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A Simple Guide to How Umbrella Companies Work

Our guide detailing how umbrella companies work is here to make your contracting journey as smooth as possible.

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Although many people choose to work through an umbrella company to reduce their administrative burden, they can still seem confusing to those who have never used one before. This guide should explain the main relationships between clients, agencies, umbrella companies and contractors.

When you work with an umbrella company, the way you work will usually follow this pattern:

  1. The umbrella company will enter into a business-to-business contract with an employment agency.
  2. As the contractor, you will sign a contract directly with the umbrella company.
  3. You will be working for the client, who will sign a timesheet for the agency to confirm how many days/hours you have worked.
  4. You will be responsible for sending your timesheet to the agency as well as sending a copy to your umbrella company which will include details of your expenses as well.
  5. The umbrella company will invoice the agency for the hours that you have worked plus any reimbursable expenses that you may have incurred.
  6. The agency will, in turn, invoice the end client for your work and expenses.
  7. The agency is paid by the client.
  8. The umbrella company is then paid by the agency, according to their payment schedule.
  9. The umbrella company receives the payment from the agency, including any expenses, and then deducts tax and National Insurance before paying you through the PAYE system. You will receive a payslip detailing the deductions which have been made, just as you would if you were in traditional employment.
  10. You will receive payment from the umbrella company, with all relevant deductions made, including a fee which will be paid to the umbrella company.

This flow chart shows you how the relationship between the client, the agency and the umbrella company works in order for you to get an idea of how they all interact to ensure that you are paid regularly. Usually it is the agency’s invoicing schedule which sets the pace of payments, so you will need to ensure that you complete all the necessary paperwork to their deadlines in order to receive your payment on time.

How umbrella companies work - flowchart

Umbrella companies employ contractors using Contracts of Employment which make the umbrella company responsible for issuing invoices for your work. Because you will not be responsible for paying your own tax, there is no need to set up your own company and you will not usually need to employ an accountant.

It is also important to understand that umbrella companies are under the control of HMRC. The payments that they make are done through the PAYE system, and expenses claims may only include items or services which are allowed by the regulations HMRC impose. This means that you should take home as much of your pay as you would as a standard employee, minus the fee you pay to the umbrella company for dealing with the admin.

It is also worth remembering that the Agency Worker Regulations (AWR) have meant that some umbrella companies have started to sneak unlawful clauses, which include deductions from their clients, into their contracts which are not made clear until the contractor has already signed. To avoid being caught out by this, you should check the reasoning behind any deductions before you sign anything.

Some umbrella companies claim to offer more than others, and whilst there are variations between the promises they make, some of them will be too good to be true. Common claims that are made by less scrupulous companies include:

  • Higher wages due to the processing of expenses which aren’t receipted
  • Assurances that HMRC will not investigate
  • Claiming that their strategies are ‘HMRC approved’
  • Advertising their fees minus higher rate tax relief
  • Deceptively low start-up fees which are ramped up later in the process
  • Claims that the company is ‘IR35 compliant’

It is important to check the credentials of any umbrella company before you enter into an agreement with them. If your tax and National Insurance isn’t paid, it is likely that you will be pursued for any outstanding amount owed, so you should choose carefully to ensure that you aren’t putting yourself at risk by using a disreputable outfit.

As a contractor, you may be seeking a simple solution to dealing with your finances, and an umbrella company reduces the pressure on you to deal with a significant amount of admin work. By allocating some of the work to an umbrella company, you can focus on your business and reduce the stress associated with working for yourself.

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Looking to join an umbrella company?

If you’re looking to take your first step into the world of self-employment, an umbrella company could be the solution for you. At Nixon Williams, we specialise in contractor accountancy, however, our sister company Parasol are one of the UK’s leading umbrella companies. They will be right by your side to guide you through the process, to take care of your finances and to box off your admin. To find out more, just fill in the form below and a member of the Parasol team will be in touch.


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