How Does an Umbrella Company Work?

In recent years, umbrella companies have become an increasingly common way for contractors and temporary workers in the UK to get paid - especially in the construction industry.

Despite their growing popularity, many people are still unclear about how they work. At Contractwise, we help protect contractors and subcontractors by keeping them CIS compliant. We’re experts in all areas of the construction industry, and in this article, we’ll provide you with a comprehensive guide that explains exactly how umbrella companies work.

Read on for more information…

What is an umbrella company?

An umbrella company employs contractors and temporary workers on behalf of recruitment agencies and clients. When you work through an umbrella company, you will be their employee rather than being a self-employed worker or working through your own limited company.

The umbrella company sits between you and the agency or client. The agency will pay the umbrella company for the work you have completed, and the umbrella company will then pay your wages through PAYE and make all the relevant income tax and National Insurance deductions.

Usually, umbrella companies are preferred by temporary or contract workers who want a compliant payroll solution to ensure they are taxed correctly.

How does an umbrella company work?

The umbrella company process is designed to be as simple as possible. Here’s how it works:

• Secure your contract: Find work through a recruitment agency or directly from the end client.
• Select your umbrella company: Choose an umbrella company and sign your employment contract. This will usually be an overarching contract of employment.
• Submit timesheets: Each week or month, you will need to submit timesheets that show the hours you have worked.
• The agency pays the umbrella company: The agency will invoice the end client and pay the umbrella company the agreed rate.
• Payroll calculations are made: The umbrella company will deduct:
  • Income tax
  • Employee National Insurance
  • Employer National Insurance
  • Pension contributions, if applicable
• You receive your pay: Your net pay will be transferred to your bank account, and you will be given a payslip with a full breakdown of earnings and deductions.
• Employment rights apply: As an employee, you will also be eligible for employment rights like holiday pay and sick pay.

Why do people use umbrella companies?

There are a wide range of reasons why contractors and agencies choose umbrella companies over other working arrangements. Some of the biggest benefits include:

Compliance and peace of mind - Umbrella companies ensure PAYE tax compliance, minimising the risk of HMRC investigations and hefty bills. 
Simplicity - Contractors don’t need to worry about managing their own limited company or complete company accounts.
Employment rights - Umbrella workers are entitled to statutory rights such as holiday pay, sick pay and parental leave. 
IR35 certainty - Umbrella workers are taxed as employees, meaning they don’t need to worry about IR35.
Continuity of employment - An overarching contract allows employment to continue between projects. 
Pension contributions - Umbrella companies must comply with pensions, which help workers save for their retirement.

For most contractors, umbrella employment provides a balance between flexibility and security.  

How to find a reputable umbrella company

Not all umbrella companies operate to the same standards, and choosing a sub-standard one can cause you issues. With this in mind, let’s take a look at some ways in which you can assess an umbrella company:

• PAYE-only payments: Make sure that all income is only taxed through PAYE and not with any loans or suspicious offshore payments.
• Transparent payslips: Payslips should clearly detail all deductions, like National Insurance and income tax.
• Realistic take-home pay: If a company is promising unusually high take-home pay that seems too good to be true, it probably is. This is a major red flag that it could be a tax avoidance scheme.
• Clear margins and fees: Reputable umbrella companies will be upfront about their margins.
• UK-based: The company should be registered in the UK and follow all HMRC guidelines. Being paid from an overseas account is another red flag.
• Positive reputation: Check reviews, accreditations and testimonials from people who have previously worked with the company.

Choosing the right umbrella company is hugely important as it protects you from compliance risks and ensures you are paid correctly.

What is the difference between an umbrella company and an employer record?

Umbrella companies and employer of record (EOR) services appear similar on the face of it, but in reality, they serve different purposes.

An umbrella company employs contractors who typically work on temporary assignments via recruitment agencies. It is designed for short-term, flexible construction work.

On the other hand, an employer of record is a third-party company that hires employees on behalf of other businesses. Often, they are used when a company wants to hire people quickly and when expanding into new countries.

It is important to understand the distinctions between the two terms to ensure a correct working arrangement.

Common misconceptions of umbrella companies

Despite their widespread use, umbrella companies are still misunderstood. Here are some of the biggest myths:

• Umbrella workers don’t get employment rights: This is not true. Umbrella workers are employees by definition, which means they are entitled to statutory rights such as holiday pay, sick pay and pension contributions.
• You work inside IR35: IR35 is not relevant when working with an umbrella company, as you are already taxed as an employee under PAYE.
• You pay more tax with an umbrella company: You should pay the same amount of income tax and National Insurance as any other employee.

Overall, umbrella companies provide a straightforward way for contractors to work in the construction industry, but it’s important to understand how they work. At Contractwise, we help companies across the UK stay on the right side of the Construction Industry Scheme (CIS). We offer a wide range of services, including payroll audits that eliminate the risk of HMRC reclassification. For more information on how we can keep you compliant, get in touch with our expert team today.