Tax & Admin

What Is An Umbrella Company?

Allison S Robinson | 24 November 2021 | 3 years ago

What Is An Umbrella Company?

When you’re working as a contractor, you may regularly find yourself being asked how you intend to provide you service to your clients. This means whether you intend to contract through agency PAYE, through your own limited company or through an umbrella company.

To be able to make an informed decision, you need to understand each of the options available to you, as well as the pros and cons of each option. Whilst many people are fully aware of what a limited company is, one question that regularly comes up is ‘what is an umbrella company?’.

In this article, we’ll explain exactly what an umbrella company is and how it works, as well as comparing and contrasting some of the different options for providing your contracting services.

What is an umbrella business?

Let’s start by answering the question ‘what is an umbrella company?’.

An umbrella company is used to act as an intermediary between a contractor and the end client or agency. The umbrella company employs contractors who are working on fixed-term contracts, dealing with their invoicing, Income Tax and National Insurance contributions.

The contractor pays a monthly fee to the umbrella company for their services, in return for them dealing with your invoicing, Income Tax and National Insurance contributions on your behalf.

So, rather than being self-employed and having your own business admin to deal with, you are instead treated as an employee of the umbrella company, who deal with that admin on your behalf.

What do umbrella companies do?

Umbrella companies enable contractors to work on an employed basis, rather than self-employed. This is because they take on the admin that you’d usually have to complete if you were self-employed, such as invoicing and paying Income Tax and National Insurance contributions.

Let’s take a look at exactly how an umbrella company works.

1.     Contracts signed

The process begins with all parties signing contracts. The umbrella company and the recruitment agency or end client will first sign a contract to agree the contracted rate and how it will be paid.  You’ll then sign an employment contract with the umbrella company to become an employee of the company. This means that they can pay you directly as an employee and manage your Income Tax and National Insurance contributions.

2.     Submit timesheets

If you were working as a self-employed contracted, or as a limited company, you’d need to submit invoices to the client for any work completed. When you’re working for an umbrella company, you’ll instead submit timesheets to the company. They will then invoice the end client or agency on your behalf for the hours that you have worked, as well as any expenses that you need to claim.

3.     Receive payment

The end client or recruitment agency will then send the payment to the umbrella company, who will calculate your Income Tax and National Insurance contributions and deduct these from your total pay. They’ll also deduct a management fee for dealing with your account. Finally, you’ll receive the money directly into your bank account. You’ll also receive a payslip which details your Income Tax, National Insurance contributions and the management fee, as well as any pension contributions.

How do umbrella companies make money

How do umbrella companies make money?

You might be wondering exactly how an umbrella company makes its money, given that it acts as an intermediary between the end client and yourself as the contractor.

The umbrella company receives payment for their work by taking a fee from the contractor. This fee is deducted from wages paid by the end client or agency, before tax is deducted. This means that you’ll be getting some of the fee back by paying less tax.

Most umbrella companies charge a set fee per month. However, some umbrella companies charge based on a percentage of your income, so it’s worth checking this before signing a contract.

What is better PAYE or umbrella company?

Whilst many contractors work on a self-employed basis or through a limited company, this option is not right for everyone. For those who would prefer someone else to deal with their Income Tax and National Insurance contributions, they’re usually left with two options: agency PAYE or an umbrella company. But what are the pros and cons of each option and which one is right for you?

There are a few different factors that you’ll need to weigh up when deciding between agency PAYE vs umbrella company. Let’s take a look at some of those factors.

Cost

It’s important to consider costs when deciding between agency PAYE and using an umbrella company. After all, any costs will be deducted from your total income, reducing your take home salary.

There’s usually no cost to working through agency PAYE. However, umbrella companies charge a fee for using their services, making this the costlier option. Some employment agencies will provide a higher contracted rate to those who choose to use an umbrella company, as a result of the reduced admin for the business. For this reason, it’s worth calculating your take home pay with both options before making a final decision of which option will provide the higher wage.

Employment benefits

Whether you choose to work through agency PAYE or an umbrella company, you’ll become an employee of the company that is paying your wage. Whichever company you choose, they will be responsible for your admin and payroll, taking a weight off your shoulders.

When you work for agency PAYE, you’ll be employed by a different company for each contract that you take on. However, when you use an umbrella company, they will deal with each contract, meaning that you are only employed by the one company. This continuity can be useful when it comes to applying for a mortgage or credit.

Whichever option you choose, you will be entitled to statutory employment rights such as sick pay and pension schemes. This offers an advantage over working as a sole trader or through a limited company, as being self-employed does not entitle you to the same employment rights.

