Want to go freelance but want someone else to take care of your taxes, paperwork, and allowances? You need to find out about umbrella companies.
What is an umbrella company?
Think of being a contractor/freelancer using an umbrella company as being in a half-way house between:
• being an employee,
• and being a contractor/freelancer running your own limited company.
Traditionally, contractors have set up their own limited companies to sign contracts with and receive payments from their clients.
What would an umbrella company do for you that’s different? The umbrella company will:
• act as an intermediary between you and your client
• they will chase up payments from your clients
• they will handle the payroll associated with the work you perform for clients
• do all your paperwork, specifically with regards to expenses claims
Umbrella companies do a lot of the legwork you’d have to do as a company director.
When you’re doing work for your client through an umbrella, you will log all the time you spent on the job for that client on a timesheet. Assuming your client agrees, they will then sign your timesheet confirming the hours served.
You forward that timesheet to your umbrella company which then invoices your client.
When the client pays, the umbrella company will forward the payment to you. Some will forward the money as soon as they are in funds from your client and others will pay you on set dates every month.
Your umbrella company will usually deduct their fee from your pay before tax which has the net effect of reducing your tax liability. When you’re paid, you’ll be on Schedule E taxation – in other words, you’ll pay the same tax and National Insurance as would an employee working at the firm which has contracted your services.
An umbrella company does NOT go out to find new clients for you. That’s entirely your responsibility.
So, you may be asking at this point what’s the benefit to you? Why should I pay an umbrella company to pay me at the same rates as an employee when there are lots of contractors out there who might be turning over the same amount of money but who aren’t paying an umbrella company’s fees and whose tax bills are substantially lower than yours?
Contractor umbrella benefits
IR35 is a subset of the tax rules in the UK designed to catch people in what HMRC considers as “disguised employment”.
Imagine working for a company for many years. You’re paying income tax and National Insurance at your normal rate. Your employer is paying an additional 13.8% of your wages above a certain level too. HMRC makes a lot of money from your employment.
What if you left that employer and set up your own limited company? What if, instead of being paid via PAYE by the very same company, you sent invoices instead? What if you were working the exact same hours in the same location, maybe even at the same desk, as a contractor that you were as an employee?
As a contractor, you can pay yourself using a mixture of dividends and salary. You can claim back all sorts of expenses that an employee cannot claim to bring down your profit. Your employer no longer has to shoulder the 13.8% National Insurance Employers’ Contribution tax they did before.
You win. Your employer-cum-client wins. HMRC loses thousands, if not tens of thousands.
HMRC set a list of questions and conditions to determine whether or not your arrangement with your client is, in fact, disguised employment. If they find out later that even one of your former clients had an arrangement with you that was, in their opinion, disguised employment, you would be “in the scope of IR35” and HMRC would bill you for unpaid tax, interest, and penalties. If they found one contract that was in the scope of IR35, they would check all of your contracts going back years to find other examples. At the end of this process, you could face a ruinous tax bill from HMRC.
If a contractor expects most of his or her contracts to be caught by IR35, there are very few strong reasons to go to the expense, time, and ongoing hassle of opening and running a limited company. You also never have to experience the laborious process of closing a limited company which are regularly challenged by both HMRC and Companies House.
Statistically speaking, the chances of being caught up in an IR35 investigation are infinitesimal. Even HMRC admits that however such is the fear of being investigated, many do not want to take the chance.
With an umbrella company, you’ll never be investigated for IR35 because you’re being paid as an employee by your umbrella partner.
They manage your tax and National Insurance. They take care of payroll, real-time information requirements, auto enrolment requirements, and much more. On the 22nd of each month, they send all your due tax across to HMRC so you know that you’re being compliant and you’re always up to date.
And when you sign with an umbrella, it’s not a contract for life. You can leave whenever you want and choose to go the limited route later. Everything is under your control.
Are you a potential umbrella contractor seeking advice on the best umbrella company?
There are lots of different umbrella companies who would love you on their books.
Competition is intense so the best thing to do to start off with is to make a list of the requirements you need a potential partner to meet.
Some companies charge a percentage of what you earn. Most charge a fixed fee every month.
Take a look at what you think your earnings will be over the next six months. Get quotes from as many companies as you can and examine how their individual fee structures will eat into your earnings.
