Umbrella Vs PAYE: What’s the Difference for Contractors?

For UK contractors, choosing how you get paid is just as important as picking up the right contract or project. The debate around PAYE vs umbrella is especially relevant for construction workers operating under the CIS system, as each model will impact how you’re paid and the employment rights you have.

In the construction industry, understanding umbrella vs PAYE and the structures of each system is essential for HMRC and CIS compliance. While both models deduct tax at source, they operate very differently, and in this article, the team here at Contractwise will take a closer look at umbrella company vs PAYE to help you understand the differences and what might work best for you.

Read on for more information…  

What is PAYE?

PAYE (Pay as You Earn) is the UK’s standard payroll system that is used across the country as a way for employers to deduct income tax and National Insurance contributions directly from wages before they are paid. This means workers receive their net salary after tax deductions have already been processed. This system is managed by HMRC and is designed to make tax payments simpler.

Under PAYE, workers are typically directly employed by a company or agency, meaning the employer will be in charge of calculating taxes and submitting contributions. What’s more, PAYE workers usually receive employment rights such as holiday and sick pay depending on the terms of their contract. For construction contractors working through agencies, PAYE offers stability and simplicity as payroll is automatically taken care of for them.

What is an umbrella company?

An umbrella company is an organisation that acts as an intermediary between a contractor, a recruitment agency and the end client. Instead of being paid directly by the agency or client, the contractor becomes an employee of the umbrella company. Then, the umbrella company will be responsible for all payroll processes, including deducting tax.

Umbrella companies operate PAYE on behalf of contractors, meaning tax is still deducted at the source. However, they also handle responsibilities like invoicing, managing employment costs and ensuring compliance with employment law. Effectively, these companies act as middlemen between the worker and the client, deducting taxes before paying the worker.

This structure is common for contractors working inside IR35 or contracts where the client requires workers to be paid through an employment intermediary.

What is the difference between PAYE and umbrella?

The key difference between an umbrella company vs PAYE comes down to the employment structure.

PAYE is a direct employment model. If you work under PAYE, you are usually employed directly by the company or agency paying you. They will manage payroll, handle tax deductions and provide you with all the relevant employment rights.

In contrast, with an umbrella company, the contractor is employed by a third party rather than the end employer or agency. The employer or client will pay the agency, which then pays the umbrella company. Next, the umbrella company will process payroll, deduct tax and National Insurance and then pay the contractor their net salary. This more layered structure is why umbrella companies are sometimes referred to as employment intermediaries.

For contractors working in construction, the structure under which you are working can have important implications. If you work under an umbrella company, you are officially an employee of that organisation. This means access to a range of statutory benefits like sick pay, annual leave and pension contributions. This is not always the case for self-employed construction workers.

However, they do sometimes come with additional costs, which you will need to factor into the contract rate. 

Benefits of umbrella pay for workers

There are a wide range of benefits of working for an umbrella company, including:

• Simplified tax: One of the biggest advantages is tax simplicity. Umbrella companies calculate and deduct tax automatically, ensuring you always stay HMRC compliant. This removes the burden of managing your own tax affairs or worrying about underpayments.   
• Holiday pay: Due to the fact that umbrella workers are technically employees, they may be entitled to statutory employment rights such as holiday pay, sick pay, maternity leave and pension contributions. This is especially valuable for construction workers who may be self-employed and do not have any employment protections.  
• Employee perks: Many umbrella companies provide their staff with a wide range of additional benefits in addition to statutory requirements. This includes things like insurance cover, employee assistance programmes and discount schemes. While these may vary by provider, they offer additional value to people beyond simple payroll services.    
• Legal compliance: Umbrella companies help contractors remain compliant with all the relevant HMRC regulations. Compliance is especially important in construction and agency work, where employment status rules and IR35 legislation can be extremely complex. By handling these obligations for you, umbrella companies reduce the risk of penalties and compliance mistakes.   
• Professional development: Some umbrella companies offer training courses and resources that support career development. This can help contractors manage their careers more effectively, understand legislation changes and make informed decisions about their future.  

Benefits of umbrella pay for construction companies

Umbrella companies also provide a range of benefits for construction companies, including:

• Reduce admin: Using umbrella companies can significantly reduce administration when it comes to payroll. This allows the company to focus more on achieving its project’s goals.
• More flexible: Umbrella arrangements allow construction firms to be more flexible, something that is especially beneficial for projects where labour needs change frequently.  
• Cost savings: Outsourcing payroll and compliance can reduce internal payroll costs.
• Legal compliance: Using an umbrella company helps construction firms remain compliant with all employment and tax legislation.

Understanding the difference between PAYE vs umbrella will depend on your priorities, whether that’s tax simplicity, employment benefits and much more. For construction companies in the UK, the team here at Contractwise provides a wide range of CIS services that protect both contractors and subcontractors. This includes important payroll audits that eliminate the risk of HMRC reclassification. For more information, contact our expert team today.