What is an Umbrella Company?

Published Date: November 8, 2017

There seems to be some confusion about what an Umbrella Company exactly stands for in the UK and why they are needed. We will try and clear things up for you including the myths surrounding Umbrella Companies and connected UK tax legislations like the notorious IR35.

How do umbrella companies work?

An umbrella company is a company that employs freelancers and contractors who are employed through recruitment agencies. The recruitment agency or client then engages with the umbrella company rather than directly with the contractor. As a contractor you become an employee of the umbrella company and will carry out a number of temporary contracts without the need to manage your own payroll. You will submit a timesheet and expenses information to them every month and the umbrella company will then invoice the agent/client for the work they have done. The umbrella company will also deal with all invoicing, PAYE and National Insurance contributions. As a contractor you are classed as the employee of the umbrella company, and you may have access to many benefits usually associated with permanent employment such as, statutory sick pay, holiday pay and statutory maternity pay. You are able to gain professional independence with all the benefits of being an employee.

Umbrella companies also offer individuals the opportunity to become a limited company contractor whereby a lower salary can be declared with various expenses being used to reduce taxable income. You may not be the sole owner of this limited company but you would be a director and therefore able to have more autonomy over your pay and conditions.

Why are Umbrella Companies Needed?

As a contractor you won’t be employed by the recruitment agency or client so you have to come up with a way to pay your taxes and get money into your bank account. This is where an umbrella company comes in. As previously stated you will be employed by the umbrella company and they will engage with the recruiter or end client under a business to business contract. Umbrella companies operate PAYE (Pay As You Earn) which means they have the legal obligation to make payment to HMRC for employer’s National Insurance contributions. These will be paid from the funds received, in settlement of their invoices, from the recruiter or end client. The umbrella company will retain a margin of these funds. An umbrella company will normally pay you on the same day as they receive settlement of their invoices and you will receive a payslip detailing your income and deductions in exactly the same way you would as a permanent employee.

There are many advantages to working with an umbrella company. In some instances you may be able to claim for work related expenses, which are paid free of tax and National Insurance and this increases your take home pay. You are also entitled to holiday pay so you won’t be out of pocket when you take a break. You may also be entitled to a workplace pension scheme. Umbrella Companies are also very easy to use as all you need to do is submit your time sheet and expenses and wait to get paid, the umbrella company will do all the paper work for you. Currently PAYE umbrella companies remain the best way to go about contracting. Limited companies take second place as they allow for certain tax exemptions.

What are Limited Companies?

A limited company is where you become the director of your own limited company, this company is registered with Companies House and is owned by you. As such, you are responsible for submitting all relevant tax and business documentation to HMRC. Operating via a limited company is the most tax efficient way to operate as you pay yourself in the form of a basic salary (typically low) and the remainder is drawn down in the form of dividends. Dividends are not subject to National Insurance contributions which results in tax savings. Typically you take home around 75%-80% of your contract (excluding any potential corporation tax liability). There is however more work involved for yourself if you decide to be paid via this method as you will be responsible for submitting annual accounts to Companies House (the register of companies in the UK), run the company solvently and responsibly, and meet your HMRC tax deadlines. This is the downside of operating via a limited company as you do not have to worry about any of this with an umbrella company PAYE solution. If you’re contract work is subject to IR35 tax legislation then the benefits of contracting via your own company are significantly reduced and an umbrella company may be the preferred option.

What is IR35?

The IR35 is a UK tax legislation that was introduced in 2000 to allow the government to properly tax ‘disguised employees’. Prior to the IR35 being created, the number of companies working via their own limited companies was rising at a rapid rate. Limited company owners enjoy a number of benefits which are not available to permanent staff. The government believed that many limited company professionals were in fact ‘disguised employees’ who provided services to their clients in the same way as normal employees, and not in the manner of typical ‘self-employed’ people who used their own limited companies. As a result the Intermediaries Legislation was created. If you are selected for a HMRC IR35 compliance check, the wording of your contract and the way you actually carry out the contract will be examined to determine whether you are ‘employed’ or ‘self-employed’ for tax purposes. In 2015 HMRC collected £524.6 million through its crackdown on ‘disguised employees’.

