading and find out more about umbrella companies, including how they work, the pros and cons, and most importantly, the reasons you must choose a compliant provider.

Trust us – compliance is crucial.

 

What do umbrella companies do?

To put it simply – umbrella companies process the payroll of temporary workers (PAYE) and are responsible for deducting the correct tax and National Insurance Contributions (NICs). These are sent to HMRC directly. The only revenue that umbrella companies generate for themselves is their margin (typically between £15 and £25 per week).

For more information, check out our umbrella company example and walkthrough.

Assuming you choose a compliant umbrella company for your payroll (as we discuss later) – you have absolutely nothing to worry about! Using an umbrella is actually really straightforward and generally regarded as the easiest way to get paid if you’re a temporary worker. Oh, and there are some benefits to using umbrellas as well. For example, when you join an umbrella, you become an employee of theirs – even though you don’t work for them. With this comes continuity of employment, Employee Benefits, and more!

 

Who needs to use an umbrella company?

If limited company contracting isn’t an option

If you find a contract that’s genuinely outside IR35 and you can operate through a personal service company (PSC) – go for it! Limited company contracting has long been the most tax-efficient way to operate as a contractor because you can benefit from paying yourself with a combination of salary and dividends. However, to the displeasure of thousands of temporary workers, the environment is changing, and finding roles outside IR35 has become more of a challenge. And, with changes of off-payroll legislation, more and more contractors are finding their assignments are inside IR35. If this is your predicament – you may decide that the best way forward is to use an umbrella, and we don’t blame you.

If your agency or end-client prefer to outsource their payroll

Plenty of recruitment agencies and organisations engaging with temporary workers prefer to outsource their payroll responsibilities. After all, running payroll for hundreds or thousands of workers can be stressful, time-consuming and expensive. Therefore, by outsourcing payroll to umbrella companies, temporary workers can be paid without any problems, and firms don’t need to add their temporary workforce to their payroll.

So, if you’re offered an assignment, part of the arrangement may involve using an umbrella company for your payroll. You will find that most ethical and established recruitment agencies (or organisations engaging directly with temporary workers) will have a dependable Preferred Supplier List (PSL) in place for you to choose from/for you to conduct your own research from.

Using an umbrella company is your choice. You should never be forced into signing up with an umbrella if you don’t want to. And, if an agency or business tells you that you must sign up with a specific umbrella – this isn’t fair. With so many umbrellas in the UK marketplace, you should be able to make your own decision, or at least have a choice from several proven providers. We quite like the idea of agencies having a Preferred Supplier List (PSL) with a selection of compliant umbrella companies for you to choose from – providing they have done their due diligence of course!

 

How does an umbrella company work?

This is probably best explained as a series of step by step processes. As umbrellas will process your pay in the same way, they’ll all follow the steps below, and while procedures may vary very slightly, these are the general processes – from signing up to getting paid.

  1. Choose an umbrella you’re comfortable with. Usually, if you’re working through an agency, they’ll have a Preferred Supplier List (PSL) and will ask you to pick one from there. If not, we recommend you look for an FCSA accredited umbrella because you’ll be in safe hands.
  2. You’ll need to register with the umbrella company, usually over the phone or by completing an online registration form.
  3. You’ll be required to provide proof of your identity, right to work in the UK and finally, a P45 (or Right to Work document if you don’t have one).
  4. Once registered, you sign an employment contract between you (the employee) and the umbrella company (the employer).
  5. At the end of the week, you will need to submit timesheets that reflect the hours you’ve worked. This is usually done by emailing the umbrella company, or using an online portal (if they have one).
  6. You may be eligible for expenses – although it’s unlikely because of the introduction of Supervision, Direction or Control (SDC). If you can legitimately claim expenses, you’ll need to email these to your umbrella company too. To our knowledge, most umbrellas aren’t prepared to allow their clients to claim expense because 99% of contractors and freelancers will fail the SDC test, thus not being eligible. They may be willing to process reimbursed expenses though – so ask them.
  7. Once you’ve submitted timesheets, your umbrella will invoice your agency (or end-client, if no agency).
  8. The umbrella will process your pay.
  9. You will be paid your assignment rate, minus the agreed deductions that would have been explained to you upon sign up. These include tax and Employee’s NIC’s (PAYE), the umbrella company’s margin, and employment costs (Employers NIC’s and the Apprenticeship Levy). And, you’ll be auto-enrolled into a pension after 12 weeks (legal requirement) and you may be required to pay back a student loan – depending on your circumstances. You can easily opt out of pension contributions, if you’d prefer.
  10. At the end of the tax year, your umbrella company gives you a P60 and P11D (for any expenses claimed).

