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What a Contractor Should Know About Umbrella Companies

Umbrella companies have grown over the past decade since it started in the middle of 2000. Using an umbrella company relieves contractors from working through their own limited company and offers a hassle free business structure. It is for this reason there are more than 200,000 people in the UK working through umbrella companies, and the figures are only rising with more and more people joining the self-employed industry. Also, after the IR35 legislation started umbrella companies have become more common in the UK.

How does this work?

Umbrella companies act as an employer to agency contractors who are placed on contract assignments usually through a recruitment employment agency in the UK.

Here is a step to step guide on how this work.

1.    You register with the umbrella company (you can do this online or over the phone)

2.    You sign a contract of employment with the umbrella company

3.    You submit timesheets showing how many hours you worked along with your expenses claim forms to the umbrella

4.    The umbrella company invoices the recruitment agency, which subsequently bills the end-client

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

6.    Umbrella Company processes your payroll, and pays you a salary, following deductions for taxes (income tax + National Insurance), the pre-agreed umbrella fee, and any other deductions (for pension contributions, for example).

Are there significant tax advantages of using an umbrella company?

You will receive an overarching contract of employment and become an employee of the umbrella company undertaking a variety of roles as suits your abilities at various different locations, these workplaces will be classified as temporary workplaces. This can let you offset subsistence and travel expenses reducing the gross salary and subsequently the amount of tax paid. This model is suitable for those contractors who work at different locations.

What about IR35?

The IR35 legislation was introduced on 6th April 2000. It was first proposed by the Chancellor in the 1999 Budget. The aim of the legislation is to eliminate the avoidance of tax and National Insurance Contributions (NICs) through the use of intermediaries. On 27 October 2014, HMRC announced that the ‘Business Entity Tests’ (BETs) of IR35 will be withdrawn from 6 April 2015. However, the IR35 legislation would still apply.

Umbrella company employees fall outside the scope of IR35 and will not be affected by it.

Contracting and national minimum wage (NMW)

NMW applies to contractors who are employed by a compliant umbrella service provider as there is a contract of employment in place.

Some umbrella companies pay their employees a salary below minimum wage and then make up the difference by including various expenses such as meals or travel costs. HMRC has stated  they are aware of ‘schemes’ whereby umbrella companies are avoiding paying the National Minimum Wage and that they view them as unlawful and will take action accordingly. 

Tips to consider while choosing an umbrella company

How can you ensure you are choosing the right company? While many of them offer compliant and quality services there are a small number of companies that have put the image of the umbrella sector at risk.    

If you are just starting as a contractor and looking for an umbrella company, you will be swamped with hundreds of companies all making variety of claims and promises and when you hear one that sounds too good to be true, it probably is.

Here are our seven tips for contractors to consider when choosing an umbrella company.

Experience – look for an established company which has specialist knowledge and provides compliant service.

Higher net pay – if a company guarantees larger take home pay which sounds unrealistic, it is best to keep away from them.

Fee structure – before you choose an umbrella company it is of great importance to establish upfront that there will be no joining and exit fees.

Claim expenses without receipts – any company that allows claiming expenses with ‘No Receipts’ keep away from them. It is best practice to retain receipts even for allowable expenses.

Personal service – make sure you are appointed a dedicated client manager to manage your assignments. Assure it is not just an online system and that you can speak to a real person when required.

Employee benefits – ensure the company you choose gives you the option of employee benefits such as holiday pay, sick pay, maternity and paternity pay.

IR35 compliant – when a company claims that they are “IR35 compliant” it may sound impressive, but this does not apply to contractors that operate through an umbrella company because your payments are processed through PAYE.

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