What are umbrella companies and how do they work?

What are umbrella companies and how do they work?

If you are a contractor, you might have heard of the term “umbrella company” without fully understanding exactly what one of these entities is and how it works. These types of PAYE schemes are becoming more and more popular in the UK and can offer a hassle-free option for contractors who do not wish to sort out every aspect of their pay and tax affairs themselves.

Here, we’ll take a look at how these schemes work, the questions to ask when looking for a scheme, and how to choose the best provider.


What are umbrella companies?

PAYE umbrella companies are a type of standard UK limited company. They act as the contractor’s employer, so your contract is between yourself and the umbrella company. They then have a contract with the recruitment agency or client. You can think of the umbrella company as a middle-man or go-between, linking you and the client or organisation. You are doing the actual work for the end client but are employed by the umbrella company.

The main benefit for you as a contractor is that the umbrella company handles all payroll issues, including processing timesheets and invoices. It then pays you a salary as an employee after allowing for deductions.

Deductions generally include any legitimate business expenses as a contractor, but the precise scope of what you can claim depends on whether your contract is considered to fall under the Supervision, Direction and Control (SDC) of the client. These new rules were brought in from April 2016.


How do umbrella companies work?

This is the typical sequence of events when working as a contractor via a UK PAYE umbrella company:

  • You secure a contract role, usually through a recruitment agency. As your “employer”, the umbrella company signs a contract with the client or agency.
  • At the same time, you sign a contract of employment with the umbrella company.
  • After working onsite for a pre-agreed length of time, you will need to complete a timesheet, which will be checked and signed by a manager.
  • The timesheet will show how many hours you worked that week or month. It will be submitted to both the umbrella company and recruitment agency.
  • The umbrella company invoices the recruitment agency and they bill the end client.
  • Payment goes back from the client through the agency to the umbrella company. The umbrella prepares and processes your salary.
  • You are paid through PAYE. Deductions – including income tax and National Insurance, fees for the umbrella company’s services and any pension contributions – will automatically be worked out and deducted. You should also be reimbursed for certain allowable expenses, such as mileage allowance if you have to drive.
  • Any remaining expenses can be claimed back against your income tax bill at the end of the financial year.

  • Finding the right scheme

    There are many different providers out there, and it’s important to find the right one for you. Many recruitment agencies have their own preferred umbrella partners and may recommend a company to you. You do not have to go with their recommendation, however, and it’s usually best to conduct your own research and consider the options available.

    As with many other areas in life, word of mouth and personal recommendations are important resources when it comes to weighing up a particular umbrella company. If you are only just starting out as a contractor, your professional circle might be limited, but the advice and opinions of any contractor friends or colleagues that you do have can be valuable. You might also find out more first-hand experience on contractor forums and groups online.

    The internet is a good place to research these companies, but a word of caution: it can be difficult to filter out the genuine opinion from the marketing copy floating around. Comparison sites can offer a decent level of background information on leading providers, but you should probably view league tables or rankings with cautiousness as these can be manipulated or slanted in certain ways.

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