Working through an umbrella company means that you become an employee of a company which in turn signs a contract with your agency or client. The umbrella company will then pay you your agreed amount less Income Tax, Employee’s and Employer’s National Insurance, and a fee for the umbrella’s services.
The employment nature of an umbrella company means that the return is lower than that available from a limited company, however it also means there is less administration required from you. Whilst each umbrella will have their own processes and procedures for signing up, for most companies all you will need is to complete a form and provide ID and proof of address. The umbrella company will then contact your agency/client to arrange the contract.
Normally an umbrella company contractor will submit timesheets signed by the client to the umbrella company, who will then invoice the client/agency. Once they have been paid the umbrella company will then calculate and deduct Income Tax and National Insurance (including both employers’ and employees’ NI) and their fee, usually a fixed weekly or monthly amount, but sometimes a percentage of your rate, and then pay your net salary into your bank account.
One contrast with the limited company approach to contracting is that as an employee you are not allowed to claim expenses such as travel and subsistence against tax. These costs will need to be covered out of your net income. You will need to bear this in mind both when choosing whether to use an umbrella or limited company and, having chosen to use an umbrella, whether to take a contract or what rate to ask for.
The low amount of administration means that an umbrella company is a great option if you are only planning on contracting for a short time, or on a low rate, and therefore do not want the longer-term commitment of a company or would not benefit greatly from the tax savings a limited company allows. As an employee, an umbrella company contractor is not covered by IR35, so it is a preferred option of many contractors for roles “inside” IR35, and is demanded by some public sector clients. You can also use an umbrella if for any reason you are not able or willing to become a company director.
Advantages of using an umbrella company
- No admin
- One payment on the PAYE system
- Suitable for one-off short term contracts
- IR35 does not apply
Disadvantages of using an umbrella company
- Less tax efficient (lower take-home)
- Not able to claim expenses
- More difficult to work for multiple clients
- Not working under your own brand
- Less control – another link in the chain
- Many agencies operate a preferred suppliers list