Umbrella companies: key facts for contractors and freelances

An umbrella company is a private limited company. Umbrella companies act as an employer for contractors working on fixed-term contracts (usually through a recruitment agency), while also serving as an intermediary between the contractor and their agency or end client.

Normally, on the contractor’s behalf, a contract is signed between the umbrella company and a recruitment agency or the end client.

After that, an umbrella company’s main function is to sort out payment for the contractor/freelance. The umbrella company provides payroll services to its employees (ie contractors/freelances), processing their timesheets and invoices, paying salary to employees (ie contractors/freelances), after making necessary PAYE deductions, which are payable by the umbrella company to HMRC.

Contractors and freelancers use umbrella companies for many reasons. Firstly, it means you don’t have to set up your own business or deal with its administration and associated costs, which can save time and money. If a contract is only for a short time, you may not want to set up your own business or you may first want to try contracting, to see whether it suits you (it may not).

If you work through an umbrella company that has deducted tax and NICs on all of your earnings and you don’t earn more than £100,000 per year or have income from another source, you won’t have to fill out a self-assessment tax return.

You won’t have to deal with tax-related correspondence from HMRC and won’t need a bookkeeper or accountant, because you won’t have to maintain financial records, do your own PAYE or invoice clients, with the umbrella company also chasing up overdue invoices. And you may still be able to reclaim some legitimate business expenses. Working for an umbrella company can mean you get holiday and sick pay, while some also offer free insurance.

It can be far less tax-efficient. Working for an umbrella company means you’re paid salary only via its PAYE payroll, which means you’ll pay relatively more tax on your earnings. Plus, the umbrella company takes its cut, which further reduces your take-home.

Working as a contractor for a limited company that you set up could enable you to take home more, because you can pay yourself a basic salary plus share dividends, which can be a more tax-efficient way to pay yourself.

Some agencies tell contractors which umbrella company they must use and they’re discouraged from using other umbrella companies. In truth, you have the power to choose your own umbrella scheme, and you should compare several options before deciding. Fees and services differ.

Most umbrella companies operate within the rules. However, there have been cases of umbrella companies promising high rates of take-home pay to contractors and freelancers, made possible by operating schemes that aren’t HMRC compliant, which can involve making bogus expense claims or other tax avoidance tactics.

If HMRC challenges a scheme, the contractor/freelance can be left in dispute with HMRC over unpaid tax, which can lead to penalties. It’s wise to avoid such schemes and operators altogether.

Visit the government website GOV.UK for more information.

There are a number of umbrella comparison sites and directories which you can use to find a company suitable for your needs. Do your due diligence and ensure you research them properly:

• Personal endorsements: It’s always worth speaking to fellow professionals directly or checking with an accountant to find out more about the reputation of a company. 
• FCSA Accreditation: Accredited Membership is awarded to service providers that have been independently audited by industry experts. Look for this. 
• Fees: Whether you’re paying a fixed fee or a percentage fee, consider which is likely to be more costly in the long run. Also, look for other fees for signing up, exiting early, and same-day payment. 
• Payment: How quickly will you be paid and how often?
• Admin: Do they have a user-friendly online portal that makes it easy to submit timesheets and expense claims?

IR35 is the more commonly used name for “off-payroll working rule” reforms. Their introduction into the private and third sectors has been delayed until at least 6 April 2021.

As explained on GOV.UK, they’re being introduced to “ensure that individuals working like employees but through their own personal service company, pay broadly the same income tax and NICs as individuals who are directly employed.” The reforms could affect contractors working for medium-sized or large businesses or third-sector organisations (not small businesses).

When IR35 reforms were introduced to the public sector in 2017, some organisations put all contractors “inside IR35” to prevent any issues. But, consequently, contractors had to pay similar amounts of tax as employees, without enjoying any employment benefits.

Ahead of April 2021, to ensure that they don’t similarly lose out, many private-sector contractors may opt to contract via umbrella companies. For reasons outlined previously, diligence is advised when considering umbrella company options. If an umbrella company’s offer seems too good to be true – it probably is.