Updated on: Mar 7, 2024
We have been providing our contractor accounting service for nearly 20 years and are well positioned to provide a detailed guide on using an umbrella service. This is not only because we’ve lived through nearly 20 years of IR35 updates and Off Payroll changes, but also because we have been running our own Umbrella service for nearly 10 years. I’m not completely sure that this is “the” Ultimate Guide, but it is “our” Ultimate Guide.
Key Takeaways
- Umbrella companies act as an employer for contractors, providing services mainly centered around payroll and timesheet processing.
- They offer employment benefits, legal protections, tax management services and payment solutions to ensure compliance with relevant regulations.
- Researching compliant providers and comparing fees is useful when transitioning from a limited company to an umbrella company in order to avoid potential negative consequences. Make sure you get a payslip illustration before you sign up that clearly shows your timesheet income, all deductions, and your net pay,
Understanding Umbrella Companies: A Comprehensive Overview
An umbrella company acts as an employer for contractors, managing payroll, taxes, and administrative functions, providing a convenient solution for those working on short-term contracts or within IR35 regulations. These companies offer services including:
- Payroll
- Timesheet processing
- Invoicing
- Deductions to pay employees a salary
However, tread carefully when signing up for umbrella companies promising net take-home percentages that are not lawfully achievable, as they may be indicative of a tax avoidance scheme. Any umbrella scheme that advertises a net paid percentage (eg, “take home 80% of your income!”) will most likely be part of some tax avoidance scheme. An umbrella that operates compliantly has no choice but to deduct all lawful taxes from your payslip and so your net pay percentage is dictated purely by (a) the HMRC tax rates (b) the fee (margin) that your umbrella charges.
A key distinction between an umbrella company and a limited company is that umbrella companies are designed for contractors working within IR35 who have chosen not to join an agency payroll, become a direct employee of an end client, or operate through an Umbrella. A very small number of clients continue to work inside IR35 through their personal service company but usually the cost and admin make it better to use an alternative structure. This comprehensive overview covers the role of umbrella companies in the contracting world and their key features.
The role of umbrella companies in the contracting world
Umbrella companies serve as employers that provide umbrella company work, employment benefits, HR support, and can consolidate pay from multiple clients for contractors. They have an obligation to provide HR support to contractors, similar to any employer or recruitment agency, and ensure contractors receive statutory benefits such as holiday pay, maternity pay, and statutory sick pay that they are entitled to.
In terms of payment, umbrella companies can also consolidate funds from multiple hirers into one single payslip, offering a tax-efficient and convenient solution for contractors who work at short notice, at changing locations for various clients on different days.
The role of umbrella companies in the contracting world is pivotal, providing the necessary support and benefits to contractors as umbrella companies work diligently to ensure their needs are met. A recent report suggested that the UK umbrella company sector is responsible for 700,000 umbrella contractors, and £11.8bn in tax and NICs.
Key features of umbrella companies
Umbrella companies serve as intermediaries between contractors and clients, employing workers on fixed-term contract assignments, administering payroll and payments for contractors, and providing employment rights and statutory benefits to contractors. They manage PAYE tax processing by employing individuals and paying their wages through the PAYE system, which entails the umbrella company deducting and paying the relevant taxes, such as income tax, National Insurance and the Apprenticeship Levy to HMRC on behalf of the employees.
In terms of employment rights, umbrella companies offer contractors a written contract, equal treatment under the Agency Worker Regulations after 12 weeks, and entitlement to statutory benefits including holiday pay and maternity pay.
Advantages of Using an Umbrella Company
Umbrella companies offer numerous advantages for contractors, such as employment benefits, legal protections, and simplified tax management. Contractors engaged by umbrella companies are entitled to holiday pay, sick pay, and pension contributions. Take-home pay is determined by subtracting Income Tax and National Insurance from the gross pay.
Umbrella companies operate their employees with the PAYE (Pay As You Earn) tax system that is compliant with HMRC regulations. Moreover, umbrella companies adhere to the same tax and employment law rules, guaranteeing that employees receive the appropriate take-home pay and benefits.
Employment Benefits and Protections
Umbrella companies offer contractors employment benefits such as holiday pay, sick pay, and pension contributions. Contractors employed by an umbrella company are entitled to the same employment rights as other employees, including a written employment contract, payment of at least the National Minimum Wage or National Living Wage, and entitlement to statutory benefits such as holiday pay and maternity pay. Additionally, contractors have equal treatment rights under the Agency Worker Regulations after 12 weeks on the same contract.