 

Umbrella companies get some negative press

We’re not here to put wool over your eyes – some umbrella companies have often been on the receiving end of negative press, and in many cases, rightfully so. However, it’s just a small handful of companies that have tainted the reputation of the industry as a whole. To be honest, we feel sorry for transparent and compliant umbrella companies because they make up a significant majority of the marketplace.

Compliant umbrella companies

Choose a compliant umbrella company – and you have absolutely nothing to worry about. Your tax affairs will be in order, you’ll be paid on time, you’ll have access to Employee Benefits, and you’ll be free to join and leave them as often as you like. Compliant umbrella companies make contracting a dream!

But, here’s a question – with over 150 umbrella companies out there, how do you know if the umbrella you’re looking at is compliant or not?

Here are some tips that we recommend you adhere to when selecting an umbrella company for your payroll:

  • Accreditation – Check the umbrella company you’re looking at is accredited by a well-respected and trustworthy industry body, such as the FCSA (the most recognised body). To achieve such an accreditation, umbrella companies are examined from top to bottom, with no stone left unturned. Every internal process is investigated, and umbrellas must be able to prove that everything they do follows UK tax law and abides with HMRC’s rules and regulations. Check out our top 10 umbrella companies and our umbrella companies directory for more information.
  • Track Record – Have a little Google search of the company your considering and see if they’ve been in the news before. If a company has previously been involved in dodgy goings-on – we recommend you stay clear!
  • Realistic take home – Umbrellas will pay you in a similar way to permanent employees (PAYE). Therefore, you should expect to pay realistic tax and NICs. If a company is offering you an eye-catching pay retention – be alarmed! They’re probably a tax avoidance scheme. Remember, compliant umbrellas will process your pay in exactly the same way (PAYE) and the only thing that varies between providers is their margin. You should expect to retain between 60% and 70% of your salary through a compliant umbrella.
  • Location – If you’re working in the UK, expect your umbrella to be based in the UK too! If you see a company trying to entice you from a known tax haven such as Jersey or the Isle of Man – run like the wind!

Tax avoidance schemes

HMRC is always looking to step up their efforts in catching tax avoidance schemes, and the people who engage with them. If you look carefully, you’ll be able to find some “umbrella companies” offering you upwards of 90% of your pay. Sure, it may sound tempting to keep more of your hard-earned money, but trust us when we say this – it’s not worth it. Tax avoidance schemes could ruin your life.

Tax avoidance schemes trick as many contractors as possible to sign up with them. They deliberately help the contractor pay less tax and NICs. Then, sooner rather than later, HMRC will identify the company as being dishonest and will issue them with a Scheme Reference Number – meaning they’re under investigation. Then, almost overnight, the tax avoidance scheme will disappear. HMRC will struggle to find the people behind the company, but it won’t be hard for them to find those who have engaged with them.

The Loan Charge (Government legislation) allows HMRC to retrospectively reclaim underpaid tax from contractors who avoided tax historically. Therefore, even if you think you’ve gotten away with tax avoidance – you could be punished well into the future and face a life-changing fine.

If you purposely want to avoid tax – please leave this website. We’re here to offer solid and trustworthy advice to contractors looking for guidance. We’re not fussed which umbrella company you choose as your payroll provider – so long as they’re compliant, operate PAYE, and have your best interests at heart.

What are the pros and cons of using an umbrella company?

Well, providing we’re talking about compliant umbrella companies, here are the pros and cons:

Pros

  • Efficient service that’ll ensure you’re paid on time.
  • Correct tax and NICs paid to HMRC on your behalf. Your tax affairs will be in order.
  • No tie in period and no hidden costs (no joining fee or leaving fee).
  • Easy to switch between umbrella payroll and limited company contracting – if you tend to work on assignments that are both inside and outside IR35.
  • Low cost – the umbrella company’s margin applies per timesheet you submit, and is usually no more than £25 per week. Umbrellas are traditionally far cheaper than using a contractor accountant to support you with a limited company.
  • Insurance is included for free.
  • Employee Benefits, including Statutory Sick Pay and Statutory Maternity/Paternity Pay.
  • Very little administration required on your part. Registration can be completed in 10 minutes and then you only need to submit timesheets to get paid.
  • Umbrellas can be used for any contract role, and specialist services exist for more niche positions, such as drivers and construction workers (CIS).
  • Perfect for first-time contractors who don’t want to run a limited company yet.
  • Continuity of employment.
  • Plenty of contractor financial service companies can help you with careful financial planning.

