What is an Umbrella Company?

An Umbrella Company is a special type of organisation that employs contractors in order to help them fulfil and invoice for numerous short to medium term contracts. Have more questions? Talk to the team at Umbrella Supermarket today.

In order to help a contractor to fulfil their contract, the Umbrella Company will engage with their agency or end client, seconding the contractor to fulfil the contract on their behalf.

When the contractor notifies the Umbrella Company of the time spent on the contract (weekly or monthly depending upon their contracted terms) the Umbrella Company will raise an invoice to the agency or client for the value of the work.

Once funds are received for the work, the Umbrella Company will calculate and pay the correct income tax and National Insurance contributions to HMRC, passing the remainder to the contractor less any costs.

Although contractors consider themselves to be self-employed, when working through an Umbrella Company (assuming they don’t have any other forms of income) they become employees of the Umbrella in order to be processed through their PAYE payroll.

Umbrella Companies take a fee in exchange for providing contractors with these employment services. This fee is deducted from the gross billed amount prior to processing their payroll.

Umbrella Company Benefits

Becoming an employee of the Umbrella Company grants contractors access to various statutory rights including:

  • The Minimum Wage
  • Holiday Pay
  • Sick Pay
  • Maternity/Paternity Pay

Additionally, as an employee the contractors work will be covered under the Umbrella Companies Professional Liability & Professional Indemnity Insurance.

In order to differentiate in a crowded market place, some Umbrella Companies might also choose to provide their employees with additional benefits such as access to store discounts, cycle to work schemes and gym memberships.

Contracting through an Umbrella Company is therefore considered to be the lowest hassle way for a contractor to get paid and pay any taxes due.

However due to the fee charged and the contractor shouldering the Employers National Insurance (ENI) Liability they can often be seen as offering a lower take home pay than if the contractor were employed direct by the end client or if the contractor were to use Limited Company.

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What’s the difference between an Umbrella Company and standard PAYE?

Contractors using an Umbrella Company’s PAYE payroll will encounter additional deductions from their gross pay in the form of fees and Employers National Insurance contributions when compared to a normal employee.

Employers National Insurance (ENI) contributions are additional National Insurance payments that an employer has to make over and above the contributions an employee makes from their salary. As part of the Umbrella Contractor relationship, in return for a low Umbrella Company processing fee, the cost of ENI is deducted from the gross billed amount on a contract.

Through standard PAYE, there’s no Umbrella processing fee, and the burden of ENI falls on the employer meaning that the full salary is goes through the company payroll.

It’s important to remember that contractors are often paid a higher day rate than a normal employee for the same work to compensate for this.

Additionally, there are other reasons why a contractor’s day rate might be inflated over and above an equivalent employee’s including:

  • The loss of holiday pay
  • The loss of sick pay
  • To cover basic equipment costs
  • Down time between contracts

If a contractor were to be paid the same per day as an employee they would be at a significant financial disadvantage.

Firstly, this is because a salaried worker on £52,200 per annum is effectively paid £200 for every possible working day of the year (in 2019 that will be 261 days).

An equivalent contractor will not be able to bill 261 days a year, as they will need to take time off on holiday. This means that assuming on average contractors take 25 days holiday a year, they will need to earn £221 per day to make £52,200 per year.

Secondly,the impact of holidays on billable days is not actually the biggest hit a contractor will take. If a contractor were to earn £52,200 per year, they would actually pay £5,972.64 more in tax than an employee because they have to pay the full Employers National Insurance contributions from their day rate. That’s an effective hit of £25 per working day.

Thirdly, in addition to the ENI and billableday’s implications of being a contractor, the fee charged by an Umbrella Company comes off the £52,200. On average working through an Umbrella Company will cost £4 per working day meaning that a contractor will actually take home £51,256 (£196) before even considering points one and two.

For a contractor on £52,200, the relative hit when these three problems are combined is £50 per day, meaning to move from standard PAYE to Umbrella PAYE, a £52,200 contractor needs to be earning 25% more than a normal employee to see any financial benefit.

What is IR35?

