What is an umbrella company?
At first glance, the concept of an umbrella company may seem incompatible with the ‘be-your-own-boss’ incentive generally seen to be central to the decision to embark on a contracting career. However, umbrella companies occupy an important niche in the contracting market, and even the dedicated go-it-aloner should be aware of the service they can offer.
Using an umbrella is the main alternative to setting up your own limited company. They serve as an intermediary between the contractor and their client (either an employer or an agency), with their principal responsibility being to organise payment for your work.
Umbrella company vs limited company
The central difference between operating via your own limited company and under an umbrella is your employment status. Operating your own limited company, you are a director and can take advantage of a variety of methods for minimising your exposure to tax – provided you are willing to take full responsibility for your financial affairs. Working via an umbrella, you are an employee and therefore eligible for PAYE and National Insurance contributions. Hence, while you retain much of the flexibility in being able to set your own working conditions that contracting offers, the bulk of the paperwork and back-office administration is carried out for you, at the cost of a higher tax and NICs liability.
How does an umbrella company work?
The mechanics of working through an umbrella company are straightforward. Once the contract is agreed, you will be required to log your time using a timesheet, which will normally be countersigned by your client. This is then forwarded to the umbrella company (some will want the actual timesheet, while others may offer an online utility where you can upload the details) who will use it to invoice the client. Once the client has settled the invoice the umbrella company will forward payment to you, less their fees and any tax or NI due, along with a payslip that gives full details of how your pay has been calculated.
As with any business activity, this black-and-white statement of the umbrella company’s role is subject to various shades of grey, and there are important differences between the services offered by different providers. Some claim that they can provide tax advantages – treat these with caution, as there is very little opportunity to manage your tax liability to your advantage once you enter PAYE. Others give the impression that they can simplify the process of claiming or maximise the benefit of your business expenses. Again, this should be taken with a grain of salt – the expenses that a contractor working through an umbrella company may claim are strictly limited and the requirements on the contractor don’t change – the expense must have been incurred entirely and exclusively in the discharging of your contract, and you will still be required to keep all receipts. More details on the expenses that may be claimed as a contractor can be found in the ContractorUK expenses section.
Comparing umbrella companies
Be aware that different umbrella companies have their own payment schedules – some will forward your cut as soon as they receive the funds from the client, while others pay out on a regular date. You should also be clear about the fees you will pay. Umbrella companies will normally deduct their fee (which can be a fixed amount or a percentage of earnings) before tax, slightly reducing your tax liability; note that some will quote their fees ‘net of tax’, i.e. with the expected savings factored in to make the fee appear smaller.
It’s easy to dismiss the use of an umbrella company as a half-hearted approach to contracting that sacrifices many significant advantages of an independent career and which represents an unnecessary bite out of your profits. Depending on your personal circumstances and goals as a contractor, however, there are many benefits of using an umbrella company, which could – if you’ll excuse the expression – pay dividends over the long run.
Further reading: Directory of umbrella companies here.