Ok, So What Are Umbrella Companies?
In a nutshell umbrella companies are basically a one-size-fits-all invoicing service for contractors, which act as intermediaries between employers (or employment agencies) and the contractors they use. The contractor becomes an ‘employee’ of their chosen umbrella company, (which itself might well have thousands of other PAYE contractors on its payroll.) In doing so, the umbrella companies are offering a service to the contractor – they will be responsible for handling and processing all of the contractor’s admin, paperwork and tax, dealing with HMRC and issuing invoices to clients.
Why Are Umbrella Companies Advantageous to Contractors?
The main reason is the one mentioned above – that the umbrella company takes over all of the annoying and tedious stuff that limited company (or sole trader) contractors have to deal with. By becoming an employee of an umbrella company a contractor hands over the responsibility of sorting out tax, dealing with HMRC, issuing invoices to clients (and then chasing those clients for the money) and doing any other paperwork that is required, to the umbrella company. Secondly, it frees up the contractor from any risks or legal issues to do with limited company contracting (see IR35 below.) Thirdly, it allows contractors to work with clients who won’t work with sole traders but who insist their contractors are ‘deemed employed.’ And moreover, being employed by an umbrella company means a contractor will benefit from the complete range of employment laws- from holiday pay to maternity and sick leave. Finally, people often think that limited companies offer more scope for maximising income but this doesn’t have to be the case. By removing the need for contractors to spend time on any tax issues or paperwork and admin, umbrella companies allow contractors to work more and work better, spending more time on contracting and earning more money!
Ok, But There Must Be Some Disadvantages?
Sure, for some contractors limited company contracting will make more sense and they will have more options when it comes to tax efficiency and expenses and the VAT Flat Rate. And it could be argued that by working for an umbrella company rather than your own company it will be harder for you to build your own ‘brand.’
How Do I Know If An Umbrella Company Is Right for Me?
There are some contractors who earn in excess of £300 per day and who want to handle every aspect of their admin and paperwork themselves. For these people, a limited company may make sense (although these days more and more higher earner contractors are opting for umbrella companies.) If you want to take advantage of more expenses and use the flat rate VAT scheme then limited companies are worth a look. For everyone else though, umbrella companies make the most sense. Umbrella companies allow you to contract for short periods, on and off, and to go away and come back again whenever you want – something that is more difficult with a limited company. And they offer an easy life, freeing you from the paperwork and admin of tax and invoicing. If you think you are someone who considers the freedom from paperwork a price worth paying then the marginally better tax and expenses rates of a limited company are not for you! And, as you will see below, if there is any chance of you being ‘IR35 caught’ of it is something that worries you then you should sign up to an umbrella immediately.
Do Many Contractors Use Umbrella Companies?
Absolutely, yes. Ever since HMRC cracked down on other vehicles for contractor earnings – from Managed Service Companies to Employee Benefit Trusts – there have really only been two viable options for contractors when it comes to managing their income – limited companies and umbrella companies. And certainly for the majority of contractors, with the tax advantages being similar between limited and umbrella companies the choice has been easy – they have been opting in their thousands for the option that means no paperwork and no hassle! Umbrella companies are now seemingly the default option for contractors, with more than 200,000 contractors in the UK currently employed by one and more and more joining each and every year.
Ok, So What About IR35 Then?
That’s the beauty of umbrella companies – they make IR35 irrelevant! This is another reason for the ever-growing popularity of umbrella companies. Contractors hate the IR35 legislation and live in constant fear of an investigation and the associated bills and fines. It is one of the main downsides of contracting through a limited company. PAYE umbrella companies on the other hand cannot fall under IR35. Umbrella contractors pay PAYE and NIC’s and are not avoiding any tax. The same thing happened under the 2007 Managed Service Legislation in which it was explicitly declared that umbrella companies would not be caught by the legislation. In other words, in the eyes of HMRC, umbrella companies are 100% compliant and safe! On top of all their other advantages, umbrella companies are the most secure working arrangement open to contractors.
Ok, I’m In! How Does It Actually Work?
Really easily and quickly actually! The contractor joins the umbrella company with a simple phone call, email or a form on their website. They would then sign an employment contract between the umbrella company as ‘employer’ and the contractor as ‘employee.’ It’s as simple as that! The contractor would then start working their contracts as normal and at the end of the week (or month) they would get a timesheet signed by the person who is contracting them and they would submit this and a sheet detailing any of their expenses to the umbrella company. The umbrella company would then take care of sending out an invoice to the client, collecting the money for that invoice, deducting the contractor’s expenses and their NIC’s and then would pay them their money via PAYE.
Lastly, How Do I Choose A Good Umbrella Company?
There is not a lot of difference between umbrella companies and any company that claims it can offer extra services or significant tax reductions should probably be avoided. Tax liability under PAYE offers very little room for extras so chances are they’re either not being quite truthful or they are doing something a bit dodgy! Similarly, many will say they can offer better expenses claims but once again the rules are quite strict. In reality the best way to judge an umbrella company is on whether they are up front and honest, whether they offer an attentive service and in the fees they charge and the way they pay their contractors. Some will pay on a regular day and others will pay their contractors as soon as the money is moved over from the client. Some umbrella companies will charge a set fee whilst others will operate based on a percentage of earnings. Some will deduct their fees before you pay tax to allow you to lower your liability. All of these factors are worth considering.