What is an umbrella company?

The primary function of an umbrella company is to organise payments for fixed-term work undertaken by independent contractors. They employ temporary workers or contractors on behalf of the employment agency, who will then provide the worker’s services to the client.

Umbrella companies’ popularity lies in their simple design, which allows the contractor to concentrate on their work while all administrative tasks such as invoicing, tax deductions, and payment processing, are being taken care of.

In what cases would you use an umbrella company?

Now that we know what an umbrella company is let’s look at when you’d use one.

Short-Term or Project-Based Work – Contractors engaged in short-term assignments or project-based work often find it convenient to use an umbrella company. It allows them to focus on their work without having to handle administrative tasks or set up their own limited company.

Risk-Averse Approach – Contractors who prefer a more risk-averse approach may opt for an umbrella company. It provides them with the security of being treated as an employee, with access to certain employment rights and benefits, such as sick pay and holiday pay.

IR35 Compliance – The off-payroll working rules, commonly known as IR35, have a significant impact on how contractors are taxed in certain situations. Working through an umbrella company can help contractors ensure compliance with IR35 regulations, as the company takes responsibility for determining and managing their tax status.

Limited Company Not Preferred – Some contractors may choose to work through an umbrella company because they don’t want the administrative burden and responsibilities that come with running their own limited company. This option allows them to work as a contractor without the complexities of company formation and maintenance.

Testing the Contracting Waters – Contractors who are new to self-employment or uncertain about committing to a full-fledged business structure may initially opt for an umbrella company. It allows them to experience the contracting world without the long-term commitment and administrative complexities associated with setting up a limited company.

Support and Guidance – Contractors who value professional support, guidance, and access to additional services often turn to umbrella companies. These companies can provide assistance with contracts, tax matters, legal issues, insurance and other administrative aspects, offering a level of support that may be beneficial, especially to those starting out in contracting.

Employment Continuity – Contractors seeking employment continuity or looking to bridge gaps between contracts may choose an umbrella company. As employees of the company, they can maintain continuous employment, which can be advantageous for various purposes, such as obtaining loans or mortgages.

What are the disadvantages of using an umbrella company?

In the point above, we discussed how you can benefit from using an umbrella company. Let’s see some of the disadvantages now, to see both sides of the coin.

Lower income retention in some cases – Using an umbrella company means that contractors are effectively employed by the company and receive payments as employees rather than as independent contractors. As a result, the contractor’s income may be lower than if they were invoicing clients directly and managing their own taxes.

Umbrella Company Margin – Contractors using an umbrella company are typically required to pay fees for the services provided. These fees can vary between different companies and may impact the overall income the contractor receives. It is worth noting, however, that contractors working through their own companies incur accountancy and other admin fees, which are typically higher.

Limited Control – Working through an umbrella company means relinquishing some level of control over financial and administrative matters. Contractors must adhere to the policies and processes set by the umbrella company, which may restrict their flexibility and decision-making.

Lack of Business Ownership – By working through an umbrella company, contractors are essentially employees rather than business owners. This means they may have less autonomy and freedom in shaping their career path and business strategy compared to being a self-employed contractor.

The advantages and disadvantages of using an umbrella company can vary depending on individual circumstances and personal preferences. We recommend seeking professional advice from our team, for example, who will help consider these factors before deciding whether to work through an umbrella company as a freelance contractor in the UK.

How will you get paid?

Because the umbrella company is your employer, you will receive your pay in the form of a salary from them for the work you do for the employment agency’s client (end client).

The payment process starts with the end client paying the agency for your work, who deducts their fee for placing you in the position and pays the rest over to the umbrella company.

The rate you get paid from the umbrella company will be different because of the additional costs they need to cover to employ you. These are:

• Employer National Insurance contributions
• Auto-enrolment pension contributions
• Holiday pay
• Admin and other costs, such as Apprenticeship Levy

It is important to remember salary reductions under PAYE rules, so you will see Employee National Insurance, Income Tax and Student Loan repayments (if applicable) deducted from your pay. The rules and rates for these deductions are the same for every employer in the UK.

What are the costs involved in using an umbrella company?

The amount you pay for an umbrella company’s services varies from company to company and will affect your take-home pay, so it will likely be a large part of your decision in choosing your provider. We have another article that looks at fees in detail here.

Typical fees or margin is usually between £70 and £120 per month. Companies often run limited-time promotions, and so their prices are not always shown on their website. Most, however, will be happy to provide a quote if you contact them.

Understanding your pay

Before you start your contract, the employment agency will give you a Key Information Document that contains the details of your pay. It will list all the deductions and fees affecting your pay and clarify the payment process and your contract rate.

Contract rate

This is what is set out in your contract, often called gross pay. It is usually an hourly rate and a bonus or additional pay added to it – all taxable, of course. After the deductions of Tax and National Insurance, Student Loan or workplace pension (auto-enrolment), we arrive at the net pay amount, or what we call your take-home pay.

Holiday pay

As any other employer, the umbrella company is legally required to provide you with statutory annual leave (paid holiday) based on your hours. Also, any unused holiday pay owed to you should be paid when you leave your umbrella employer.

Payslip

The payslip you receive will show the number of hours you worked in the pay period and also the pay rate for those hours if it varies. If you receive any statutory benefits such as sick pay, maternity or paternity leave, then these will show on there as well. You will be able to see the amount of all deductions made in the period, such as Tax, National Insurance, pension, student loan repayments etc. It is essential that you have a careful look at your payslip to make sure that nothing you didn’t agree to is being deducted.

What to be aware of?

Although efforts are being made, the umbrella sector is largely unregulated at the time of writing, so it is important to be vigilant when shopping around for an umbrella company.

Tax Avoidance Schemes

Some tax avoidance schemes set up umbrella companies and disguise income by converting them into loans. They trick you into avoiding paying tax, which is your responsibility, so HMRC will go after you in the end.

Click here to look at our other article that looks into tax avoidance schemes and lists all the red flag items you need to look out for.

Mini Umbrella Companies

The other scam recently featured in the news is the mini umbrella company fraud based on the abuse of two particular Government schemes, the VAT Flat Rate Scheme and the Employment Allowance.

Mini umbrella companies have some common features that might be challenging for a contractor to spot. You can find our dedicated article that looks into these in detail by clicking here.

What are the signs that you are dealing with a compliant business?

A compliant umbrella business will carry industry accreditation from a reputable trade body like the FCSA (The Freelancer & Contractor Services Association). No FCSA Accredited Member is allowed to operate Offshore Schemes, Loan Schemes, Trusts, Managed Services Companies Schemes, Pay-day-by-Pay models or similar.

A genuine umbrella company will become your employer, give you full employment rights and pay all of your wages through HMRC’s PAYE (Pay as You Earn) system.

Why work with SmartWork?

SmartWork is an accredited FCSA member and undergoes a yearly audit to demonstrate full compliance with HMRC and the trade body’s strict code of conduct.

Our umbrella package is provided with a host of additional benefits:

• We process statutory sick pay, maternity/paternity and holiday pay and can assist you with mortgage advice and references.
• We cover you for all of your work-based insurances, including Professional Indemnity and Employers/Public Liability are included with our service.
• We are proud of our personalised service that provides each of our workers with a dedicated account manager.
• Our SmartWork portal allows our contractors to upload timesheets, submit expenses and e-sign documents easily.

As always, if you’d like to get in touch with SmartWork, please feel free to call us on 0800 434 6446 or send us an e-mail at info@smartwork.com.

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