Cons

  • Not as tax efficient as operating through a limited company. Your pay retention will be less.
  • In theory – umbrella companies are simple to get your head around. However, if you’re new to contracting, or you haven’t used an umbrella before – you’re in for a shock when you get sent your contract. Why? Because it’s long!
  • Less freedom with your finances and no opportunity to take tax advice onboard.
  • Less hands-on approach with business finances.
  • Claiming expenses is no longer feasible due to SDC. You may be able to claim reimbursed expenses
  • Employment costs can be frustrating (read below for more information).
  • Having a limited company can help boost your credibility and professional image within your sector.

 

Employment costs (Employer’s NI and the Apprenticeship Levy) and why they’re passed on to you

The biggest concern that first-time umbrella users have is about employment costs. Why should contractors be faced with “double-taxation” and have to cover the Employee’s and the Employer’s National Insurance Contributions (NICs)? And, on top of this, why should the contractor then be responsible for the Apprenticeship Levy? Well, let us answer these questions for you. It’s pretty straightforward to understand.

Each role you work on will have an assignment rate of pay (e.g. £200 per day). If the role requires you to use an umbrella company for your payroll, the assignment rate should include an uplift that will cover the employment costs – meaning you are no worse off. If you work on an assignment and believe the employment costs have not been taken into account and you feel you’ll be underpaid as a result – contact your end-client and explain the situation to them.

We’ve already seen the market adapt pretty well. If we’re honest – we’ve noticed loads of roles being advertised with two different rates – a “PAYE rate”, and an “umbrella rate”. The “umbrella rate” is always higher – to account for the Employer’s NICs and Apprenticeship Levy.

Please remember, umbrella companies are not there to take your hard-earned money and keep it for themselves. They are there to help you get paid efficiently and compliantly with HMRC rules and regulations. Remember, the only revenue umbrellas generate for themselves is their margin – and usually this isn’t much! They don’t keep hold of your tax, NICs, or the Apprenticeship Levy. These are sent to HMRC directly. Umbrellas receive your assignment rate from your agency or end-client, make the legal deductions, and then pay you your salary. It’s as simple as that. They get a small margin for their administrative responsibilities (to cover their costs such as staff, equipment, business running costs, etc.) – and that’s it!

Think of it this way – if you have an 8-week assignment and use an umbrella company with a weekly margin of £15.00 – the total margin that the umbrella will retain is £120.00 (£15.00 x 8). This £120.00 is all the umbrella will earn. With that in mind – here’s a scenario. Imagine what would happen if the umbrella company had to cover the Employer’s NI and the Apprenticeship Levy as well! They would operate at a significant loss week-on-week (because £120.00 minus the Employer’s NI and minus the Apprenticeship Levy would equal a number way below zero!) And, don’t forget – you’re not actually carrying out any work for the umbrella – despite being their employee. If umbrellas were responsible for the Employers NI and Apprenticeship – they wouldn’t exist or their margins would be a lot higher.

Finally – it’s not all doom and gloom. Don’t forget, you actually get some pretty cool benefits as an employee of an umbrella company. For starters, you’ll be covered by comprehensive insurance. And, you’ll have access to Statutory Benefits – just like permanent employees. Providing you’re satisfied the employment costs are covered in your assignment rate – using an umbrella company is a pretty good way to go about your contracting. Sure, you won’t retain as much when compared to contracting through a limited company (PSC), but this isn’t the brolly’s fault! They’re simply there to process your payroll – if you need it.

 

What is IR35?

IR35 is a piece of tax legislation brought in by the Labour Government in April 2000. It is designed to catch contractors and freelancers who have an ’employment relationship’ with their clients, yet fail to pay the correct amount in PAYE taxes. Contractor umbrella companies were first introduced to the freelance marketplace following the arrival of IR35. They rapidly became the choice of many contractors who wanted to work in an IR35 compliant way, yet still take home more than they would under normal PAYE.

Up until April 2017, it was always the contractors’ job to determine whether or not they were inside IR35, and to pay themselves accordingly. However, the government decided that many were abusing the system and paying themselves with a combination of salary and dividends – even though their assignment was technically inside IR35. What did the government do about it? They introduced changes to “off payroll” legislation.

