Advice for Contractors: Working Through an Umbrella Company

Originally announced in the 1999 Budget, IR35 has attracted much controversy over the last 20 years and took centre stage once more in 2017 & 2021 when the new form of the Off-Payroll legislation came into effect in the public sector, then the private sector. Hirers were made responsible for assessing the status of contractors. Many self-employed contractors who found themselves ‘inside IR35’ faced two options – either become an employee or work through an umbrella model.

Crawford Temple is CEO and founder of Professional Passport, the largest independent assessor of payment intermediary compliance, and here he outlines what an umbrella company is and how the umbrella model works. He also spells out the importance of looking carefully at the credentials of a provider claiming to be an umbrella firm and understand what is really being offered. It is this detail that will determine if it is an umbrella company or a ‘have I got a good idea for you’ scheme and best avoided.

What is An Umbrella Company?

An umbrella company is a company that employs contractors to carry out temporary assignments. The contractors often work through recruitment agencies for an end client. The contractors are paid PAYE income in the same way as every other employee.

Why You May Need to Use One

With the introduction of Off-Payroll Working which took effect on April 6th 2021, many organisations are insisting that workers deemed to be ‘inside IR35’ move to either PAYE through the recruitment company or operate through an umbrella company. Many recruitment companies do not operate their own PAYE arrangements for their contracting workforce and in these cases they will rely on umbrella companies.

Employment Status and Contractual Terms

Contractual terms offered by umbrella companies do vary and we would always advise that you read and understand the key terms.

As a contractor, you will be an employee of the umbrella company so you will have the same employment rights as any other employee would have. Such benefits include auto-enrolment into a pension, where you meet the qualifying criteria, as well as statutory benefits such as sick pay and maternity/paternity pay. Your pay will be operated through PAYE with all tax and National Insurance deductions made at the point of pay, just like all other employees.

Working through an umbrella company for a series of assignments also gives you continuity of employment which can help if you are seeking a mortgage or loan.

Rate of Pay

This is an area where many contractors new to umbrella companies become confused. The rate paid to the umbrella company is not the rate you get paid. If you are paid by an agency directly, then the rate they offer you (commonly known as the PAYE rate) is the amount, before your tax and NICs, that you should receive. But this PAYE rate is not the true cost to the agency of paying you. In addition, they have to pay employers’ NICs, holiday pay, apprenticeship levy and contributions into a workplace pension.

As such, the real cost to them of taking you on may be significantly more. When the agency contracts with an umbrella company, and you are employed by the umbrella company, they should pass the umbrella company the full costs of your employment – that is, the PAYE rate plus all the associated employment costs (from the funds they themselves have received from the end client). They will often uplift the rate to also cover the margin cost of the umbrella company. This is commonly known as the limited company rate, or uplifted rate. Where the rate has been uplifted correctly, your take home pay from the umbrella company should be no less than you would receive had you been on agency PAYE.

If you have a PAYE rate and an uplifted rate provided by your recruitment company many responsible umbrella providers will produce a pay comparison for you.

It is also worth noting at this point that all umbrella companies have to operate within the same tax rules and therefore there should be very little difference between the take home pay you are offered. Should you be offered significantly more take home from a provider, this should set alarm bells ringing and could result in HMRC challenging you at a later date for unpaid taxes. If that were to happen you would end up with less money overall than if you had paid the correct taxes in the first place.

Holiday Pay

Generally, umbrella companies will provide 28 days holiday as part of the employment contractual terms. This is one of the costs that is covered in the uplifted rate provided to the umbrella company. This equates to 12.07% of your gross taxable pay and should include both salary and any bonus element of your pay.

Umbrella companies will retain this money to pay to you when you are either on holiday or not working, although the majority of contractors prefer to have this paid to them immediately. If that is the case, you will be asked to confirm your request in writing before this process is applied. You must remember that were you to request advanced holiday pay this will mean that you have no funds held back for times where you are on holiday or out of work.

