What an Umbrella Company is to a Contractor
When it comes to choosing their business structure, contractors or freelancers have two options. They can either set up their own Limited Company, or they can work via an umbrella company. In this article of "Path of Education for New Contractors," we try to put some light on umbrella companies.
Umbrella companies can be of great help to contractors who do not want the hassles associated with running a Limited Company. As part of our series 'Path of Education for New Contractors,' we have covered the basics of umbrella companies in an earlier article. In this article, we look at what are the legal obligations of an umbrella company towards contractors.
Introduction to Umbrella Company
An umbrella company is an arrangement for managing the accounts, taxes, and administration of a contractor's business. An umbrella company allows a contractor to take up contracts independently, without worrying about the challenges of running their own Limited Company. If a contractor agrees to work through an umbrella company, the company becomes the employer of the contractor. It is estimated that nearly 200,000 people in the UK work through umbrella companies.
Working through an umbrella company is ideal for you if:
- You want to save on the costs and the effort involved in setting up a limited company.
- You are not keen on managing your accounts and taxes.
- You are on a short-term contract, and it doesn't make sense to create a Limited Company for a short period.
- You need time to decide on whether you want to operate as an independent contractor for the long term.
- You want to become a contractor for independence and work-life balance, and not necessarily for lower taxes or higher income.
- You want to take up different kind of projects, which may not be available to you as a full-time employee.
Advantages of working through an Umbrella Company
- It is easier and faster to start operating through an umbrella company as opposed to starting your own Limited Company. You can register with an umbrella company either online or through phone.
- You don't have to worry about correspondence with HMRC regarding VAT, payroll, or filing of accounts, etc.
- Unlike operating a Limited Company, there is no paperwork or filling of forms with the Companies House.
- If you are becoming a contractor for a short-term, you can avoid the costs and effort involved in setting up a Limited Company.
- You will pay lesser taxes against what you would have paid as a full-time employee by deducting many expenses like food, accommodation, and mileage.
- You can choose your clients and contracts.
- You can decide your own rates for contracting.
Disadvantages of operating through an Umbrella Company:
- Tax savings are lesser when compared to working as a Limited Company contractor.
- You will be dependent on the umbrella company for many things such as payments and filing of taxes.
- You cannot showcase yourself as an independent business owner or a Limited Company Director to prospective customers.
- There could be some delay in receiving payments from the umbrella company.
- You will have to trust the umbrella company as you are passing your own money through the umbrella company.
Working through an Umbrella Company - How does it work?
As a first step, you will have to register with an umbrella company. Registration is very simple and can be done within a few hours.
Once registered, you will have to maintain a timesheet, which you will be required to forward to the umbrella company. Upon receiving the timesheet, the umbrella company will invoice the client as per the amount mentioned in the timesheet. The umbrella company will collect the invoice amount, and pay you after deducting income tax, National Insurance, and their service fees.
You should note that the payment schedule will depend on the umbrella company. Some providers will pay you as soon as they receive money from your client while others may transfer funds only at a set date.
Your responsibilities towards the umbrella company:
- Always keep your timesheet up-to-date and submit it regularly
- Keep all receipts of all contract-related expenses and send them to the umbrella company
Responsibilities of the umbrella company:
- Invoice your clients or recruitment agency
- Follow up with clients or agency for payments
- Deduct National Insurance and income tax from your salary
- Minimize your tax liability by deducting legitimate expenses
- Interact with the HMRC for tax and accounting matters related to your business
Factors to consider while selecting an umbrella company:
- Compliance with HMRC: If the umbrella company is compliant with HMRC, then it will be required to deduct income tax and National Insurance deductions as per HMRC rules, and also pay it to the HMRC on time. You can know whether the umbrella company is compliant with the HMRC if they are asking for receipts of all their expenses. An HMRC-compliant umbrella company is legally required to check that only valid expenses are claimed by the contractors. Also, you should stay away from companies that promise you a very large take-home pay, because HMRC rules are the same for everyone. Some companies may be more customer-friendly and can guide better on how to save taxes, but there shouldn't be a major difference between the take-home pay guaranteed by two different umbrella companies.
- Fees: One of the main differentiators between different umbrella companies is the fees charged by them. A good umbrella company will not charge you on the basis of your earnings but should charge you a fixed fee irrespective of how much you earn. If they are quoting fees as a percentage of sales, the fees should not be more than between £15 and £27.50 per week.
- Hidden costs: Check if there are any hidden costs for joining or leaving the umbrella company. A reputable umbrella company will not charge any joining or leaving fees.
- Insurance: You should check if the umbrella company is providing you with insurance. Most umbrella companies offer different types of insurance such as professional indemnity insurance, public liability insurance, and employer's liability insurance.
- Personal recommendation: If anyone in your network is using an umbrella company and if they are happy with the service, you can go for the same company. You can also ask your recruitment agency for a recommendation.
Just like an umbrella, an umbrella company is at best a temporary arrangement. An umbrella can protect you from rain or snow for some time, but eventually you will have to find a more solid and permanent structure for shade. This is particularly true for contractors whose contracts are outside IR35 and who intend to work as independent contractors for a long term. For such contractors, forming their own Limited Company is the best choice.
Having said that, an umbrella company has many advantages for contractors with short-term contracts or those who aren't fully sure about making a career in contracting. By working through an umbrella company, such contractors can solely concentrate on the work and leave all the paperwork to the umbrella.
If you are looking for an umbrella company, check the services of Contractors Umbrella Company (CUC). CUC is fully compliant with HMRC rules. In 2013, CUC was rated as the number one umbrella company in the UK by Umbrella Compare, a leading comparison site for umbrella companies.
You may also find the following contractor calculators useful for your salary and tax calculations.
Self Assessment Guides for Contractors and Freelancers