Umbrella companies are a method to support an ever-changing labour market, where labour trends can be met more flexibly and with less rigidity. However, they are relatively unknown, and this article aims to highlight some of its features. It is estimated that approximately 600,000 people work under umbrella companies.
What is an umbrella company?
Although there is no statutory definition, an umbrella company is a company that an independent freelance contractor can join as an alternative to setting up and running their own business. When a contractor joins the umbrella company, they become their employee. Although the umbrella company does not provide work, they outsource the contractor’s services to a recruitment agency or directly to the end user. As an employee, they will deal with the contractor under the PAYE system. All the usual employment rights, duties and obligations arise and apply in this relationship. Usually, the contractor will submit timesheets to the umbrella company, and they will handle the payroll. The umbrella company then invoice the service user and get paid for the work completed. They then pay through PAYE, deducting costs such as taxes, National Insurance contributions and workplace pension payments. As part of the process, they also handle the accounts and tax returns on the contractor’s behalf.
Why use an Umbrella Company?
There are various reasons why contractors may want to use umbrella companies.
- The contractor becomes an employee of the umbrella company, and becomes entitled to all the statutory employment rights including sick pay, statutory holidays/pay, pensions, maternity rights, redundancy pay and unfair dismissal etc.
- They can avoid all the administrative bureaucracy of running a business. The umbrella deals with invoicing, chasing payment, sending timesheets and payroll.
- They are very useful for short-term contractors, who may be in-between assignments, want a break or are returning after a break. They provide flexibility.
- It removes the burden of IR35 requirements. In ordinary cases, the service user is now obligated to carry out checks and assessments to determine the status. But these rules do not apply if a contractor is taken on by the umbrella company as an employee.
- Where there is a labour shortage, service users (usually private businesses) may want to use temporary staff to plug the staff shortages. This provides flexibility for both parties.
However, there are disadvantages associated with umbrella companies.
- Umbrella companies employ the contractor under PAYE, meaning that all their income is treated as salary and will be subject to tax and national insurance deductions. It does not provide tax efficiency. They will also deduct their fees (umbrella membership can cost approximately £30 a week).
- The contractor will not have much control. Running your own business means you are in control of the business/activities/duties/obligations and how much you pay yourself. The contractor losses that freedom – which is often the most appealing feature of setting up as an independent business.
- Umbrella companies are required to comply with all tax and employment laws. But at present, there is no specific regulatory framework dealing with them. In contrast, employment agencies have a strict regime governing their conduct.
- There are some unscrupulous umbrella companies that are not compliant. Often, they will disregard sick pay, holiday pay etc, meaning that they limit their outlay making them more profitable. This non-compliance creates exploitation and inequality in the labour market.
How do umbrella companies work?
- When the contractor secures a role, the contractor will enter a contract with the umbrella company, and they will then enter a contract with an agency or end user to provide services.
- The contractor agrees to spend an amount of time with the agency or end user, who then confirm that record and sign it. This signed record is then submitted to the umbrella company.
- The umbrella company then invoices the agency or end user.
- When the umbrella company receives payment, they will process the contractor’s payroll. The contractor will be paid a salary, which deductions in income tax, National Insurance contributions, pension contributions and the umbrella fee. Allowable expenses can be reclaimed, which the umbrella should process too.
- The umbrella company will give a payslip that shows the take-home pay as well as all the deductions.
Umbrella companies can provide a useful medium to run an independent business without the bureaucracy associated with running a business. However, care should be taken in selecting the most appropriate company. Contractors should check if the umbrella company is a member of Freelancer & Contractor Services Association (FCSA).
Please note that this article is intended as a brief guide. If you are interested to learn more, readers are advised to contact Quest, where a dedicated team of Legal and HR team can offer you the initial advice and guidance. We can also provide specialist drafting consultancy service. Call us on 01455 852 028.
(Source; govt.uk, simply business online)
