What is an Umbrella Company? And should I use One?

As a freelancer or independent contractor, you enjoy the freedom to work on your own time. However, in the UK, you may find it hard to get regular projects due to tax risks or issues with employment rights. To solve these issues, you need to work under an umbrella company.

In this post, we will discuss what an umbrella company is, how it works, and what its advantages and disadvantages are.

What is an Umbrella Company?

Umbrella companies differ from recruitment agencies in their role. They don't source work for contractors or find employees for companies. Instead, they facilitate contracts by acting as intermediaries between contractors, clients, and recruitment agencies.

There's no statutory definition of an umbrella company in the UK. However, the HMRC defines it as an "umbrella company that employs temporary workers who work at different end clients' premises."

The primary function of an umbrella company is to handle the employment and payroll responsibilities of contractors. Additionally, they aid in shielding end clients or recruitment agencies from potential IR35 liabilities.

How an Umbrella Company Works

An umbrella company employs contractors who sign a contract of employment, entitling them to standard employment benefits such as maternity leave and sick pay. And then there is an agreement between The umbrella company and the customer, between the umbrella company and the recruitment agency and Sometimes, between the recruitment agency and the end client

1. Payment

The end client pays the umbrella company at the agreed rate for the services, which might be a single project or a continuing service. Alternatively, the recruitment company may pay the umbrella company, which the end client then compensates for.

After receiving payment, it retains some money for:

• The agreed administration fee
• Payment for holidays and eligible expenses
• Invoicing for work you've done
• Money for NIC

The umbrella company disburses the remaining funds to the contractor as their gross pay, which is subsequently subject to PAYE deductions, including Income Tax and National Insurance Contributions.

2. Payslips

As per legal regulations, umbrella companies must provide their contractors with detailed payslips reflecting individual earnings. These payslips outline the payment received by the umbrella company from the client or agency. They include all deductions, such as company administration and NICs.

What are the charges of umbrella companies?

Umbrella companies do not have a fixed fee for all their services. Their charges vary based on services which they can charge:

Fixed weekly and monthly charges: this ranges from £20-£120 based on the service or,

From a percentage of your earning

Many umbrella companies determine their margin depending on your earnings. While online calculators can estimate your net income, it's advisable to approach these predictions cautiously. Actual take-home pay may vary significantly due to factors such as expenses.

Let's have an example comparing two different companies

Let's also look into the most popular umbrella companies in the UK

It's advisable to review the services offered by these companies; this could be the reason for the variation in weekly rates. However, be cautious of umbrella companies that guarantee higher net pay, as this could signal a red flag.

Why Use Umbrella Companies?

One of the primary attractions of umbrella companies is the ability to maintain the key advantages of self-employment, such as flexibility in scheduling, choice of work location, and project selection, while also enjoying the benefits of traditional employment.

This includes:

1. Administration: someone handles your tasks, such as client invoicing, payments, and HMRC affairs.
2. Employment rights: Since you're categorised as an employee, you are eligible for statutory benefits such as maternity or paternity pay, as well as statutory sick pay. Additionally, if you're engaged in multiple contracts, you'll have a single pension scheme for all, simplifying matters and reducing confusion.
3. Employment continuity: You may juggle multiple clients or projects concurrently or experience periods of inactivity followed by a single project. This fluctuation creates an impression of unstable employment. However, with an umbrella company, you'll have a single employer, eliminating employment gaps. Despite being a contractor, for taxation and employment purposes, you're considered an employee of the umbrella company. This classification simplifies the process of applying for loans or credit cards.
4. HR support: the company handles all your invoices, and in case there is a pay dispute or any HR-related issues, the umbrella company takes care of it.

It's easy for short-term contractors who are not interested in setting up a limited company.

However, umbrella companies are not all perfect; they have their drawbacks. Let's explore their downside.

Disadvantages Working Under an Umbrella Companies

Many workers say they don't see the importance of working under umbrella companies. Some are dissatisfied because they cover their employer's national insurance and, other times, apprenticeship levy resulting in reduced take-home pay.

1. Fees: In the UK, umbrella companies levy fees ranging from £12 to £35 weekly. Compliant umbrella companies only impose administrative charges for payroll processing and benefits, with the remaining deductions paid to HMRC.
2. Employment pension: Certain umbrella payroll companies may not permit workers to retain their current pension schemes. Moreover, transitioning from a limited company may result in alterations to the rate of compulsory pension contributions.
3. Insurance: Some umbrella payroll companies won't offer health insurance, especially the more economical options, which may not offer this benefit due to their narrower profit margins.
4. Taxes: you will be taxed like any regular employee in the UK. However, you are unable to claim additional business expenses or deductions of expenses for research and development, as you can in a limited company.

Is the Umbrella Company affected by IR35?

Umbrella companies have gained popularity among self-employed contractors on short-term contracts because they are not affected by IR35 off-payroll working regulations.

Contractors under an umbrella company have PAYE tax, and NI is automatically deducted from their salaries, similar to full-time employees.

How to Choose an Ideal Umbrella Company

Before committing to an agreement, do your research, especially due to the recent surge in tax avoidance schemes pausing themselves as umbrella companies. This increase aligns with the alterations made to IR35 off-payroll working regulations on April 6, 2021, making umbrella companies a more appealing tax choice for self-employed contractors on short-term contracts.

If you are caught using such a tax avoidance scheme, the umbrella won't suffer the consequences. It will be you. Mind you, these repercussions could be severe. Therefore, be more vigilant when a company appears excessively appealing. For example, when a company offers suspiciously high promises of take-home pay. They might not be genuine.

Here are tips for verifying company legitimacy:

• Check for professional passport accreditation. This indicates that the company undergoes an annual audit and evaluation to verify its compliance with HMRC standards.
• Use the Companies House to know if the umbrella company is registered in the UK. If a company is under Cayman Island or Isle of Man jurisdiction, this could be a red flag.
• Take advantage of online reviews. A legitimate company must have a strong online presence. Use platforms like Trust Pilot to check for reviews.
• Verify if an umbrella company has been assigned a Scheme Reference Number. This suggests that HMRC is monitoring it as potentially crafty and should be avoided.

Is there an Alternative to Umbrella Companies?

Instead of using umbrella companies, most contractors in the UK register their own limited companies, also referred to as personal service company (PSC).

This eliminates the intermediary and saves costs that would have entered the umbrella company account. Nevertheless, this involves additional administrative tasks and could potentially result in issues concerning compliance with IR35 regulations.

If you want to set up a limited company, it's easy, and Incorpuk can complete it within 5 hours, especially if you do it through your trusted company formation agent.

Umbrella Companies vs. PSC

Let's look into the difference between an umbrella company and a Personal Service Company.

Incorporate Your Company with Incorpuk Today

At Incorpuk, we will help you file accurate information when you register your company through us. We will help you with incorporation articles, a registered office address, and all you may need to register your company in the UK. Contact our team if you seek any information; we will gladly assist.

Winding Up

Umbrella Company provides several advantages to short-term contractors and freelancers, such as streamlined administration, simplified taxation, and access to employment benefits. However, it's essential to be aware of potential drawbacks, including reduced take-home pay, limited control over finances, and the risk of engaging with unethical companies.

When choosing an umbrella company, you should consider factors like fees, services offered and compliance with HMRC regulations. Although umbrella companies offer convenience and benefits, as a contractor, you should weigh the pros and cons. If an umbrella company doesn't fit your job, you may consider its alternative Personal Service Company. Do you have any questions about Umbrella company? If yes contact one of our Incorpuk experts here.