What are umbrella companies, and how do they work?

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. With hundreds of suppliers on the market, we look at how a PAYE scheme operates in practice, how to compare providers, and questions to ask when choosing a scheme.

What is an umbrella company?

A PAYE umbrella company is a standard UK limited company, operated by a third party supplier 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.

You can reclaim the cost of any legitimate business expenses you incur as a contractor, however what you can claim depends on whether or not your contract is deemed to be under the ‘Supervision, Direction and Control’ (SDC) of your client. If your contract work is caught by the SDC rules, you cannot reclaim the costs of travel and subsistence.

You can if your contract is not deemed to be caught by the SDC rules. You can read the official background to these rules, which took effect from April 2016.

For information on the differences between working via an umbrella or limited company, read this guide first.

How does an umbrella company work in practice?

Here are the steps you will take if you join a UK-based PAYE umbrella firm:

1. Once you have secured a contract role, the umbrella company (as your ‘employer’) signs a contract with your recruitment agency.

2. You will also sign a contract of employment with the umbrella.

3. Once you have completed a pre-agreed time period on site, you complete a timesheet and pass it on to your manager to sign.

4. Submit your timesheet to both your recruitment agency, and umbrella, showing how many hours you worked that week / month.

5. The umbrella company will invoice the recruitment agency, which subsequently bills the end-client.

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

7. Your umbrella will process your payroll, and pay you a salary, following deductions for employment taxes, the pre-agreed umbrella fee/margin, personal taxes,  and pension contributions (if applicable). They will also reimburse you for certain allowable expenses you have claimed – such as mileage.

8. You will be issued with a payslip which details all of these deductions and your net take home pay.

9. At the end of each tax year you can reclaim the cost of any remaining expenses against your income tax bill.

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 would recommend you take some time to consider your options, and research the rest of the market before signing up to a particular scheme.

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 schemes are well-regarded by your peers, and which are best to avoid.

Which umbrella should I choose?

Visit our list of trusted PAYE umbrella companies as a good starting point.