Switching from limited company to umbrella company in 2022; if you’re not already using both models

A lot can happen in a year and not more so, perhaps, than in 2021; when coronavirus, UK-wide lockdowns and IR35 reforms made it the most challenging 12 months in living memory for the private sector’s flexible workforce.

Then, and now

On the eve of that perfect storm (a year ago this month), ContractorUK published a guidance-based article on moving from a limited company to umbrella, agency or client payroll.

And it’s with that same intentionality that switching from a limited company (or Personal Service Company) to an umbrella company, should be explored now. That’s because the hellish covid-IR35 mix has made brollies the strongest of those three off-payroll working options, and that switch from PSC to umbrella – or even the combination of the two whereby contractors use a brolly for one contract and a limited company for another contract – is likely to permeate 2022, writes Joanne Harris, head of technical, compliance and payroll at Parasol.

Apples and oranges…

From the outset, let me acknowledge that umbrella company working may not be for everyone. But there are also lots of misconceptions about umbrella employment that unfairly tarnish the industry and those working in it. Compliant providers are often tarred with the same brush as unscrupulous tax avoidance schemes, and these schemes typically masquerade as a genuine umbrella company to entice contractors to sign-up.

And to some workers who don’t want the responsibility of running a company, it’s easy to see why choosing an umbrella company is an attractive option.

In particular, bonafide umbrellas offer a way of contracting – a way of undertaking temporary assignments -- without the associated administrative workload of running your own business, which can be time-consuming and complex. 

What’s beneficial about brollies

Furthermore, it’s relatively straightforward to become an umbrella employee. You’ll become an employee of the umbrella company and sign a contract of employment.

Your umbrella employer will invoice the client or recruitment agency the agreed assignment rate, and the umbrella employer will deduct costs of employment including Employers’ NI, Apprentice Levy (where applicable), Employer Pension Contribution and the umbrella’s fee (its ‘margin’), to arrive at the gross taxable pay figure. From this, the usual PAYE, National Insurance, and employee pension contributions are deducted from your gross pay before paying you your net salary.

While there are many benefits to working as a limited company or a sole trader, there are no employment protections or statutory benefits. It’s a different story for umbrella employees, who receive the same rights and protections as any other employee, including rights such as maternity/paternity pay, sick pay and holiday pay.

Umbrella employees also have a continuous record of employment from the start date of their first assignment. This can potentially be a significant benefit when it comes to applying for loans and mortgage applications.

Are there downsides to being an umbrella employee?

Pay has often caused confusion for contractors when first switching from working as a PSC to umbrella, as it has not always been clear what the ‘umbrella rate’ or ‘limited rate’ included.

In recognition of this, the government has introduced legislation requiring all employment businesses to provide work-seekers with a Key Information Document (KID) regardless of how they will be paid. This document details all the deductions that will be made from the agreed ‘assignment rate,’ all the way through to net pay, providing the contractor with improved clarity on what their overall pay will look like. 

Typically, contractors working through umbrella companies do not take home as much net pay as contractors who work through their own PSC, because of the additional tax liabilities, and the fact that Employers’ NI, plus the Apprenticeship Levy (where applicable), will be deducted from this rate.

However, many contractors tell us that lower take-home pay it is a trade-off against the benefits that umbrella employees enjoy. So it’s up to each contractor to choose what sounds, looks and works best for them.

But why choose if you can have both? Let me explain.

Umbrella and PSC - a dual solution

The off-payroll reforms in the private sector have seen lots of contractors with their own limited company working through an umbrella company for assignments deemed ‘inside’ IR35. However, there are providers (including us), that have created a solution that gives contractors the flexibility to switch between umbrella employment and PSC working.

Many contractors across the industry have embraced this more agile, contract-specific way of working and it’s expected by us that this brolly-PSC model will become more commonplace next year. Its main appeal is that it allows contractors to work on contracts that require employment through their umbrella company (some clients in reaction to the April IR35 reforms mandate umbrella contractors, not PSCs), while also permitting them to take on assignments that are ‘outside IR35’ through their limited company, with higher take-home pay on offer.