You can change it back at a point in the future should you wish. Should you decide to have the umbrella retain the holiday and pay it out on request you must make sure that you understand the ‘holiday year’ that the umbrella operates. All companies, not just umbrella companies, have a ‘holiday year’, for example January to December, and you must take any holiday entitlement during that year or it is lost. So, you must ensure you request all of your entitlement before the end of the holiday year.

Expenses

The rules relating to expenses for contractors operating through umbrella companies have seen many changes over recent years and are different to the normal expenses’ rules with many complexities.

There are two types of expenses that can be claimed:
1. Those that are paid from your normal, or general, earnings
2. Those where the agency / end client reimburses you

In the case of those you wish to have reimbursed from your general earnings, and keeping things as simple as possible, these tend to only be mileage allowances to temporary workplaces, i.e. not the normal site you visit. If you have other allowable expenses such as train fares or subsistence, these must now be claimed through your Self-Assessment Tax Return.

Agency reimbursed expenses, where the money is additional income and not general earnings, typically where you claim specific costs incurred, can cover any category of expense, as long as it is to a temporary workplace and wholly, necessarily and exclusively for business.

Your umbrella is likely to require a detailed expense claim form from you as well over and above the one submitted to the agency. This is simply because the umbrella must demonstrate to HMRC why the expenses are allowable for tax purposes, something the agency/end client doesn’t have to do.

If you feel you are likely to have either category of expenses, it is worth discussing this at the outset with your umbrella to ensure they can accommodate these and you are aware of their processes for claiming.

Agency Workers Regulations

Umbrella workers will generally work under the Agency Workers Regulations. This means that you should receive the same pay and holiday entitlement as a comparable full-time employee.

This means that your gross taxable pay should be equal to or greater than a comparable employee after you have had the correct holiday entitlement applied.

Where the holiday entitlement is greater than 28 days, the umbrella will adjust the percentage being deducted for your holiday accordingly.

Selecting an Umbrella Company

Since the Off-Payroll legislation came into effect in the public sector in 2017, a proliferation of schemes has been set up purporting to be “umbrellas” and offering a higher take-home pay. If you are tempted to unwittingly engage with one of these disguised remuneration schemes you could face significant future tax bills once HMRC discovers that.

The message is clear and take-home pay should not be one of the criteria used to select an umbrella company as they should all be within a few pence of each other.

When selecting an umbrella firm, consider the following:

• Are you likely to have expenses and will the umbrella you are looking at be able to deal with these?
• Do you want to make significant contributions into your own pension scheme? Make sure the umbrella can handle this for you as there are some real benefits when this is done correctly.
• Do you have no special requirements and just want to be paid safely? If so, it is worth selecting one of the cheaper compliant umbrellas as there is little point paying higher costs for no benefits.
• Will your agency deal with the company?
• Are you happy with the person you spoke to and how things were explained? Service levels can be a large part of the selection process.

Spotting a Potentially Non-Compliant Scheme

It is worth reiterating HMRC’s official guidance that warns contractors to check the following to find out if you may be engaged by a disguised remuneration scheme:

• The company promises that you can keep 80, 90 or 95% of your income and be tax compliant
• Only a fraction of your salary is paid through payroll and subject to PAYE (indicating that you are only paying tax on some of your income)
• You are paid using a loan, credit of investment payment and the company claims this isn’t subject to income tax of National Insurance Contributions (this is tax avoidance)
• The payment from your umbrella company is routed through various companies before it reaches you.

*Crawford Temple is CEO and founder of Professional Passport, the largest independent assessor of payment intermediary compliance. You can find many useful articles and videos on the Professional Passport website in the Hot Topics section. This article was first published on workingmums.co.uk, who's assets were acquired by 55/Redefined in 2024.

Additional Resources

• Jobs/Redefined Jobs board: Find your next new career with an age-inclusive employer on our jobs board
• Life/Redefined Purpose Finder: Not sure what your next step should be? Check out our purpose finder.
• Upskill, Change Careers or Start a Business?: Take this personality test to figure out what your next step should be now you’re over 50