Insurance

When you’re deciding between agency PAYE and an umbrella company, you might be concerned about insurance requirements. Do the requirements differ between agency PAYE and an umbrella company, or are they the same?

Whether you choose to work through agency PAYE or an umbrella company, you’re likely to need to take out insurance. Depending on your job role, this is likely to include public liability insurance and professional indemnity insurance. However, you might find that some agencies or umbrella companies provide insurance on your behalf, but you’ll need to check this to ensure that you’re covered.

IR35

IR35 is the off-payroll working regulations, which were updated to include the private sector in April 2021. This means that it is now critical that you are aware of this regulation and how you can remain on the right side of the law when it comes to IR35.

This legislation aims to prevent workers who should be treated as employees from offering their services through a limited company, or as a sole trader. As those working through umbrella companies or agency PAYE are not self-employed, they will typically fall outside of the IR35 legislation. However, it’s always best to check to avoid any fines or legal action being taken against you.

Employee support

You might also be wondering whether there is any support available to those who are working through agency PAYE or an umbrella company. Unfortunately, this depends entirely on the company for which you are working, or the umbrella company that you choose to represent you.

Whichever option you choose, you should have access to the HR department for support and professional advice and guidance. You may use this service for anything from notice to pay disputes and unfair dismissal.

However, the reliability and quality of the HR support that you are offered will depend on the company. The best thing to do is to ask current employees of the agency or umbrella company for their opinions of the service, as well as searching online for unbiased reviews.

Umbrella vs agency PAYE – Which is right for you?

So, we’ve discussed the pros and cons of both working through an umbrella company and agency PAYE, but which is the right option for your individual circumstances?

Here is a generalisation of which option may be right for you. However, it’s always important to fully research each option for yourself before making a final decision.

Choose an umbrella company if you…

  • Are working simultaneously on multiple different contracts
  • Want to enjoy the benefits and security that come with continuous employment
  • Want to be able to claim for travel and subsistence expenses

Choose agency PAYE if you…

  • Plan to contract for a short time period before going back into permanent employment
  • Will only be working for one company
  • Want to avoid using a third party

How are umbrella companies legal?

Umbrella companies are perfectly legal. However, there can be some disadvantages to opting to be paid through this method, and it’s always critical that you do your research before signing a contract.

For many workers, umbrella companies enable them to get paid by a single employer, no matter how many different contracts they are working on. This gives them a better chance of being accepted for a mortgage or credit, as well as simplifying admin requirements for the worker.

However, umbrella companies are not regulated. For this reason, there are some unethical umbrella companies out there that exploit workers and make unnecessary deductions from pay, leaving workers worse off than if they’d chosen to be paid through agency PAYE.

For this reason, it’s important to be selective when you’re choosing an umbrella company and ensure that you read reviews carefully before making your decision. This will help you to avoid unethical companies and find one that’s right for your needs.

Related questions

Are umbrella companies bad?

Umbrella companies are not inherently bad. However, it is important to note that umbrella companies are not regulated, meaning that there will be unethical companies out there that you need to watch out for. It’s vital that you do your research before signing a contract with an umbrella company to ensure that you aren’t hit with high fees and poor terms and conditions.

Can an agency force me to use their umbrella company?

It is illegal for an agency to force an employee to use their umbrella company for payment. It’s critical that any contractor does their research before making the choice between agency PAYE and an umbrella company, and before deciding to sign a contract with an umbrella company. Whilst there are many ethical umbrella companies out there, the market is not regulated, meaning that there are also many umbrella companies that charge high fees and do not offer the levels of security that contractors deserve.

Are you self employed if you use an umbrella company?

An umbrella company is a business that employees contractors and manages their contracts with agencies and end clients on the contractor’s behalf. So, by signing up to an umbrella company, you are effectively becoming an employee rather than a self employed person. However, some sole traders will choose to only put some of their contracts through the umbrella company, maintaining certain contracts as a self-employed contractor. These contractors are both an employee of the umbrella company and self-employed in their own right.

Is it worth working through an umbrella company?

There are both pros and cons of working through an umbrella company. Whilst it may be the ideal solution for many workers, it could also be potentially problematic for other employees who might be better off opting to work through agency PAYE.

In this article, we’ve answered the question ‘what is an umbrella company’, as well as discussing some of the key differences between working through an umbrella company and agency PAYE. Whichever option you choose, it’s important to thoroughly research your options, calculate your potential take home pay and read unbiased reviews of the company that you choose to ensure you’re getting the best deal.

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