What is an umbrella company?

An umbrella company is a business that takes on agency workers and other types of temporary workers as their employees, with continuous contracts of employment, writes Shelley-Ankers Wainwright, the founder of SAW Consulting.

What is an umbrella company, and what does an umbrella do?

As the employer of these workers – who are often informally called ‘contractors,’ the umbrella company handles their payroll.

As a result, the umbrella will pay Employer’s National Insurance and (where applicable) the Apprenticeship Levy which will be deducted from the invoice value.

By law, the umbrella company (as the employer) must also deduct PAYE costs, like Income Tax and National Insurance Contributions, before paying the worker.

What about my obligations to HMRC when using an umbrella company?

Individuals contracting through an umbrella company do not need to worry about calculating and paying tax to HMRC, as they would have to do if they were self-employed or operating through their own limited company.

Instead, everything concerning HMRC is taken care of by the umbrella company.

What is an umbrella company defined as, or called?

It should be acknowledged that there is no single definition of an umbrella company, nor any statutory definition.

Therefore, anyone can set up a company and call itself an ‘umbrella company,’ although running a ‘brolly’ – as they are informally called -- efficiently, profitably and compliantly isn’t easy.

Related, most umbrella companies operating in the UK are compliant with employment and tax law.

What rules do umbrella companies have to follow?

But some umbrella companies are not. And despite a recent government consultation proposing to place rules around their operation at some point in the future, umbrella companies are currently unregulated.

More positively from a worker’s standpoint, IR35 does not apply if you work via an umbrella company. As you are an employee of the umbrella company, all of your income is already taxed as employment income.

How does an umbrella company work if I’m an IT contractor?

Despite what some people think, working through an umbrella company is pretty straightforward!

While there will be some slight differences with processes from one umbrella to another, generally the process from you doing the work to getting paid, is the same.

What do umbrella company workers have to do?

Once the contract with the umbrella company is signed by you, as its employee you will then be required to log your time (hours of work) using a timesheet, which will normally be countersigned by the client.

This timesheet is then forwarded to the umbrella company which will use it to invoice the client. Once the client has paid the invoice, the umbrella company will forward payment to you -- less their employment costs, margin, and the tax/NI due.

You will receive a payslip that gives full details of how your pay has been calculated.

How to choose an umbrella company?

Some umbrella companies claim to be, ‘HMRC approved’, but this is a misleading term. In fact, HM Revenue & Customs does not grant its approval to any umbrella company.

Some businesses that say they are an umbrella company claim they can provide tax advantages.

Our recommendation is that you treat these operators with extreme caution, as there is very little (lawful) opportunity to manage your tax liability to your advantage under PAYE.

Some other ‘umbrellas’ give the impression that they can simplify the process of claiming and/ or maximising the benefit of business expenses. Again, approach these providers with much caution, as the expenses that a contractor working through a bonafide, standard PAYE umbrella company can legitimately claim are very limited.

Can contractors detect a potentially dodgy umbrella company?

One way to spot a potentially non-compliant umbrella company is them offering very high take-home pay. For example, it is very unlikely that an umbrella provider that promises take-home earnings of 80% or above is operating lawfully.

However, there are some very good umbrella companies out there in 2024, so don’t be put off by the horror stories!

Can contractors detect a potentially decent umbrella company?

That doesn’t mean you shouldn’t do your research (remember to check out the umbrella company’s reviews and look out for recognised accreditations which signal they take compliance seriously), to make sure you are joining a reputable umbrella!

Be aware, it’s very likely that any recruitment agency you use as an IT contractor will have a PSL (Preferred Supplier List) in place. So the agency will likely ask you to work with one of their chosen umbrellas companies.

However, our recommendation is that you still do your own research into that umbrella, and make an informed decision about using it. Despite what the agency might tell you, or even insist in some cases, you are completely within your rights to choose your own umbrella company.

Why do umbrella companies need to be paid by their employees?

Finally, while it may seem unusual to pay an employer, you do have to pay an umbrella company for processing your pay and for the associated admin. Also, when employed through an umbrella company, you are covered by their company insurance policies. So you needn’t take out insurance for standard IT contractor jobs, as a limited company/ Personal Service Company often is required to do!

Very finally, remember, the umbrella’s fee is usually referred to as a ‘margin.’ The margin can range between £10 - £30 per week. Expensive doesn’t always mean the best and cheap doesn’t always mean the worst! Ideally, ask a fellow tech contractor who they use and get some genuine testimonials from people you trust.

Good luck, and happy umbrella company contracting!