Umbrella companies have flourished over the past decade in the UK, and can offer a ‘hassle free’ business structure to operate under for many contractors. Here, with a 10-step walkthrough, we explain how umbrella companies work in practice.
What is an umbrella company?
A PAYE umbrella company is a standard UK limited company, operated by a third party acting as an ‘employer’ on behalf of its contractor 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 provides a payroll service to its employees, processes all timesheets and invoices, and pays its employees a salary after allowing for deductions.
For information on the differences between working via an umbrella or limited company, read this guide first.
How does an umbrella company work? A 10-step walkthrough for contractors
If you’re new to umbrella companies, they may sound like complex arrangements, and you will almost certainly have many questions.
To help explain how umbrella companies work, we have produced a 10-step walkthrough for contractors which explains the entire process, from a contractor seeking a role to the worker being paid PAYE by the umbrella company.
Meet Monica, a contractor seeking a new IT role
In this scenario, we’ve created Monica – a contractor seeking a role in IT. We’ve run through the whole process – from Monica landing a six-month contract (inside IR35) working for an organisation specialising in electromechanical development – to the day she is paid by an umbrella company. Here are the key bodies in the supply chain:
- Monica – a contractor seeking a new role in IT.
- Friendly Personnel – a recruitment agency specialising in placing temporary workers.
- Bionic Limited – the end-hirer (the organisation seeking a contractor for a temporary role).
- Safeguard Umbrella – an umbrella company that provides PAYE payroll services for temporary workers.
1. Bionic Limited are looking for a contractor to fulfil an IT role for 6 months
Bionic Limited, a business specialising in electromechanical development, is seeking an IT contractor for a 6-month assignment that is inside IR35. To help with their search, they contact a recruitment agency called Friendly Personnel.
Friendly Personnel uploads a job description to their website, along with the rate of pay and the contract status (inside IR35). The role is advertised with an “umbrella rate” of pay because Friendly Personnel does not have a payroll facility for temporary workers. Therefore, an umbrella will be introduced into the supply chain.
2. Monica, an IT contractor, is successful in landing the new role with Bionic Limited
Monica finds the role online and applies. After speaking with a professional at Friendly Personnel, she lands an interview at Bionic Limited’s HQ and is offered the job. She is delighted, and accepts.
3. Friendly Personnel give Monica a Preferred Supplier List (PSL) – a list of umbrella companies she can use for her payroll
Upon landing the role, Monica is required to register with an umbrella company for her payroll. She will conduct her duties at Bionic Limited’s HQ and Bionic Limited will send her funds to the agency – Friendly Personnel (as well as additional commission, depending on the arrangement between the agency and end-client). Friendly Personnel will then transfer her funds to the umbrella company (as explained later in the process).
Friendly Personnel place hundreds of temporary workers each year and have a Preferred Supplier List (PSL) consisting of approved umbrella companies. Monica is strongly advised to use one of the umbrellas on the PSL because they all have an accreditation from the FCSA or Professional Passport – two self-regularly bodies promoting compliance within the contractor payroll sector.
4. Monica contacts 3 umbrellas from the PSL to request a take-home pay calculation
Monica approaches three umbrella companies on Friendly Personnel’s PSL and requests a take-home pay calculation from each. This is a document that will show Monica her expected pay retention and the deductions the umbrella will make.
After reviewing the three calculations, she decides to register with Safeguard Umbrella. The take-home pay calculation they provided her was the most accurate because they took all of her circumstances into consideration (rate of pay, hours worked, student loan, tax code, pension) and answered complex questions about holiday pay – unlike the others. Safeguard Umbrella also offered the lowest weekly margin and a heap of benefits, including: *
- Same Day Faster Payments – the umbrella will pay Monica the same day they receive the funds from Friendly Personnel.
- Employee Benefits – including sick pay and maternity/paternity pay.
- Insurance cover – including Professional Indemnity, Employers Liability and Public Liability insurance.
- Employee discount scheme – a scheme that provides Monica with discounts at high street retailers and restaurants (similar to Perkbox).
- No tie in or hidden costs – not a benefit as such, because all compliant umbrella companies will offer this as standard.
- Continuity of employment – one of the biggest benefits of using an umbrella is continuity of employment. This allows Monica to use the same umbrella (Safeguard Umbrella) for all future assignments, meaning she will have one ongoing employer. This makes sourcing finances easier, such as a mortgage or bank loan.
*Actual benefits between umbrella companies will vary, but the above list consists of common offerings from compliant umbrella companies in the UK.
5. Monica contacts Safeguard Umbrella and asks to register
Having chosen Safeguard Umbrella to be her umbrella company, Monica rings their Customer Support Team to start the registration process.
Firstly, Monica is required to provide a series of personal details, including her name, address, date of birth, contact details, national insurance number, bank account details, assignment information, and more.
Once she has completed the initial registration process, Safeguard Umbrella requests the following (legal requirement):
- Proof of identification – a photo or copy of a valid passport, or a Settled Status 9-digit share code.
- Proof of her right to work in the UK – a Settled Status 9-digit share code.
- P45 – Monica doesn’t have a P45, but this isn’t a problem. Instead, she is required to complete the Starter Checklist for PAYE – an online government form. The purpose of this is to ensure Monica is placed on the correct tax code, and isn’t emergency taxed.
