The Umbrella Company: How It Works

Freelancers and contractors in need of affordable accounting and tax solutions may choose to work under an umbrella company rather than hire an accounting firm. An umbrella contract enables the freelancer to continue serving customers without having to invest the time or resources in dealing with taxes, payroll, and reporting issues.

An umbrella company is a legal entity that 'hires' numerous contractors and freelancers under umbrella contracts. We use the word 'hires' loosely because the freelancers and contractors remain independent in terms of the work they do and the assignments they accept. The umbrella company provides support only in the areas of invoicing, accounting, and tax compliance.

HMRC regulates the activities of UK umbrella companies for the protection of freelancers and contractors. Not only does the umbrella company provide freelance and contractor tax help, it provides an entire accounting solution enabling the freelancer to work independently without having to set up a legal business entity or hire an accountant.

Practical Implementation

The practical implementation of working with an umbrella company is straightforward. It begins with a contract of employment signed by both the contractor and the umbrella organisation. Most umbrella contracts are offered through recruiting agencies, although it is possible for contractors and freelancers to find umbrella organisations by themselves.

With a contract signed, the freelancer accepts job assignments from the recruiting agency as he or she sees fit. The agency may require the individual to fill out a time sheet to confirm hours worked. The recruiting agency sends a copy of the time sheet to the umbrella company along with a record of any qualifying expenses. The umbrella company then handles all of the accounting.

An invoice will be produced by the umbrella company and sent back to the recruiting agency; the agency then forwards the invoice to the client. Payment received from the client goes through the agency and back to the umbrella company for complete processing. Payment is then made to the freelancer directly by the umbrella company through the PAYE scheme, minus all applicable deductions. Deductions include National Insurance contributions, taxes and umbrella company fees and charges.

In cases where a recruiting agency is not used, the above process works the same way by just eliminating the agency intermediary. The majority of contractors and freelancers do work through agencies, however.

Other Things to Be Aware Of

Umbrella companies legally employ individual contractors and freelancers under a Contract of Employment. In real terms, this means an umbrella contract is more than just contractor or freelance tax help. It is a contract that essentially makes the freelancer a legal employee of the umbrella company. The umbrella company raises all invoices, processes all payments, handles all tax and insurance contributions, and pays individual contracts through the PAYE scheme.

Contractors should be aware that there are less honourable umbrella companies that attempt to include unlawful deductions without disclosing them prior to contracts being signed. Contractors should insist on full disclosure of all deductions, and the reasons for those deductions, before any contracts are agreed to.

Lastly, if claims made by umbrella companies or agencies trying to recruit you seem too good to be true, be cautious. Pay attention when umbrella companies or recruiters use marketing tactics that include claims of HMRC approval, protection from HMRC investigation, being IR35 compliant, higher take-home pay through manipulation of expenses, and unusually low starter fees.

Working with an umbrella company enables contractors and freelancers to do what they love without having to set up their own companies. It is one of the most popular freelancer and contractor tax solutions available in the marketplace today.