Typically, contractors must choose between registering as a sole trader or becoming a limited company director. However, there is a third option. Umbrella companies take away the hassle of tax admin, serving as a go-between PAYE scheme. Keep reading to learn how umbrella companies work in the UK.
Umbrella companies explained
An umbrella company is registered as a UK limited company. It operates as a third-party between contractor, recruitment agencies, and HMRC, providing standard payroll services. Typically, the recruitment company signs a contract with the umbrella company on a contractor’s behalf. In return for a fee, the umbrella company processes invoices and timesheets. They pay contractors a ‘salary’ after taking out tax deductions, pensions payments, and National Insurance contributions.
This type of service is usually in demand for temporary contractor assignments, where a self-employed individual wouldn’t want to go through the hassle of setting up their own limited company. Essentially, if you choose to sign up with an umbrella company, you become an employee solely for admin purposes.
How does an umbrella company work?
Here’s a step-by-step breakdown explaining at how an umbrella company works in practice:
You, as a self-employed contractor, secure a role through a recruitment agency.
The umbrella company, acting as your ‘employer’, signs a contract with the agency.
You sign a separate contract of employment with the umbrella company.
As you complete your work, you fill out a standard timesheet and submit this to the umbrella company.
The umbrella company invoices the recruitment agency, who receives payment from the end client.
After this payment is received, the umbrella company processes payroll.
You’re paid a salary, minus deductions for income tax, pension contributions, National Insurance contributions, and the umbrella fee. You’ll receive a payslip detailing all of these deductions and net pay.
Because you’re an employee, you’re paid through the Pay as You Earn (PAYE) system and don’t need to worry about registering as a limited company or sole trader.
Benefits of an umbrella company
Working with an umbrella company offers certain benefits, including the following:
Less paperwork: All you have to do is sign a contract and submit your timesheets to the umbrella company. There’s no need to worry about chasing up payments or invoicing the end client, and taxes are automatically deducted.
Ideal for short-term contracts: If you’re working on a temporary contract, you don’t have to worry about setting up a limited company or registering with Companies House.
Additional benefits: Some umbrella companies offer additional benefits as part of the contract, including maternity and paternity leave, paid time off for holidays, and sick leave. Some also offer workplace pensions, so it’s worth comparing benefit options.
Drawbacks of an umbrella company
Although there are many benefits of umbrella company schemes, this type of set-up isn’t for everyone. Some of the drawbacks include:
Lack of control: Although you can leave at any time, you’re considered an employee of an umbrella company and are bound by contractual terms. As a limited company director, you’re in full control of all financial decisions and payment methods.
Administration fees: You’ll be paid via PAYE, but umbrella companies will deduct their fees from your pay. Umbrella membership typically costs around £30 per week, which adds up over time in lost income.
Extra research: The main drive behind signing up for an umbrella company is convenience, but you will still need to make sure the company is legitimate. Make sure that the umbrella company is part of an accredited association and adheres to all current HMRC regulations.
Umbrella company vs. limited company
Is it better to register a limited company or pay fees to an umbrella company? This depends on the nature of your work and your appetite for admin. When comparing umbrella company vs. limited company pros and cons, the best fit will depend on a few factors.
Contractors just starting out probably don’t need to set up a limited company. While it offers tax advantages in the long term, you must keep company records, register at Companies House, and file VAT returns. By contrast, umbrella companies handle all the paperwork on your behalf.
This is particularly true if you only plan to contract in the short-term, because you’ll need to dissolve your limited company when the work is complete. If you do decide to run a limited company, you can still work as an umbrella company employee on certain contracts if you wish.
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