What is an Umbrella Company?

For contractors thinking about which structure to use, working under an umbrella company is an increasingly popular alternative to becoming a limited company director or operating as a sole trader.

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. Our guide is here to help explain how umbrella companies work, the main relationships between clients, agencies, umbrella companies and contractors, and how to find a reputable umbrella company.

What is an umbrella company?

An umbrella company is an organisation which employs contractors working on temporary assignments. Once you register, you will become an employee of the company, who will invoice your recruitment agency for the agreed rate and make all statutory deductions of  tax and National Insurance on your behalf before paying your earnings to you. You can find out more in our guide to umbrella companies.

How does using an umbrella company work?

When you work under an umbrella company, you can expect it to look a little something like this:

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 of employment directly with the umbrella company.
3. You will be completing an assignment for the end hirer, 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 submitting a copy to your umbrella company.
5. The umbrella company will invoice the agency for the hours that you have worked at the agreed charge out rate plus any agreed 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 reimbursable expenses. The umbrella company will retain an agreed margin from the invoice value and deduct tax and National Insurance before paying you your net pay. You will receive a payslip detailing the deductions which have been made, just as you would if you were in traditional employment.
10. The money you receive in your bank account is your money, there is no need to make provision for taxes from this, as with any employment, your employer has taken care of this for you.

As an employee, you will be covered by your employer’s insurances and your agency may wish to see a copy of this. Because you will not be responsible for paying your own tax, there is no need to set up your own company or register for self-assessment and you will not usually need to employ an accountant.

All compliant umbrella companies will employ you and pay you all of your income through the Pay as You Earn (PAYE) system. You may still be able to benefit from some tax relief on legitimate business expenses; however, these are restricted. This means that you should take home as much of your pay as any other employee, minus the fee you pay to the umbrella company for dealing with the admin.

Should I work under an umbrella company?

As a contractor, you may be seeking a simple way to get paid, and an umbrella company reduces the pressure on you to deal with a significant amount of admin work. By opting for employment you can focus on your assignment and reduce the stress associated with working for yourself.

Many contractors have also turned to umbrella companies as an alternative due to the IR35 private sector reforms (now postponed until April 2021). After the reforms, the responsibility for determining IR35 status will fall to the end hirer, and for contractors whose assignment is deemed inside, they will no longer have access to all of the tax benefits associated with running a limited company. You can find more information about the reforms in our blog.

How do you choose a reputable umbrella company?

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:

• Promises of a higher take home pay than can be achieved by legitimate means – often this is achieved by making payments to you as something other than salary
• Claiming they have found a ‘loophole’
• Advertising their strategies as ‘HMRC approved’
• Advertising their fees minus higher rate tax relief
• Deceptively low start-up fees which are ramped up later in the process

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, 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.