Off-payroll in the public sector

From April 2017, contractors in the public sector were no longer able to determine their own IR35 status. This responsibility now falls on the end-client.

Off-payroll in the private sector

The same changes are rolling out into the private sector in April 2021. They were initially scheduled for April 2020 but were deferred for 12 months as a result of the coronavirus pandemic.

For the avoidance of any doubt, if you work through an umbrella company, you will NOT be affected by IR35. Visit our dedicated IR35 page for more information on IR35 and changes to off-payroll legislation.

 

Umbrella company myths and facts

Here are some of the most common misconceptions people have about contractor umbrella companies.

 

Myth 1: I’m still self-employed, even though I’m working through an umbrella company.

FACT: You’ll be an employee of the umbrella company, with employment rights just like any other permanent member of staff.

 

Myth 2: My income will be split between a small salary, expenses and dividends.

FACT: Your income will be made up of a gross salary and tax deductions will be made before you are paid. You will NOT receive dividend payments.

 

Myth 3: IR35 is dead. I’m not really self-employed but I pay myself as if I was.

FACT: DO NOT underestimate HMRC. If investigated, you would be liable to pay back all the underpaid tax, a penalty and worst-case scenario you could be prosecuted for tax evasion.

 

Myth 4: My umbrella company is offering me a really high take home pay retention. I’m going to use them because I’ll be better off.

FACT: Don’t use a tax avoidance scheme. Make sure if you use an umbrella, they operate a compliant PAYE payroll service. It may be tempting to earn more money now but HMRC will come after the underpaid tax and NICs and you could be in serious trouble.

 

Myth 5: Some umbrella companies claim to be able to pay me much more than others.

FACT: Umbrella companies will process your pay in exactly the same way. The only thing that will be different between providers is the margin that they retain for their services. E.g. If ‘Umbrella A’ and ‘Umbrella B’ both have a weekly margin of £20 – you should expect to be paid the same with both – to the penny. Oh, and be careful – we’ve been told that some umbrellas are manipulating take home pay projections. You know – using unrealistic figures to inflate your take home pay calculation. Make sure they’re being straight with you. We heard one guy who was quoted a high take home pay and when he did some digging, it turns out they were basing his calculation on him working every weekday (including bank holidays) with no holiday!

 

Myth 6: Umbrellas are dishonest and are stealing my money.

FACT: No – far from it actually. Providing an umbrella is compliant, they will ensure you pay the correct tax and National Insurance Contributions to HMRC on your behalf. Sure, your take home pay will be lower than if you were contracting through a limited company, but the umbrella company isn’t profiting from this. The only income they generate for themselves is the margin they deduct each time your paid.

 

Myth 7: Umbrellas are making a mint while contractors suffer.

FACT: The only income that umbrellas retain is their margin. Every other deduction on your umbrella company payslip (tax, NICs, the Apprenticeship Levy) is sent directly to HMRC.

 

Myth 8: If I use an umbrella, my limited company is effectively dead.

FACT: No! Ask your account if they have a system in place that’ll keep your limited company ticking over (dormant) while you work on your assignment through an umbrella. Umbrella’s won’t tie you in – you’re free to leave as you please.

 

Myth 9: I’m being asked to send a photo of my passport – Is this normal?

FACT: Yes! It’s normal. Umbrellas need proof of your identity and right to work in the UK in order to legally pay you.

 

Myth 10: If all umbrella companies are the same, why bother looking for one with a shiny accreditation?

FACT: You should carry out your own due diligence when choosing an umbrella company. And, you should look for one that has obtained a well-respected accreditation because it means they’ve been able to prove their internal processes are compliant with HMRC rules and regulations, and UK tax law. Why would you not make sure the umbrella you use is compliant? Yes – there will be compliant umbrellas that don’t have an accreditation. But, in our opinion, an industry-recognised “seal of approval” will help you achieve peace of mind.

 

If you’re looking for a compliant umbrella company you can trust, we recommend you check out our top 10 umbrella companies. Not only are these umbrella companies FCSA accredited, but there are offering some really attractive discounts at the moment.

There is every chance your busy and are looking for ways to save time. We have the answer. Why not complete the short form below and request a call back from one of our top 10 umbrella companies? We’ll send your details on to one of them and they’ll give you a call at a convenient time. There is no obligation to use their services – this is just the perfect opportunity to ask questions and get a free take home pay calculation over the phone. It’ll only take a few minutes.

Click here to see our top 10 umbrella companies!

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