Contractor’s Guide: When should you use an umbrella company?

18 November 2020

Are you just starting out contracting or perhaps looking into some freelance work? There are a few different trading options available, but how do you know which one to choose?

There are several factors to consider, which we will go through below, including your main aim to retain as much of your earnings as possible.

Contract and rates

Let’s look at your circumstances first: are you looking at picking up short term contracts with multiple clients or perhaps a longer engagement?

And there is the question of your daily rate. If it is relatively low, say below £250, the cost of running a limited company may outweigh the benefits it could provide.

Working with an umbrella company is very convenient and cost-effective as it takes care of all your admin and your tax deductions when moving between short-term contracts for a small monthly margin. You’ll receive full employment benefits, insurance and more, like the ones we offer here at SmartWork.

Operating a limited company requires more commitment from you in terms of admin and cost, but if you are on a higher fee and a longer contract (over six months), those could be offset by a higher earnings retention rate. Many companies, like us, offer a limited company option, which we do through our sister company Ltd.

A reputable umbrella firm should be able to work out the right trading vehicle for you and prepare a calculation of your take-home pay.

The IR35 Legislation

The ‘intermediaries’ legislation known as IR35 was introduced to combat “disguised” employees. This refers to an individual who would be treated as an employee were it not for the fact that they provide services via their own personal service company (PSC) and pay less tax in the process.

If your contract is deemed to be inside IR35, working through an umbrella company such as SmartWork could be the perfect solution because the legislation doesn’t apply to umbrella workers.

IR35 impacts those the most who are contracting through a Personal Service Company (a limited company) as, if deemed to be inside IR35, the company’s entire turnover becomes subject to payroll deductions making the arrangement more expensive than if the contractor was simply employed.

Claiming Expenses

One benefit of contracting, of course, is to be able to claim expenses and obtain tax relief against allowable earnings. The fundamental rule for claiming a business expense is that it is actually incurred wholly, exclusively and necessarily in the performance of your duties of employment.

Before putting through any expenses, your umbrella company will require you to look at your working practices by providing you with a questionnaire. The reason for this is the legislation introduced to reduce tax avoidance by contractors. These rules dictate that umbrella employees cannot offset their full range of expenses if they are deemed to be working under supervision, direction or control (SDC).

SmartWork’s expenses guide can be found here.

On the other hand, operating through a limited company arrangement, the rules are relatively simple. As long as your contract is outside IR35 and your expenses were incurred exclusively for business (as above), your accountant can guide you through what you can claim.

What about Agency PAYE?

An alternative to an umbrella PAYE solution is a recruitment firm seemingly offering to do the same in reducing admin and taking care of tax deductions for you. But what are the differences?

Just because the agency is paying your taxes over does not necessarily mean that you are their employee, but an “agency worker” without full employment benefits such as maternity pay, sick pay or auto-enrolment pension.

How much should you expect to pay for an umbrella service?

How much you pay for an umbrella company’s services will, of course, form a large part of your decision as it will affect your take-home pay.

Companies typically charge between £80 and £120 per month, often running limited time promotions, so their prices are not always shown on their website. Most, however, will be happy to provide a quote if you contact them.

Some will charge a weekly or monthly fee, while others may take a percentage of your earnings, which is good to keep in mind for a higher-paying contract.

It is worth contacting a few compliant firms to get a quote. For top tips on what to look out for when shopping around, click here.

How to find a compliant umbrella firm?

When shopping for a firm, you will find that there are a lot of companies around, including those taking advantage of contractors offering retention rates that are too good to be true, and they are, as explained here by the Government.

It is important that you only engage with companies that demonstrate compliance by passing a stringent annual audit by a leading trade body such as FCSA. This ensures that the firm is operating according to legislative requirements and that its employees are protected against any fraud.

Also, look and see if they offer the following services at no cost (they should):

  • Same day payments – they should pay you as soon as they receive payment from the client or recruitment firm
  • An online portal for you to submit your timesheets and expenses
  • Insurance included
  • Your own dedicated business manager

If you’d like to see what SmartWork can offer, please do not hesitate to contact us at 0800 434 6446 or via e-mail at

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