If you are considering contracting via an umbrella company, then IR35 is not an issue, as you will pay tax and National Insurance Contributions on your income. If you are a contractor with your own limited company however, it is suggested you should send your contract to an employment status specialist before signing it.

Myths around Umbrella Companies

Working via an umbrella company is now popular practice among contractors, however there are many contractors and freelancers who aren’t aware exactly what an umbrella company does, how they work and the benefits they can bring. Umbrella companies are the most protected method for service providers to manage their profits, however there are many myths surrounding what they offer.

There is the myth that you can take home 90% salary if you chose the right umbrella company. This is incorrect. A compliant umbrella service provider is aligned with UK employment tax laws and these are applied to all workers. Compliant umbrella companies operate Pay As You Earn (PAYE) income tax and National Insurance contributions. Hence it is not possible to take home 80% – 90% of your salary. The only difference that could affect your net pay is the umbrella company fees and how much expenses a contractor claims.

Many also believe that they won’t get the full benefits like traditional employees do. That’s not the case and you will be entitled to sick pay, holiday pay and statutory maternity pay etc. However, these payments are not funded by the umbrella companies themselves they are funded by the contractor, typically calculated at the national minimum wage rate. Most umbrella companies accrue holiday pay and hold it aside until employees take time off, or either when the period of employment finishes or at the end of the financial year. Other PAYE umbrella schemes do not accrue holiday pay and pay it each week or month to their employees.

Another myth is that you will be subject to IR35 investigations. As long as you’re not getting paid dividends from your umbrella company you don’t fall under IR35. After the introduction of MSC Legislation, most of the umbrella companies do not pay dividends, if your umbrella company is, beware that it’s illegal.

Similarities between TCP Solutions and Umbrella Companies

Umbrella Company is a term that comes up time and time again when people in the UK refer to TCP Solutions. Although we bear many similarities to an umbrella company and many of the services we offer are the same, we are not technically called an “umbrella company”. This paper discussed what exactly an umbrella company is and you can now find out what the similarities are between what they do and what we do, as well as the differences.

TCP is technically not an umbrella company, however we do have many similarities as we provide Umbrella Services. We are more of a ‘professional employment’ agent than an invoicing facility that often umbrella companies are seen to be. Many umbrella companies act as a billing agent that sits between the client or recruiter and the candidate. The candidate would invoice the umbrella company for days worked and receive payment as gross amount. The umbrella company would then deduct the taxes and National Insurance on behalf of the candidate/contractor. As previously discussed many umbrella companies employ the candidate/contractor meaning they will have access to many benefits usually associated with permanent employment such as, statutory sick pay, holiday pay and statutory maternity pay. This service is also offered by TCP Solutions and would therefore be the reason as to why TCP and other umbrella companies are similar.

As mentioned earlier in this article umbrella companies also offer the opportunity for individuals to become a limited company contractor, whereby a lower salary can be declared with various expenses being used to reduce taxable income. You may not be the sole owner of this limited company but you would be a director and therefore able to have more autonomy over your pay and conditions. TCP are also able to work with limited companies however we ensure that there is no breach of IR35 – in some instance whereby a Limited Company is set up solely for the purpose of a specific contract there are breaches of IR35, most commonly ‘concealed employment’ and TCP Solutions cannot and do not operate in a non-compliant manner.

Umbrella is also a UK centric term, whereas TCP operates in 12 countries all over Europe, working on behalf of clients in all these countries. With our locally registered companies we can offer compliant country solutions in: Germany, The Netherlands, Switzerland, Norway, Belgium, Sweden, United Kingdom, Spain, Finland, Luxembourg, Ireland and Denmark. Non-EU Candidates may find it difficult in obtaining work visas for Europe. TCP has established a solid reputation and relationships with local authorities across Europe, enabling visa sponsoring in most countries we operate. We provide clients, agencies and contractors with solutions that allow them to operate in countries where they may not have entities or where they require further office support. Our work enables our clients to reduce administrative costs, simplify and centralise payments while helping agencies, employers and contractors create smooth, efficient working relationships.