How Do Umbrella Companies Work?

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You have just found out you need to use an umbrella company, but you are spoilt for choice! Umbrella companies have flourished over the last decade in the UK. They offer a ‘hassle-free’ business structure to operate under for many contractors.

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This is all down to changes to the IR35 legislation in the private sector. In this article, we will look at what an umbrella company is, what they do, and how to compare them.

What are umbrella companies?

An umbrella company, or PAYE umbrella, acts as the intermediary between a contractor and their end-client or the recruitment agency they have engaged with for an assignment. The umbrella company acts as an employer on behalf of its contactor employees.

A contract is signed between the umbrella company and recruitment agency (or end client) on behalf of the contractor who will be carrying out the assignment.

The umbrella company provides a payroll service to its employees, processes all timesheets and invoices, and pays its employees a salary after allowing for deductions such as PAYE, national insurance and pension deductions.

How does an umbrella company work in practice?

Here are the steps you will take if you join a UK-based PAYE umbrella firm:

1. Once you have secured a new contract, the umbrella company (as your ‘employer’) signs a contract with your recruitment agency.

2. You will also sign a contract of employment with the umbrella.

3. Once you have completed a pre-agreed time period on site, you complete a timesheet and pass it on to your manager to sign.

4. Submit your timesheet to both your recruitment agency and umbrella, showing how many hours you worked that week/month.

5. The umbrella company will invoice the recruitment agency, which subsequently bills the end client.

6. Once the umbrella company receives payment from the agency, they can prepare your payroll.

7. Your umbrella will process your payroll, and pay you a salary, following deductions for employment taxes, the pre-agreed umbrella fee/margin, personal taxes,  and pension contributions (if applicable). They will also reimburse you for any pre-agreed (chargeable) business expenses you have incurred (see below).

8. You will be issued with a payslip that details all of these deductions and your net take-home pay.

How to find and compare companies?

If you are starting your first contract, chances are you found the role via a recruitment agency.

Many agencies have preferred supplier relationships with some of the largest umbrella schemes, and they will encourage you to join one of their partner suppliers.

We recommend you take some time to consider your options and research the rest of the market before signing up for a particular company. If a recruiter gets a ‘kickback’ for recommending a particular umbrella, it may not be the best one for you.

The main source for contracting-related information is clearly online, however, it is a task in itself filtering out the marketing speak from genuinely useful content.

You could try some of the contractor comparison sites for background information on the leading umbrella companies, although we recommend you take any league table rankings with a pinch of salt, as they are easy to manipulate.

Above all, the best place to get feedback about umbrella companies is from existing clients. This may be difficult if you’re just starting out, but if you have any contracting colleagues, ask for their opinions. You will soon find out which umbrellas are well-regarded by your peers, and which are best to avoid.

How much does an umbrella company cost?

Umbrellas typically charge a fixed weekly or monthly fee. This can range from as little as £12 to £25 or more per week.

Things you should avoid at all costs

As a result of the April 2021 Off-Payroll changes, more contractors than ever have been forced to use umbrella companies. In an unregulated industry, how do you know if an umbrella company is operating legitimately or not?

Now, more than ever, contractors should be extremely careful when signing up to an umbrella company; a simple umbrella-related Google search will return a host of adverts for companies who promise to deliver net take-home percentages that simply aren’t possible to achieve legitimately.

As we know from the Loan Charge – which retrospectively taxes users of offshore loan-based umbrella companies – HMRC will always go after clients of tax avoidance schemes, and rarely pursue scheme operators.

It should go without saying that you should never sign join a tax avoidance scheme – offshore, loan-based, or any other structure apart from a UK-based PAYE payroll company.