Typically, umbrella company employees pay a contribution of 5% of their salary, and the umbrella company will provide the employer’s contribution of 3%. Umbrella companies have a duty to provide holiday pay to contractors, ensuring they receive the benefits and protections they are entitled to.
Streamlined Tax Management
Umbrella companies provide a range of tax services for contractors, including calculating and deducting the correct amount of tax and National Insurance from payments. They also manage the associated paperwork and ensure compliance with relevant regulations. Certain umbrella companies may also provide additional benefits, such as health insurance and access to reward schemes.
Umbrella companies streamline tax management for contractors by utilising their expertise in navigating complex tax laws and regulations. They ensure accurate tax filing for contractors and assist client companies in meeting their tax obligations for their international workforce. Moreover, umbrella companies manage payroll, taxation, and legal compliance on behalf of contractors, making it easier for them to manage their tax responsibilities.
Identifying Compliant Umbrella Companies
Identifying compliant umbrella companies is important to avoid potential tax liabilities and ensure a seamless contracting experience. Contractors should:
- Seek out an accredited umbrella company
- Review the feedback provided by other contractors
- Evaluate the quality of customer service and the team’s level of knowledge
The primary directive for contractors is to guarantee that their selected umbrella company pays their entire income via PAYE.
If contractors are uncertain of a scheme’s compliance, it is advisable to switch to another provider that will process 100% of their income through PAYE. In case a contractor becomes aware that they have been working through an arrangement that promotes tax avoidance, they should withdraw immediately and settle their tax affairs. For further assistance, contractors can reach out to [email protected].
FCSA Accreditation and Other Industry Standards
The FCSA accreditation, which stands for the Freelancer and Contractor Services Association accreditation, is recognized as the industry’s gold standard for compliance among umbrella companies. Umbrella companies that hold FCSA accreditation have gone through rigorous and stringent assessments to guarantee compliance with industry standards. Compliance with relevant industry standards and codes of conduct, as well as adherence to detailed guidance, regulations, and rules are other industry standards.
Note to readers. Our No Worries Red Umbrella service is accredited by the FCSA. We have been through the audit process several times and can attest to its rigour.
FCSA accreditation and other industry standards guarantee compliance of umbrella companies by establishing stringent entry criteria and performing independent audits to evaluate the company’s observance of industry regulations. These accreditations act as a recognized gold standard for compliance and demonstrate that the umbrella company has achieved the highest standard of compliance in the industry.
Red Flags and Warning Signs
When selecting an umbrella company, it is important to be aware of potential red flags such as:
- Lack of transparency
- Unrealistic promises
- False compliance claims
- Tax avoidance schemes
- Outsourced payment
Umbrella companies may offer high percentages of gross income as take-home pay (e.g. 79%), claim that you can keep 80-95% of your income, and promise increased tax efficiency. However, these promises should be met with caution as compliant umbrella companies are obligated to follow UK tax laws.
Contractors who choose a non-compliant umbrella company may be subject to tax liabilities due to the potential engagement in tax avoidance schemes or failure to deduct income tax and National Insurance contributions from their pay. By being cautious of red flags and warning signs, contractors can avoid potential tax liabilities and negative consequences.
Costs and Fees Associated with Umbrella Companies
Understanding the costs and fees associated with umbrella companies is important for making a well-informed decision. The umbrella company makes deductions for the following from the contractors timesheet income:
- Their margin
- Employers’ NI
- The apprenticeship levy
- Employers’ auto-enrolment pension contributions
The typical fee of an umbrella company in the UK ranges from £20 to £30 per week, or £80 to £120 per month.
The apprenticeship levy is a mandatory tax charge for employers whose annual pay bill exceeds £3 million, calculated at a rate of 0.5% of the company’s gross payroll. This levy affects the costs in an umbrella company as it is legally obligated to deduct the apprenticeship levy from the employee’s pay.
Fee Structures and Comparisons
The typical fee structures of umbrella companies typically range from fixed fees to percentage fees. Some common fee structures include:
- Fixed weekly fees, which are typically around £20-£30 per week
- Fixed monthly fees, which are typically around £80-£120 per month
- Percentage fees, which are calculated based on a percentage of your earnings (not common!)
It’s important to research and compare different umbrella companies to find the fee structure that best suits your needs and budget.
Potential Hidden Costs
The UK umbrella industry has been under scrutiny for hidden costs that may be costing workers and the exchequer as much as £4.5bn a year 1. As many as 700,000 temporary workers in the UK are thought to be employed by umbrella companies, used by recruitment agencies and companies to cut temporary payroll costs. In some cases, they can provide useful services for contractors, but industry experts and the Trades Union Congress (TUC) fear they are increasingly being used to diminish workers’ rights and misappropriate billions of pounds in unpaid wages and tax fraud 1. The umbrella company employment costs include Employer’s National Insurance Contributions, Apprenticeship Levy, and Umbrella Company Margin (fee). It is important that umbrella companies are transparent about their costs and do not have any hidden costs. This will help to ensure that workers are not exploited and that the exchequer receives the taxes it is owed.
