What is an Umbrella Company? What UK contractors need to know (2021)

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If you are a contractor and you think about the best structure to use, you may consider working under an umbrella company, which is becoming more popular than working as a sole trader or becoming a limited company director.

Most people work under an umbrella company to get rid of most of the administrative burden. However, it is still confusing for those who have never tried it before.

In this guide, we will explain to you how umbrella companies work, how things work between contractors, clients, agencies, and umbrella companies, and how to choose the best umbrella company for you.

What is an umbrella company?

An umbrella company or PAYE umbrella is an organization employing self-employed contractors instead of setting up their limited companies. Once you join, you will be one of their employees.

The umbrella company works as an intermediary between contractors and their recruitment agencies or end clients. It takes care of any administrative issues such as taxes and accountancy on your behalf and then pays you your earnings after deducting costs like National Insurance and taxes.

How does an umbrella company work?

Here is a step-by-step guide of how umbrella companies work.

  1. Contractors sign an employment contract with the umbrella company which will sign a contract with the recruitment agency or end client as well.
  2. You will send a copy of your timesheet to your agency for a confirmation of the days or hours you have worked and submit another copy to your umbrella company.
  3. The umbrella company invoices the recruitment agency of your work according to the agreed rate in addition to any extra expenses.
  4. The agency will invoice the end client for your working days or hours and get paid.
  5. The agency will pay the umbrella company.
  6. The umbrella company will give you your earnings after deducting taxes, National Insurance, pension contributions, and its agreed-upon fee.
  7. The money paid to you is yours. You do not have to pay any fees or deduct taxes. The umbrella company took care of everything already.  

Notice that as an employee at the umbrella company, you will be covered by the company’s insurance. You should send a copy of your insurance to the recruitment agency.
Also, you do not need an accountant or set up your company since the umbrella company will take care of your taxes.

Payments are processed through the PAYE system, which refers to Pay as You Earn. In some cases, you may take advantage of some tax facilitations, but they are restricted. Therefore, you will be paid as an employee after paying the umbrella company the fee, and the money you take home is yours completely.

Should I work under an umbrella company?

Contractors who are looking for the simplest way to get paid should consider working under an umbrella company. You do not have to deal with any administrative problems. Umbrella companies reduce all this pressure. You will be able to focus only on your tasks and assignments, which are already stressful.

In April 2021, new IR35 tax changes will come into action in the private sector. Self-employed workers and the businesses they work with will pay taxes in different ways. Many tax benefits which are associated with having your own limited company will no longer be available in April 2021. The end hirer will be responsible for determining the IR35 status.
The umbrella companies are considered a great alternative and many contractors are already turning to them.

How do you choose a reputable umbrella company?

Umbrella companies make promises and claims before joining them. The promises vary from one company to another, but some companies’ offers may make you suspicious.

The following claims are too good to be true and they are usually made by less reputable companies.

  • Some companies promise higher payments that are completely legal. However, this is usually done by giving you money besides your salary.
  • If you heard the word “loophole”, it is probably not true.
  • HMRC approved strategies are just for advertising.
  • If the company advertises their fees minus higher rate tax relief than other companies.
  • Some companies start with low fees and then add more when you join.

Before becoming one of the umbrella company employees, check its credentials. If you have not paid your taxes or National Insurance, you will be asked to pay them. Choose carefully to make sure that you are 100% safe and represented by a reputable umbrella company.

What are the key benefits of using an umbrella company?

  • You get employees’ rights such as holiday pay, workplace pension, and maternity and paternity pay.
  • Great for short-term contractors instead of setting up their own limited companies.
  • Reduction of administrative and legal requirements and burdens. You will just do your work.
  • Overseas operations are completely legal and free of any risks of back-pay taxes or attendant penalties.

  • A reputable umbrella company will provide you with all the help and support if something goes wrong with your clients.

What are the risks of using an umbrella company?

  • You are not in control of your finances or administration.
  • Since you are on the company’s payroll, all your income will turn into salary.
  • Some companies are unscrupulous and promise to take home higher payments and reduce tax liability. They are not trustworthy.
  • Some companies are not transparent about their fees and may add more during the process.

Before signing a contract, dig deeper into the umbrella company’s background, get the complete picture of fees, and ensure you receive a full contract of employment. Ask the umbrella company’s representative all your questions and if you suspect that the company is not transparent, find another.

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