Working via an umbrella company – the pros and cons

Although most professional contractors work via limited companies, a significant percentage prefer to (or have to) work through umbrella companies. Here we look at the pros and cons of contracting via an umbrella.

Choosing an Contractor Umbrella Company – Positives

  • This is often said to be the ‘hassle-free’ way to contract. You won’t have any of the administrative or statutory responsibilities associated with running a limited company.
  • For short-term IT contractors, an umbrella is a sensible solution, rather than going down the more time-consuming route of setting up a new limited company.
  • You don’t need to file an annual self-assessment tax return, unlike company directors, unless you have received untaxed income during the tax year.
  • You don’t need to set up a business bank account to receive your earnings. If you’re a limited company director, you cannot use your personal account for business transactions, as a company and its members are separate legal entities.
  • Set-up is simple. You join the umbrella company and provide your contract and personal details. Each week (or month), you send your timesheet to the umbrella company. The umbrella then invoices the client. You will then receive your payment, net of income tax, national insurance, the umbrella fee, and any other deductions (such as pension contributions).
  • If you’re new to contracting, using an umbrella company is an easy way to get started. You can set up your own limited company at a later date if you want to switch at a later stage.

Choosing a Contractor Umbrella Company – Negatives

  • Assuming your contract work is not caught by the IR35 / Off-Payroll rules, if you work via a limited company, there is a tax advantage to be had – mainly due to the fact that employers’ NICs are not payable on dividends, whereas they are on salaried income.
  • Limited company owners have more tax-planning opportunities – they may be able to split shareholdings with a spouse or other family member. They can elect to delay paying dividends until the following year, for example, to reduce tax liabilities.
  • If you are keen on running your own business, and demonstrating that you are in control of the day-to-day running of all aspects of your enterprise, then an umbrella company is not the best option for you.
  • Although there are many solid well-run umbrella companies, many firms – even some of the biggest ones – aren’t transparent when providing take-home pay ‘quotes’. The only difference between any quotes you receive should be in the margin (the fee) the umbrella company charges. All PAYE firms must deduct the same amount of tax, by law.

Questions to ask prospective umbrella firms

  1. Fees – How much are the monthly or weekly GROSS and NET fees – i.e. how much do they charge before tax relief, as well as after tax relief has been factored in?
  2. Payment – Does the scheme have fixed payment dates, or do they pay immediately upon receipt of a timesheet?
  3. Speed – Does the company pay their clients via Faster Payments, not some outdated payment method?
  4. Age / Reputation – Is the scheme long-established, and how many contractors does it employ currently? Does it have any professional accreditations, such as membership of the FCSA?
  5. SLAs – Does the company offer any service guarantees?
  6. Personal Service – Some umbrella companies will provide you with a dedicated ‘account manager’. Other’s won’t.
  7. Business Insurance – Does the umbrella company provide you with business insurance, such as professional indemnity cover?
  8. Expenses – If any scheme promises to boost your income and encourages its employees to claim for expenses they haven’t incurred, they should be avoided!
  9. Other Benefits – You may be enticed by other ‘benefits’, such as private healthcare provision, family legal cover, childcare vouchers, etc.
  10. Technology – How robust is the firm’s online technology?

A word of warning about unscrupulous schemes

If you want to contract via an umbrella company, here is an essential tip from the Bytestart team. We have worked as contractors, and written about our experiences for over 20 years, and have experienced both good, and bad service providers.

  • For the unaware, schemes that offer wildly high rates of ‘take-home pay’ may seem attractive. We’ve seen companies who promise to return their clients ‘80%’ or more. This is simply impossible to achieve, legally. Be beware, HMRC can pursue you for unpaid tax respectively if you have worked via an illegitimate umbrella company. Look up the Loan Charge if you need convincing. Only sign-up to an established PAYE scheme, and make sure they are FCSA registered.

What if you have no choice?

If you’re working as a contractor, you will have heard of the IR35 / Off-Payroll changes, which take effect from April 2021 for most private sector clients.

Under the new rules, it is the client rather than the worker who must now determine whether or not the contract falls within the IR35 rules.  Many clients are reluctant to take on the potential liability of determining employment status incorrectly, so have applied blanket bans on all of their limited company contractors.

This means that many contractors are being forced to use umbrella companies, rather than out of choice. Not only that, but you may not even have a choice over the umbrella company you use – as many recruitment agencies enjoy large kickbacks from umbrella firms in return for new sign-ups.

Whatever your circumstances, take some time to research the umbrella market (assuming you have a choice), and whatever you do – never sign up to a scheme offering returns that are too good to be true, and only use a UK-based PAYE umbrella scheme.

Last updated: 21st March, 2022

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