When you ask for a payslip illustration from an umbrella firm that you are thinking about using ensure every single item on the payslip is explained to you. There should be no “wrapped up costs” (items that are combined together making it unclear what they’re actually for), and every item on the payslip should be easily explainable.
Using our Umbrella Pay Calculator you can easily see what your net pay will be, based on your timesheet income, tax code, pension contribution amounts, and any student loan payments you need to make.
Transitioning from Limited Company to Umbrella Company
Contractors may need to transition from a limited company to an umbrella company due to changes in their work situation or IR35 status. There are several primary motivations for a contractor to switch from a limited company to an umbrella company, but the most typical reason is when seeking work through an agency or end client, it might be specified that the contractor has to use an umbrella and cannot use their limited company.
Transitioning from a limited company to an umbrella company may require the following steps:
- Identify a compliant umbrella company.
- Ask your accountant to issue a P45 from the limited company.
- Complete the application form provided by the umbrella company with the required personal and banking details.
- Dissolve the limited company or make it dormant based on your preference.
Reasons for Making the Switch
Reasons for switching to an umbrella company could range from working on a short-term contract, falling within the scope of IR35 regulations, or seeking a simplified tax management solution. The IR35 regulation determines whether a contractor should be classified as an employee or not, thus influencing the decision to switch to an umbrella company. Contractors working on short-term contracts may prefer umbrella companies due to the payroll and employment complexities they manage, the ease of establishment they provide, the continuity of employment they offer, and their suitability to the preferences of recruitment agencies.
Utilizing an umbrella company for tax management offers several advantages, such as handling the processing of your salary, including tax and National Insurance contributions, on your behalf. This allows for the accurate payment of taxes to HMRC while removing the need for the contractor to manage their own tax payments. On the downside, working through an umbrella company is less tax efficient than working through your own limited company.
Steps to Making the Transition
To transition to an umbrella company, contractors should research compliant providers, compare fees and services, and follow the registration process with their chosen company. The procedure for registering with an umbrella company involves submitting the necessary paperwork, providing proof of identity and address, signing the contract, setting up a payment method, and beginning to work with the umbrella company.
For No Worries Red Umbrella, we have spent years refining our onboarding process and it is now done completely online.
Summary
In conclusion, umbrella companies offer numerous advantages to contractors, such as streamlined administration, employment benefits and protections, and simplified tax management. By understanding the role of umbrella companies, identifying compliant providers, and learning from real-life examples, contractors can make an informed decision when choosing an umbrella company that best fits their needs. Remember, a compliant umbrella company can be a valuable asset for contractors in today’s complex and ever-changing contracting landscape.
Frequently Asked Questions
Is it better to be paid by PAYE or umbrella?
The choice between PAYE and umbrella depends on your personal circumstances. Typically, if you work through an umbrella For more than 12 weeks you are entitled to the same pay and benefits as a full time PAYE employee gets. The benefits part of the comparison is usually turned into a cash equivalent, so your cash take home pay may be higher then a PAYE employee to account for the benefits difference. On the downside, you don’t get to attend employee training courses, staff parties, and once your work is complete you usually then need to find more work through your recruitment agency or by other means. So, you can see it’s not a straightforward decision.
Do you pay less tax with umbrella company?
The tax that you pay through an umbrella company is determined by the HMRC. The exact same tax rates are applied to full time employees. It used to be that you could claim expenses as an umbrella worker which would help reduce your overall taxable income, but by and large this is no longer the case.
Do you get holiday pay with an umbrella company?
Every element of pay is funded from your timesheet income. Once the Umbrella takes their weekly (or monthly) fee from that income, everything else is taxed through the PAYE tax system. This same system is extended to the payment of holiday pay. Yes you do get holiday pay working through an Umbrella because you are entitled to it, but the holiday pay is funded from your timesheet income. This is not extra income that is provided to you by the umbrella (all the Umbrella ever gets from you is the weekly payslip fee) so the funding for your holiday pay must come from your timesheet income.
Are there any legal requirements for umbrella companies?
Yes, all the usual legal requirements for being an employer in the UK must be met by the Umbrella firm. This includes having a contract with each contractor, staff handbook, grievance policy, insurance, data protection policy, and disciplinary procedure.