UK Tax Umbrella Companies

UK based Contractor and freelance umbrella companies have been around since the middle of 2000. Up until that point, most freelancers and contractors either worked through their own limited company or as a PAYE employee of a recruitment agency or the end client.

Nowadays, it is believed that over 200,000 people in the UK are paid through umbrella companies, with this figure set to increase as more and more individuals enter the freelance workforce either through career choice or redundancy.

How does an umbrella company work?

This is probably best explained as a series of step by step processes.

1. You join an umbrella company either through their website or over the phone
2. You sign an employment contract between you (the employee) and the umbrella company (the employer)
3. At the end of the week, you submit your hours & expenses to the umbrella using their on-line portal
4. The umbrella company invoices your recruiter or client (if working direct)
5. The umbrella company pays you through PAYE, after the deduction of allowable business expenses
6. At the end of the tax year, your umbrella company gives you a P60 and P11D (for any expenses claimed)

What are the tax advantages of using an umbrella company?

Unlike traditional employees, umbrella workers will undertake a series of separate assignments with their umbrella company, and on the whole each assignment will be performed at a separate location (usually the office of the end client). Provided the umbrella has a sufficiently robust ‘overarching employment contract’ with it’s employees, these workplaces will be classed as ‘temporary’ for tax purposes. This means that umbrella workers are able to offset the cost of their travel & subsistence expenses getting to work, and whilst on site.

Claiming expenses pre-tax reduces an umbrella worker’s taxable gross salary and subsequently the amount of tax paid. On the whole, there is usually a 5 -10% difference in take home pay between umbrella company and straight PAYE.

What is IR35?

IR35 is piece of tax legislation brought in by the Labour Government in April 2000. It is designed to catch contractors & freelancers that have an ‘employment relationship’ with their clients, yet fail to pay the correct amount in PAYE taxes. Contractor umbrella companies were first introduced to the freelance marketplace following the arrival of IR35. They rapidly became the choice of many contractors who wanted to work an IR35 compliant way, yet still take home more than they would under normal PAYE.

For the avoidance of any doubt, if you work through an umbrella company, you will NOT be effected by IR35. If you have a limited company then this may not be the case

Umbrella company myths and facts

Here are some of the most common misconceptions people have about contractor umbrella companies.

Myth 1I’m still self employed, even though I’m working through an umbrella company

FACT: You’ll be an employee of the umbrella company, with full employment rights and potentially insurances just like any other permanent member of staff.

Myth 2My income will be split between a small salary, expenses and dividends

FACT: Your income will be made up of a gross salary and expenses (if you incur and claim these). You will NOT receive dividend payments.

Myth 3IR35 is dead. I’m not really self employed but I pay myself as if I was.

FACT: DO NOT underestimate HMRC. If investigated, you would be liable to pay back all the underpaid tax, a penalty and worst case scenario you could be prosecuted for tax evasion.

Myth 4My umbrella company has a dispensation. That means I can claim £30 in subsistence expenses, even though I only spend £3.99 on a Meal Deal

FACT: A dispensation is NOT a magic bullet. You can only claim expenses that were actually incurred (i.e £3.99 NOT £30).

Myth 5 Some umbrella companies claim to be able to pay me much more than others

FACT: As long as you don’t claim fictitious expenses, your take home pay will be more or less the same from one umbrella company to the next. There may however be a small difference due to a higher or lower admin fee.