What is an Umbrella Company?

For contractors in the UK, especially those working in the construction industry, it’s vitally important to understand how you get paid. This is just as important as the work you do, and with legislation constantly evolving and HMRC imposing strict penalties for those who don’t comply, many workers now find themselves operating under umbrella companies. But what is an umbrella company, and is it the right choice for you?

In this article, the team here at Contractwise will outline everything you need to know about umbrella companies, including how they operate and their range of benefits.

Read on for more information…

What is an umbrella company?

An umbrella company is an employer that works on behalf of contractors, temporary workers and agency staff. Instead of being self-employed or operating through a limited company, the individual will become an employee of the umbrella company.

In practical terms, the umbrella company sits between the contractor and a recruitment agency or the end client. The agency pays the umbrella company, which then pays the contractor through the usual PAYE method. Income tax and National Insurance contributions will also be deducted by the umbrella company before paying the net wage.

In construction, umbrella companies are commonly used as they can help with specific tax schemes, like the Construction Industry Scheme (CIS), that govern the sector. As construction workers are often moving between multiple sites and short-term projects, umbrella companies are often a convenient solution.

In many cases, umbrella companies provide a straightforward way to manage payroll and ensure workers are taxed correctly.  

How do umbrella companies work?

While different umbrella companies will have their own specific ways of working, they generally operate in the following way:

1. Find work: A recruitment agency will place you on a temporary or contract assignment with an end client, usually this will be a construction firm.
2. Sign up with an umbrella company: You will then enter into an employment contract with an umbrella company. This will often be an overarching contract of employment.
3. Timesheets are submitted: You will need to submit your working hours via a timesheet to the agency or umbrella company.
4. The agency pays the umbrella company: The agency will invoice the end client and pay the umbrella company the gross amount. This will include your pay, employer’s National Insurance, pension contributions and any other payments.
5. You receive your net pay: You will be paid directly into your bank account, along with a payslip that provides a full breakdown of deductions.
6. Employment rights apply: As an employee, you will also accrue holiday pay and other entitled statutory benefits.

Benefits of choosing an umbrella company

Using an umbrella company offers several advantages, especially for contractors who are looking for support with simplicity and compliance.

• Legal employee status: Being employed by an umbrella company means you gain access to statutory employment rights such as holiday pay, sick pay and paid maternity and paternity leave. 
• Simpler for contractors: There is no need to worry about running your own company or dealing with complex tax filings.  
• No unexpected tax bills: All tax and National Insurance deductions are made for you, which reduces the risk of a surprise HMRC bill. 
• Administration handled for you: The umbrella company will take care of payroll, payslips and HMRC reporting. 
• HR support: Reputable umbrella companies will provide you with HR assistance when it comes to contracts, grievances and general employment queries.
• Continuity of employment: An overarching contract allows employment to continue between different projects, helping to maintain a continuous service. 
• Pensions: Umbrella companies must comply with auto-enrolment of pension schemes to help with retirement savings.

What is an overarching contract?

An overarching contract of employment is a contract that seamlessly links multiple assignments together under one continuous employment agreement with an umbrella company.

Instead of each assignment being treated as a new job, an overarching contract means that the contractor remains employed by the umbrella company even when moving between clients or different agencies. This continuity is what legally establishes the contractor as an employee rather than simply being a short-term worker.

For temporary workers, especially in the construction industry, this structure also helps ensure access to important employment rights.

Do you have to pay more tax with an umbrella company?

No, you do not need to pay more tax if you’re employed by an umbrella company. This is a common myth when in reality, you will pay the same income tax and National Insurance as any other employee earning the same salary.

Working under an umbrella company means:

• Income tax will be deducted via PAYE
• Employee National Insurance is deducted
• Employer National Insurance is paid

As long as the umbrella company itself is fully compliant, there is no reason why you should be paying more tax.

Spotlight 71 considerations: what to watch out for

HMRC has recently announced Spotlight 71 guidance that warns contractors about disguised remuneration schemes that are sometimes illegally marketed as umbrella companies. In these cases, a scheme may promise greater take-home pay.

However, HMRC regard such schemes as tax avoidance, and workers may end up with significant tax bills in the future. This will still be the case even if you are not aware of the issue, so it’s important to know what the red flags are:

• You’re only paid via PAYE
• You are constantly moved between different umbrella companies
• You are paid more than expected
• You are often paid by a company overseas

With this in mind, it’s essential you always choose a compliant provider so you are not hit with a big bill in the future.  

Here at Contractwise, we provide a host of services that protect both contractors and subcontractors. This includes payroll audits that eliminate the risk of HMRC reclassification, which can have huge consequences. We’ve helped construction companies across the UK remain CIS compliant for many years, allowing you to focus on your business. Contact our team today to find out more.