6. Safeguard Umbrella send Monica a Contract of Employment
By completing the registration process with Safeguard Umbrella, Monica becomes an employee of theirs. Therefore, the final stage of registration involves reading, signing and returning a Contract of Employment. Monica reads it thoroughly and signs it because she’s entirely satisfied with all of its content.
7. The Onboarding Department at Safeguard Umbrella contact Monica and run through the payment process
Monica has completed the registration process and officially becomes an employee of Safeguard Umbrella. The Onboarding Department contact her to discuss the payment process and what Monica needs to do in order to be paid on time.
Friendly Personnel, Monica’s recruitment agency, is self-billing, meaning they have an agreement in place with Safeguard Umbrella and will send Monica’s funds at agreed intervals. As a result, Monica doesn’t need to submit signed timesheets to the agency and her umbrella (making her life easier) – a situation many contractors using umbrella companies find themselves in.
Monica is told she will be paid every Friday afternoon. As the umbrella processes payments with Same Day Faster Payments, Monica will receive her pay on the same day.
In the background, Bionic Limited has entered into an overarching contract agreement with Friendly Personnel, and Friendly Personnel have entered into an overarching contract agreement with Safeguard Umbrella. These agreements have been entered into to allow Monica’s funds to be passed down the supply chain. All Monica needs to do now is go to work at Bionic Limited and complete the first week of work.
8. Bionic Limited send Monica’s funds to Friendly Personnel, and Friendly Personnel pass these down the supply chain to Safeguard Umbrella
Monica completes her first week of work and Bionic Limited send her funds to Friendly Personnel. These funds are then passed down to the umbrella company to process.
9. Safeguard Umbrella receive Monica’s gross funds and process PAYE
Safeguard Umbrella receives Monica’s gross pay (before taxes are deducted). As a responsible and compliant umbrella company, they will now process Monica’s pay in accordance with HMRC’s tax system – Pay As you Earn (PAYE). Here are the deductions that will be made:
- The umbrella company’s margin – Safeguard Umbrella offered Monica a £15 per week margin. This is deducted from the gross pay, meaning it’s tax-efficient (taken before tax applies).
- Income tax
- Employee’s National Insurance Contributions
- Employment costs, consisting of the Apprenticeship Levy and Employer’s National Insurance – Monica was offered an umbrella rate of pay by Friendly Personnel which took the employment costs into consideration. As a result, her rate of pay would have been inflated to ensure she was not worse off using an umbrella company for payroll (compared to if she received agency PAYE).
- Student loan repayments – as Monica is currently paying back a student loan (plan one), she will notice a student loan deduction on her payslips.
- Pension contributions
- Holiday pay – umbrella companies are required to show holiday pay on every employee’s payslip. Holiday pay is actually a reallocation of the worker’s funds, and they are no better or worse off. It is a legal requirement that umbrellas showcase this. Some umbrella companies will offer you the chance to retain holiday pay and have it paid in a lump sum at a later date. However, Monica spoke with Safeguard Umbrella and requested to have her holiday pay processed each payment frequency.
10. Monica is paid by Safeguard Umbrella
On Friday afternoon, Monica checks her bank account and she has been paid by her employer – Safeguard Umbrella. She has also been issued a payslip that shows every deduction that has been made to her pay (accessible via an online portal).
The above scenario showcases how an umbrella company works when focusing on the entire supply chain. While appearing complex on first inspection, umbrellas are relatively straightforward. They become the contractor’s employer for payroll purposes and help ensure contractors pay the correct taxes and NI. Umbrella processes will vary between suppliers, but all compliant umbrella companies will operate similarly.
If you are a contractor considering using an umbrella company, please ensure you choose a compliant provider. Unfortunately, while most umbrellas are fully compliant with HMRC, a few facilitate tax avoidance and engaging with such an arrangement could result in you being issued a life-changing tax bill in the future. Pick your umbrella wisely!
How to find reviews/compare schemes
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 to 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.
- Here are 10 questions you should ask any prospective umbrella company providers.
- And also worth reading – umbrella company reviews – can they be trusted?
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. For an in-depth guide, read our comprehensive lowdown on umbrella fees and costs.
What will my net take home pay be?
Importantly, assuming you are using a legitimate UK-based PAYE umbrella, your take home pay should be the same regardless of the payroll operator you are using. The only variable should be the margin (fee) charged by the umbrella.
Before signing up, ask all of your prospective umbrella companies to provide you with a take home pay illustration. This should be a clear, transparent breakdown of your income and costs.
As a new client, you should be provided with a Key Information Document which shows both your PAYE rate (upon which personal taxes are payable), and the umbrella rate (which is how much the agency will be billed for your time, and includes employment costs, such as Employers’ NI and the Apprenticeship Levy).
Here are some useful guides to help you understand some of the deductions you will see on your payslip:
- Why am I paying employers NICs, if I’m not an employer?
- What is the Apprenticeship Levy, and why am I paying it?
- How is holiday pay calculated?
- A guide to all the different take-home pay ‘rates’ you might be quoted
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.
If you’re still not convinced, find out more about how to spot a rogue umbrella.
Which umbrella should I choose?
Visit our list of trusted PAYE umbrella companies as a good starting point.
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