What is an umbrella company?

As an independent contractor, you have the freedom to control your time and earnings. But you might find it challenging to find regular projects or a continuous stream of work. Additionally, some companies in countries like the UK may hesitate to hire freelancers who work on their own due to the tax risks and potential employment rights issues.

Another option for you is to work under an umbrella company. 

This article will explain what an umbrella company is, pros and cons, and some frequently asked questions about using an umbrella company. We’ll also check out some alternative business strucutues for you to consider such as setting up a limited company or a professional employment organization (PEO).

What is an umbrella company?

An umbrella company acts as an intermediary between an independent contractor and their recruitment agency or direct client. They handle the administrative burden for contractors and ensure continuity of employment between projects.

Over 500,000 contractors in the UK, including consultants, nurses, temporary workers, and care professionals, were working as umbrella company employees as of 2021.

How do umbrella company arrangements work?

Here’s a step-by-step breakdown of how umbrella payroll works for contractors:

1. You select an umbrella company or sign up with one your recruitment agency recommends.

2. You become an official employee under the umbrella company.

3. You provide a list of expenses and a timesheet detailing your working hours every payroll.

4. The umbrella company uses those details to invoice your client(s) or agency.

5. The umbrella company processes deductions for taxes, pension contributions, National Insurance Contributions (NICs), and other mandatory deductions.

6. You receive your monthly pay, along with a pay slip detailing the deductions.

Why use an umbrella agency? 

You might be wondering why contractors and agency workers use umbrella companies in the first place. Why not just register for a limited company or use another arrangement? 

We’ll answer that for you below.

Advantages 

Here are several reasons why using an umbrella company might be a good idea:

Employment rights

Because you’re classified as an employee, you’ll be entitled to statutory benefits, like maternity or paternity pay as well as statutory sick pay. And if you’re working on multiple contracts, you’ll only have one pension scheme for all of them, which reduces confusion.

Tax and invoice handling

Handling taxes and invoicing can be complicated, especially if you work with multiple clients. An umbrella company will take care of all the invoicing and income tax payments, including filing for work-incurred expenses, deductibles, and tax returns. 

Continuity of employment

You might have multiple clients or simultaneous projects — or only one project after months of inactivity. Financially, that might look like your employment is unstable.

With an umbrella company, you’ll only have one employer and no employment gaps. Although you’re a contractor, for tax and employment purposes, you’re an employee of an umbrella company, and this makes it easier to apply for loans or credit cards.

HR support

An umbrella company will take care of your invoices, including any pay disputes or HR-related problems if things aren’t working out with your client or manager.

Disadvantages 

Not every umbrella company is created equal, and they not all of them provide the same level of care to their contractors.

About 61% of workers say they don’t see any advantages to working under an umbrella company. Additionally, 74% are dissatisfied because they have to cover the Employer’s National Insurance (ENI) and, sometimes, an Apprenticeship Levy, leading to a reduction in their take-home pay. 

Fees

Umbrella companies in the UK charge anywhere from £12 to £35 per week. Compliant umbrella companies will only charge administrative costs for payroll processing and benefits. The rest are deductions paid to His Majesty’s Revenue and Customs (HMRC).

Insurance

Not all umbrella payroll companies can offer health insurance — the more affordable ones often can’t because they have smaller profit margins. 

Taxes

As an employee, you’re taxed just like other regular employees, so you won’t have to worry about setting aside extra income to meet your tax obligations. On the other hand, you can’t claim further business expenditures, qualified capital expenses, or deductibles for research and development as you would as a limited company. 

Employment pension

Some umbrella payroll companies don’t allow workers to keep their existing pension schemes. The rate of your compulsory pension contributions may change if you convert from a limited company, too.

Umbrella company FAQs

Below are common questions contractors and business owners ask when considering an umbrella agency. 

Can you claim benefits?

Yes, you can claim statutory benefits. However, this doesn’t mean your chosen umbrella payroll company will pay for them out of pocket.

For instance, many umbrella services deduct 12.07% from a contractor’s salary for holiday pay. You’re no better or worse off than if you were a regular employee, but you should take that into account when negotiating your rates.

Learn more about employee benefits around the world, check out our report on global benefits.