Standing back from the nitty gritty of these ‘dual model’ offerings from different providers, we’ve found that contractors are receptive because they are au fait with implementing savvy, or non-conventional working styles to get the most out of their assignments. It’s been encouraging to see how they have adapted following the numerous changes of the past 12-18 months.

The clean-up

Less positively, fraudulent tax avoidance schemes masquerading as compliant umbrella employers are continuing to operate. This is another very important consideration for any contractor thinking of making the switch from limited company to umbrella company in 2022.

Until there is proper regulation of umbrella companies, these operators will likely continue to hoodwink workers. Further unfortunately, this small minority has a significant impact on the overall reputation of the umbrella industry -- and a devastating impact (potentially including with HMRC), on the contractors who inadvertently get caught up in them.

The tax authority regularly issues ‘Spotlight’ warnings of avoidance schemes that have caught its attention and which, in its opinion, don’t succeed in landing the worker with a tax advantage. Many editions have focused on fraudulent schemes targeting contractors and although it's good news that HMRC is drawing attention to schemes using the Spotlight collection of publications, the only way to truly put a stop to abusive arrangements is through proper regulation of the industry. The appointment of Margaret Beels as Director of Labour Market Enforcement will mean we will see progress towards regulation soon. Or so we sincerely hope.

How can contractors find a compliant umbrella?

There’s more to be done to clean-up the umbrella industry, but contractors can act too.

In fact, there are quite a few steps that prospective umbrella contractors can take to help themselves make the right decision when choosing umbrella employment, switching to an umbrella from a PSC, or finding a provider who offers an umbrella company-limited company combination model.

The very first step is to find an umbrella company that is compliant, meaning you need to conduct some research to avoid getting caught up in potential tax avoidance scheme by the provider you like the look of. If they say ‘compliant,’ don’t just take their word for it!

Generally, we go by the old adage (often used by HMRC in its Spotlights) that, ‘If it looks too good to be true,’ well, you know the rest – ‘It usually is!’ Remember, in the instance that you’re ever tempted to take a provider’s word for it, contractors who have been caught up in these schemes have been left with huge tax bills from HMRC, along with a lot of stress, hassle, and in seven cases, even worse.

Ironically, stress and hassle are often two undesirable elements that contractors who successfully work through bonafide umbrellas say they are able to avoid! We would also say that the FCSA (Freelancer and Contractors Services Association), is a good place to start when looking for an HMRC-compliant umbrella employer. Umbrellas with accreditation from the FCSA, or Professional Passport, have been audited against various standards, with the aim of providing peace of mind to you, the worker, that you are choosing a genuine umbrella and not a tax avoidance scheme in disguise.

The (umbrella) contractor mood music as the festivities draw closer

We know that contractors and freelancers are the backbone of the UK economy and that sentiment has been echoed by the government many times already. However that sentiment has taken a bit of a backseat during covid, IR35 reform and even Brexit. As a result of these three pressures, and even though umbrella employment has been a popular solution for contractors for many years, lots of contractors have chosen to switch to umbrella employment this year, in line with a desire for more security and peace of mind. But some haven’t switched entirely and instead, can be found using a dual solution, whereby they retain their limited company way of working for some assignments, and go brolly for other assignments.

A bit like the clean-up of the umbrella industry, more needs to be done on education to continue to help end-users grasp IR35 reform, yet we are seeing positive signs of increased understanding of the off-payroll rules. And therefore we also see contractors who choose umbrella, PSC -- or a combination of both operating models – as having a busy New Year with a bountiful supply of temporary contracts, as we are confident that demand will be there for their services in 2022 and beyond.

Monday 6th Dec 2021
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Written by Joanne Harris

Joanne joined the Optionis Group in 2009 as an account manager, working closely with our agency partners. After developing an interest in the technical aspects of the role, she took the opportunity to train as a chartered accountant. She is now fully qualified, and a member of the Association of Chartered Certified Accountants (ACCA).
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