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  • Writer's pictureUmbrella Search

How does an umbrella company work for contractors?

Contractors and freelancers often navigate complex tax and employment laws, making umbrella companies a popular choice for simplifying these processes and an appealing option for contractors at the start of their contracting journey.


In this article Umbrella Search  look at how umbrella companies work for contractors and what makes this intermediary between contractor, their recruitment agency and the end client a great solution for contractors. 


Using an umbrella company can simplify administrative tasks for contractors, providing a straightforward way to manage taxes, NICs, and payroll. However, it's essential to understand the associated fees, limitations on expense claims, and the implications for holiday and National Insurance contributions. By weighing these factors, contractors can determine whether working through an umbrella company is the right choice for their professional and financial needs.


What is an Umbrella Company?


An umbrella company is a third-party organisation that employs contractors who work on fixed-term assignments, typically through a recruitment agency. The umbrella company handles administrative tasks such as payroll, taxes, and other statutory obligations, allowing contractors to focus on their work.


How Does It Work?


Employment Setup:

When a contractor chooses to work through an umbrella company, they become an employee of that umbrella company. This means that they receive a regular salary, which includes deductions for tax and National Insurance contributions (NICs).


Contracts and Assignments:

The umbrella company signs a contract with the recruitment agency or the end client. The contractor then completes their work assignment as usual.


Timesheets and Invoicing:

The contractor submits their timesheets to the umbrella company, which then invoices the recruitment agency or client for the hours worked.


Salary and Deductions:

Once the umbrella company receives payment, they process the contractor's salary after deducting necessary taxes, NICs, and any other agreed deductions. The remaining amount is then paid to the contractor as their net salary.


Claiming Expenses through an Umbrella Company

While working through an umbrella company, contractors can often claim certain business-related expenses. However, the ability to claim expenses has been restricted due to changes in tax laws, particularly concerning travel and subsistence expenses. Here are common types of expenses that may still be claimed:

  • Professional Subscriptions: Membership fees to professional bodies relevant to the contractor’s work.

  • Training Costs: Expenses for training courses that are necessary to maintain or improve skills for the current role.

  • Equipment: Costs of equipment essential for the completion of assignments.

  • Travel and Subsistence: This is often restricted, but some local travel costs might be claimable if the contractor is not under Supervision, Direction, or Control (SDC).

National Insurance Contributions (NICs) and Holiday Entitlement

National Insurance Contributions for Contractors


National Insurance Contributions (NICs)

Contractors working through an umbrella company are treated as employees, meaning they must pay both employee and employer NICs. The employer's NIC is usually deducted from the contract rate agreed with the recruitment agency or client.



Holiday Entitlement

Umbrella workers are entitled to holiday pay, which is typically accrued as a percentage of their gross pay. The statutory minimum holiday entitlement in the UK is 28 days per year, including public holidays. This entitlement can be paid as part of the hourly rate or set aside and paid when the contractor takes time off.


Claiming Expenses through an Umbrella Company

While working through an umbrella company, contractors can often claim certain business-related expenses. However, the ability to claim expenses has been restricted due to changes in tax laws, particularly concerning travel and subsistence expenses. Here are common types of expenses that may still be claimed:


  • Professional Subscriptions: Membership fees to professional bodies relevant to the contractor’s work.

  • Training Costs: Expenses for training courses that are necessary to maintain or improve skills for the current role.

  • Equipment: Costs of equipment essential for the completion of assignments.

  • Travel and Subsistence: This is often restricted, but some local travel costs might be claimable if the contractor is not under Supervision, Direction, or Control (SDC).


What is an umbrella company?

Advantages and Disadvantages of Umbrella Companies


Advantages:

  • Simplified Administration: Umbrella companies handle all administrative tasks such as payroll, taxes, and compliance with employment laws, allowing contractors to focus on their work.

  • Employee Benefits: Contractors receive benefits similar to regular employees, including holiday pay, sick pay, and maternity/paternity leave.

  • Steady Income: Contractors receive a regular salary, providing financial stability and easier budgeting.

  • Compliance Assurance: Umbrella companies ensure that all tax and legal obligations are met, reducing the risk of non-compliance issues, such as exposure to IR35.

  • Flexibility: Contractors can easily switch between assignments and clients without needing to manage separate limited companies or tax arrangements for each job.

Disadvantages:

  • Fees: Umbrella companies charge a fee for their services, which can reduce the contractor's take-home pay.

  • Limited Expense Claims: Recent changes in tax laws have significantly restricted the types of expenses that can be claimed.

  • Less Control: Contractors have less control over their financial arrangements compared to running their own limited company.

  • Double National Insurance Contributions: Contractors must pay both employee and employer National Insurance contributions, which can further reduce net earnings.

  • Dependence on Umbrella Company: The contractor’s income is dependent on the efficiency and reliability of the umbrella company’s administrative processes.


Making the Decision: Is an Umbrella Company Right for You?


When deciding whether to use an umbrella company, consider the following:


Nature of Work

If your contracts are short-term or you frequently switch between clients, an umbrella company can offer the flexibility and administrative support you need.


Administrative Burden

If you prefer to focus on your work rather than dealing with accounting, tax filings, and other administrative tasks, an umbrella company can be a beneficial choice.


Financial Considerations

Evaluate the fees charged by the umbrella company and compare them with the potential tax efficiencies of setting up your own limited company. The reduced administrative hassle might outweigh the costs for some contractors.


Employment Benefits

Consider the value of employee benefits such as holiday pay, sick pay, and pension contributions, which are typically provided by umbrella companies.


Compliance and Risk Management

If you are concerned about compliance with complex tax and employment laws, an umbrella company can offer peace of mind by ensuring that all legal obligations are met.


Conclusion


Umbrella companies provide a valuable service for contractors, especially those who prioritise ease of administration and tax efficiency. They simplify payroll management, ensure steady income, and offer employee benefits, making them an attractive option for many professionals. However, they do come with certain costs and limitations, such as fees and restricted expense claims.


Ultimately, the decision to use an umbrella company should be based on your individual circumstances, work preferences, and financial goals. By thoroughly assessing the advantages and disadvantages, contractors can determine whether working through an umbrella company is the right choice for their professional and financial needs.


If you are ready to explore an umbrella company as the next option for you, why not get in touch with our friendly team today?


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