Should I use an umbrella company?

While umbrella companies provide you with a service, it does come at a cost. When answering the question “should I use an umbrella company?”, you need to decide whether that cost is worth the potential benefits of operating in this manner. This requires a careful examination of your present and future circumstances, Zeeshan Anwar at Contractor Umbrella discusses.

Short term contracting

If you are starting off in contracting or contracting in the short term only, then the work involved in setting up a limited company is unlikely to be worthwhile. For ease of use it is more beneficial to use an umbrella company.

Additionally if your daily rate is relatively low, it may not be beneficial to set up a limited company and thus contracting via an umbrella company would be a better option for you. Our calculators can provide you a rough guide to your take home pay.

Are you a freelancer?

A freelancer is loosely defined as a worker that completes multiple small-scale assignments for different clients at the same time, typically from their own office or home.

Freelancers will almost never work jobs with enough commitment to warrant any formal contract and will pay taxes through self-assessment or their own limited company. As such, there is rarely any consideration for IR35 status, and the unwanted implications it brings.

The remote and static nature of most freelance work means that travel expenses are either too minimal to warrant claiming, or non-existent altogether.

Claiming travel, avoiding IR35, and dealing with contracts are the primary functions of signing with an umbrella company. As freelancers rarely stand to profit from these benefits, the subscription cost of an umbrella company will often far outweigh the rewards.       

Limited companies and sole traders

Contractors that operate independently as either a limited company or sole trader can come under risk of falling into IR35 status. If investigated by HMRC and found to be illegitimately outside of IR35, you will be forced to pay back taxes on your eligible past earnings, including interest.

Operating under IR35 status can be especially damaging to personal limited companies, who are obliged to pay income tax on their entire earnings on top of the company’s corporation tax, costing them more money than if they were simply employed.

Most contractors can become nominal employees of either a recruitment agency or umbrella company to avoid the IR35 classification in self-employment.

Agency PAYE or Umbrella Company?

Many recruitment agencies will provide a ‘Pay As You Earn’ (PAYE) status to their contractors, taking care of all applicable HMRC taxes and deductions before sending you your paycheck. This ensures that your taxes are all being paid reliably, and reduces the administrative strain of your self-assessment, and managing personal finances.

Even if your agency is paying your taxes, this doesn’t necessarily mean you are their employee. Legally, most contractors in this position are classified as ‘agency workers’, and do not have full employment rights, such as statutory payments or a workplace pension.

Umbrella companies also pay your taxes through PAYE, and working through an umbrella company gives you employee status, and the additional rights that it affords.

On the surface, both options appear to deliver the same result, with one key difference - the umbrella company will charge you a for ‘membership’.

Looking at the top UK umbrella companies, their fees average at around £30 a week, with some taking a percentage of your earnings as a margin instead (though this is typically capped at around £30).

That is certainly no small amount, so what else are you getting?

Claiming expenses through an umbrella company

One of the biggest benefits for umbrella company employees is the ability to claim back expenses and receive tax relief against allowable earnings and deductions.

Accurately estimating your expenses, and how much you can save by claiming them, is one of the most important considerations to make before choosing to sign up with an Umbrella company. HMRC’s rules around expenses are very strict, especially when it comes to travel expenses.

The legislation hinges on your expenses being “incurred wholly, exclusively and necessarily in the performance of the duties of the employment”. This can include things like equipment costs, software subscriptions, specialist clothing, and professional certifications.

Essentially, if you cannot fulfil your job without paying an expense, it is likely to be applicable for tax relief.

Things get more complicated when it comes to travel costs. Journeys between your home and primary workplace cannot be claimed as travel expenses - these expenses include fuel mileage, as well as the cost of private or public transport services.

An employee who holds a ‘travelling appointment’ can deduct all of their business travelling expenses as travel in the performance of the duties of the employment, even where the journey starts from home. This type of work covers professions like delivery driving, service engineering, and door-to-door sales. People in these professions are classed ‘itinerant workers’.

The specifics of what makes an itinerant worker are somewhat undefined, as many jobs will require reasonably regular travel expenses. A key marker is the frequency of travel, the nature of the work itself, and the location of the individual’s home relative to their normal area of work.

Any travel between separate workplaces or clients is eligible for relief, providing that all work is completed for the same end client. Being traditionally self-employed, and completing multiple jobs on the same day, usually means travelling between different, independent workplaces. Unless you are an itinerant worker, these are all treated as separate temporary workplaces by HMRC, and each journey is classified as travelling to your place of work - meaning none of your travel is eligible for relief.

Here we can start to see some of the value in using an umbrella company. Because the company is your employer, all travel between separate clients is considered as ‘on the clock’ mileage. Depending on the amount you travel, this could result in surprisingly high savings.

If you want to answer the question “should I use an umbrella company?”, you need to take a vast range of factors into account. View our listings of the top UK Umbrella companies for a complete picture of the options available to you. For more information you can also visit our umbrella company tax calculator and umbrella company guides.