In April 2017 the UK Government tweaked the IR35 False Self Employment Rules. These rules sought to establish whether a contractor was really an employee in all but name.

In order to establish this fact, HMRC sought to look at the actual contract between a contractor and their end client. In order to establish if a contractor was in fact an employee HMRC would look at several factors including:

  • Can the contractor choose their place of work?
  • Can the contractor send a suitable substitute to perform the work?
  • Can the contractor wear whatever they want?
  • Can the contractor work whenever they please?

If the answer to these questions was no, then the contractor was in risk of being caught by IR35 and its subsequent financial penalties.

In response to this, most contracts were written to ensure IR35 compliance, regardless of whether or not they reflected actual working practices.

Penalties aside, if contractors were deemed to be “Inside” IR35, they would need to process their payroll as if they were employees. In practice for those working through an Umbrella Company (where they were employed and thus processing their payroll this way) the impact was minimal.

However for the 86% of contractors working as either Sole Traders or through Limited Companies, and exploiting tax breaks, it had large ramifications so remaining outside of IR35 was paramount.

In April 2017, the UK Government tweaked the IR35 rules to disregard the way a contract was written, and formally push the responsibility of deciding if a contractor was inside IR35 onto the end client (if the end client was in the public sector). As a result enmasse, government agencies declared their contractors inside IR35.

This seismic shift caused thousands of contractors to move from being sole traders or directors of their own companies to Umbrella Company payroll because the other options no longer offered any financial benefit.

From April 2020, all contracts regardless of being Public or Private sector related will be subject to these rules.

Want to learn more about IR35?

How to Find the Best Umbrella Company

Assuming a contractor has secured a day rate rise that makes it financially beneficial to contract, it’s important that you find the best Umbrella Company in the UK for you.

Yet finding the right Umbrella for your circumstances isn’t as straight forward as it may seem. Despite mentioning above that the Umbrella Company fee will have a direct impact upon your take home, this negates to focus on the relative financial benefits offered by different Umbrellas.

The fact is that not all Umbrellas were created equal. Some offer more rewards for their fee and therefore when looking for the best Umbrella Company you need to factor in not just what you take home through PAYE, but the money you’ll have left in the bank at the end of each month.

As an employee of an Umbrella Company you may be able to claim additional employed tax benefits such as the marriage allowance or childcare credits. These might seem trivial but on average a contractor on £150 per day could be £57 per week better off when factoring these in. But not all Umbrellas will help you apply for these.

In a situation where one Umbrella Company fee is £10 more per week than another, but it will help you apply for these tax breaks, you would actually end up £47 per week better off by choosing the more expensive Umbrella.

Additionally, some Umbrella Companies differentiate their services through offering employee perks such as store or retailer discounts. This means that contractors who spend significant amounts on lifestyle purchases such as cars or food, could actually find that their employee perks save them funds that not only exceed the extra Umbrella Company fee they pay but their entire Umbrella fees altogether.

For that reason it’s important to compare Umbrella Companies side by side to gauge their actual financial benefits to you. A mission that Umbrellasupermarket.co.uk set out on in 2017, helping thousands of contractors in the process.

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Umbrella Company vs Agency PAYE

So you’ve decided that using a Limited Company either isn’t for you or IR35 has ruined your plans of being your own boss. You’ll likely then be considering whether to use a Limited Company or get paid through your agencies PAYE scheme.

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Resolved: Umbrella Company vs Limited Company

Contractors are not only free to work for multiple clients on multiple projects at a time. They earn more per hour than their employed counterparts and they work on a greater variety of challenging projects. Being a contractor is not an easy life – it’s more insecure and uncertain but the rewards are there if you make the decision to go solo.

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Contractor Travel Expenses

Unlike normal full-time employees, contractors working with an umbrella company are able to claim back a wide variety of expenses incurred as part of the delivery of their professional contracts. However, in the 2015 Budget, then Chancellor George Osborne announced the decision to severely restrict claims for tax relief on travel and related subsistence costs incurred by “employment intermediaries” including contractors.

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