Can you claim expenses under an umbrella payroll company setup?

Your eligibility to claim expenses depends on your contract with the recruitment agency or client and if you have tasks where you incur expenses wholly or partially.

Do you have to pay more taxes or fees?

As an umbrella company employee, you’ll pay income tax instead of paying a 19% corporation tax on profits under £50,000. That’s why a limited company is more tax-efficient than an umbrella payroll company. 

Since you’ll pay income tax, your net pay will be lower than if you were claiming deductions on business costs. On average, your net pay will be around 55% to 75% of your gross monthly salary.

What are tax avoidance schemes to be wary of in an umbrella company arrangement?

Inland Revenue 35 (IR35) is a UK law set up to prevent contractors from paying fewer taxes by setting up a limited company when they should be classified as employees in the first place. 

If you’re deemed “inside IR35” or are already in an umbrella setup, you’ll pay taxes on your earnings as if you’re a regular employee. So be wary of umbrella payroll solution offers that let you keep 85% to 90% of your salary, as there may be more to the arrangement than you realize.

Some umbrella companies have loan schemes where they’ll frame your take-home pay as a basic salary plus a loan. 

Sounds okay, right? 

Except that loan isn’t taxed, and you don’t need to pay it back. The HMRC will be after you once they see you’ve taken advantage of this.

Remember that whatever umbrella payroll solution you choose, you’ll be liable for paying the correct deductions on your taxes.

United Kingdom —

14 min

What is IR35, and what does it mean for your business?

Discover the impact of IR35 on your business. Learn more about its complexities, and gain insights to effectively navigate it.

Now, let’s discuss alternative business structures for you to consider. 

Limited company (LTD)

A limited company or private limited company is a popular alternative for contractors. In this case, the company’s finances and legal obligations are separate from the owner’s.

In the event of a suit, the most you’ll be liable for are the business’s earnings and assets or your shares in it. Lenders and investors can’t claim your assets if the business goes bankrupt.

An LTD is also tax-friendly. For instance, an LTD that earns £50,000 or less will pay a corporate tax of 19%, while those earning £250,000 or more will pay only 25%.

You’re entitled to Marginal Relief if your earnings are between £50,000 and £250,000, so you still won’t pay much after crossing the £50,000 threshold.

Professional employer organization (PEO)

A PEO is an organization that helps businesses that need to outsource HR tasks, like payroll processing, employee benefits, recruiting, and even safety audits or training. 

PEOs are also called co-employers because organizations that hire them also have a registered business in the country they operate and are only outsourcing HR administrative tasks. 

Under this model, the PEO hires contractors and compensates them at a gross rate. This is useful for agencies who want to mitigate payroll risks. In addition, PEOs also take care of holidays, statutory payments, pensions, HR compliance, and timesheets — helping firms reduce the hassle and costs involved in tedious administrative processes.

However, not all PEOs are the same. Some companies process local employee taxes, while others can’t incorporate them into salary computations.

Employer of record (EOR)

While contracting does give you the freedom to work and earn on your own terms, it’s not without its challenges. You might struggle to find regular assignments or get paid on time.

Ultimately, your choice to be a contractor depends on ‌your circumstances — how much flexibility you want, whether it’s financially beneficial, and your appetite for security. 

If becoming an independent contractor is not for you, you can choose to work as an employee. Ask your client if they are willing to hire you as an employee. If they don’t have an office in your country, they can easily sign up for an employer of record (EOR) service.

An EOR allows companies to hire employees in another country or region without having to set up a local branch. Working with an EOR makes it easy for them to hire and onboard individuals living anywhere without violating any local employment laws they might not be aware of.

Learn more about the process of converting a contractor into an employee and share this article with your client. 

Is an umbrella company the best option?

Using an umbrella company works for those who want to have the security of employment while still enjoying the benefits of contracting.

However, joining an umbrella company may not always be the most cost-efficient option. You won’t be able to claim tax relief on your expenses and you’ll have to do your due diligence to make sure the company is legit.

Alternatively, you can choose to take control of your business and sign up for Remote’s Freelancer Hub. Our simple platform allows you to manage your clients, customize your client contracts, send invoices, get paid in your local currency quickly. Sign up with Remote to see how we can help move your freelance career forward.