How to set up and run a small business

Leaderboard – Run – Freelancers

You are here: Home » Run a Business » Freelancers » How a contractor umbrella company works

How a contractor umbrella company works

October 11, 2011

An umbrella company acts as your employer, for tax purposes, when you undertake a contract with an employment agency or a client. It is an alternative to you setting up your own Limited Company and, if your contract is outside of IR35, it is usually the most cost effective way for you to operate.

Your umbrella company will raise invoices on your behalf and will then make payment to you once they have received funds from your agency or client. The amount the umbrella company receives will be determined by the timesheet that you have signed by your line manager as this is a record of your hours/days worked.

Some umbrella companies will need a copy of this timesheet to raise and invoice and some will have an online system to which you can upload your hours/days worked directly.

When you are paid will depend on the arrangements that your umbrella company has in place for payment processing; some pay on the same day as funds are received but some will only pay once a month. Your agency/client will be able to advise you of the date that they will transfer funds to your umbrella company.

Once payment has been made you should receive a payslip which will detail the tax and national insurance contributions that you have paid as well as your expenses claimed, your umbrella company’s fees and your net earnings.

As an independent contractor working inside of IR35 you are liable for both employee’s and employer’s national insurance and these will be shown separately on your payslip.

You should be aware that, despite advertising claims, the only variance in your earnings between different umbrella companies will be their fees. The reason for this is that you are paid via PAYE and all deductions made are determined by the Inland Revenue.

You are permitted to claim expenses and these will be processed by your umbrella company. Expenses that are chargeable to your agency or client will be refunded to you in full; those which are not chargeable will be processed as a tax benefit. This means that your taxable income will be reduced by the value of the expenses. However, this does not mean that expenses can be used to reduce your tax bill – anything that you claimed must be allowable by the Inland Revenue and must be a cost to you personally that is entirely attributable to and has been wholly caused by the contract.

Umbrella companies all have a dispensation. You should be aware that this does not determine the expenses that you are permitted to claim and it does not preclude you from having to keep receipts. It simply allows the umbrella company to process certain expenses without having to record them on a P11D which they would have to do under standard accounting practice.

If you were to be investigated by the Inland Revenue you would be required to produce receipts for all your expenses regardless of the dispensation that your umbrella company has. The only expense that you can claim without a receipt is a daily subsistence allowance of £5 in the UK and £10 overseas but this is claimable only when you work away from home overnight.

Article kindly provided by Contractor Umbrella – one of the leading umbrella companies for freelancers and IT contractors.