What is an Umbrella Company?

An Umbrella Company acts as employer to independent contractors who work under a temporary contract, usually through recruitment agency.

Unless you work PAYE, recruitment agencies will only issue contracts to a limited company (they cannot engage sole traders). Since the introduction of the Managed Service Companies (MSC) legislation in the 2007 Budget, the only way a contractor can comply with this requirement is to set up his or her own PSC or use an Umbrella Company.

An Umbrella Company issues invoices to the recruitment agency (or client) and, when payment of the invoice is made, will typically pay the contractor through PAYE. Umbrella Companies have become more prevalent since the government introduced so-called "IR35 " legislation that makes it less beneficial to start your own PSC and increasingly attractive to join an Umbrella Company.

In December 2006, the UK Treasury introduced the draft legislation, "Tackling Managed Service Companies," which sought to address the use of composite companies to avoid Income tax and NICs on forms of trading that the Treasury deem as being akin to being "employed." After a period of consultation and re-draft, the new legislation became law in April 2007, with additional aspects coming into force in August 2007 and January 2008.

PAYE Umbrella Companies are effectively exempt from the MSC legislation, which can also pass on any unpaid debt if an MSC shuts down on to any other interested parties, e.g., a recruitment agency that has been deemed to encourage or facilitate the scheme.

Whilst many of the umbrella companies advertise similar offerings, would be users should always check the fine print of any agreements. Often expenses are used as a selling point but remember that it is the independent contractor who will be liable should HMRC decide that expenses have been incorrectly claimed.

Some common 'allowable' expenses include:

• Mileage & general travel expenses.
• Hotel & accommodation expenses.
• Professional subscriptions.

Below is a brief overview of the advantages and disadvantages of working through an umbrella company.

Advantages·

• Very easy to use, you simply enter your timesheet and expense details and wait to be paid.
• All tax and NICs are deducted before you receive your money, so you will have no further taxes to pay.
• Ideal for short-term contracts and contracts that are less than £25k per year.
• Good if you are unsure if contracting is for you and you're really just in between permanent jobs.
• Someone else will be doing all the paperwork.

Disadvantages·

• You will receive a salary that is subject to full PAYE Tax and NI whether you are outside of IR35 or not.
• You are reliant on the Umbrella Company to collect your money from the client or agent and then to pay it on to you.

Further Reading

Agency payroll or umbrella company?
How to compare umbrella companies - a contractor's guide
What freelance contractors should know about umbrella companies
Contractors beware - not all umbrella companies are the same!