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 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 in practice?

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

1. Once you have secured a new contract, 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 any pre-agreed (chargeable) business expenses you have incurred (see below).

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

What about expenses?

You will be reimbursed for legitimate business expenses you have pre-agreed with your client or recruitment agency, just as any other traditional (permanent) employee would. These are known as ‘chargeable’ expenses.

You may also be allowed to reclaim the cost of any other business expenses you incur as a contractor, but only if your working situation is deemed not 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.

Read the official background to these rules, which took effect from April 2016.

If you are not caught by the SDC rules, you should make a claim for any non-chargeable expenses via the self-assessment process at the end of the tax year in question.

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:

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.

FCSA-registered Umbrella Company UK has a special £12/week offer for ITContracting.com visitors – find out more here.