A percentage fee might be better for you if you expect to earn a low sum. If you expect your income to fluctuate across quite a wide range of earnings, a percentage fee might ease pressure on your domestic cashflow.
If you’re expecting higher earnings with a stable fee income every month, a fixed-fee solution may be more suitable for you.
Do your research. Ask every company quoting you to provide you with a detailed and itemised program of fees because it’s not unknown for some umbrella companies to advertise a low rate only to make up their income through additional fees and charges not prominently mentioned on their website or during their sales pitch to you.
Even in the internet age, word of mouth still counts. Do you know anyone who has gone from being an employee to working with an umbrella company? If you hear good things about a firm from someone you trust, that’s a good place to start.
Understanding your umbrella payslip
By their nature, umbrella payslips are different from standard payslips you received from your employer. They can be confusing so never be afraid to call up and speak to someone in the company if you have concerns.
It is not unknown for umbrella companies to make mistakes with payslips. It’s more common than you might think so, even though you’re paying them for the service, it’s wise to keep an eye out so that you notice anything that doesn’t look right.
Your tax, national insurance, and pensions contributions? Does it look like you’re paying too much or too little? Multiple errors can mean that HMRC will start scrutinising your tax affairs.
And it’s not just HMRC you need to be concerned about. Errors on your payslip can affect your child tax credits, working tax credits, and other benefits to which you might be entitled.
The introduction of Real Time Information for salary payments means that your payroll data is now directly linked to the benefits system. Mistakes can affect the amount you pay or you receive in child maintenance payments.
Remember that, under the law, you’re the employee of your umbrella company and, as an employee, you’re legally entitled to a clear and unambiguous payslip and you’re also entitled to ask questions of the person in charge of the process.
Don’t let yourself be pushed around if you think there’s something that’s amiss.
Umbrella company dispensation
A dispensation is a collection of expenses that your umbrella company does not have to record on a P11d form.
BusinessCostSaver tip – a P11d is an expenses and benefits form for directors and employees. It’s the way that a company reports expenses and benefits enjoyed by a director of employee that is not put through PAYE.
HMRC is the only body which can decide which expenses can reduce a tax bill or not. It is not within the power of any umbrella company. Be wary of any umbrella firm that offers “special dispensations” that other umbrella firms cannot claim on your behalf – it’s not true.
You can only claim costs ‘wholly and exclusively incurred in carrying out the duties of the employment’
You’ll need to show you’ve spent the money to claim it. If you don’t have the receipt, as far as the taxman is concerned, it doesn’t exist and it’s not claimable. If you can’t prove you incurred a cost, we would advise not trying to claim on it because, at a later date, HMRC may ask you for the evidence.
If you can’t show them the reciepts, you’ll more than likely have to pay back the tax. If HMRC think you’ve falsified expense claims, you will also be fined on top of the backdated tax.
Auto-enrolment into the Pension Regulator-run workplace pension scheme is now compulsory for all employers. The system began rolling out in 2012 and, from October 2017, every employee now has to comply.
Anyone aged between 22 and the State Pension Age is entitled to receive the option to join a workplace pension. Companies which employ qualifying staff must register with the Pensions Regulator. If you don’t have any qualifying staff, you need to let the Pensions Regulator know you’re exempt.
When you join an umbrella, they will write to you explaining the approved pensions scheme they are enrolled in. Unless you inform the umbrella otherwise, they will begin to deduct pension payments from you – this deduction will be 5% of your wages from tax year 2020/2021.
You are entitled to opt out of the workplace pension scheme by informing your umbrella company.
Maternity and paternity rights
You are an employee of your umbrella therefore all standard employment rights apply to your relationship with them.
To claim maternity or paternity pay, you need to have worked for 26 weeks as a minimum earning at least £118 a week (the so-called Lower Earnings Limit for National Insurance contributions in tax year 2019-2020) before the fifteenth week before your baby is due to arrive.
If that isn’t your situation, you’ll need to ask your umbrella company to provide you with a form SMP1. SMP1 is there to claim Maternity Allowance.
With Maternity Allowance, you can claim either £148.68 a week or 90% of your average weekly earnings (the lesser of the two) for 39 weeks, £27 for 39 weeks, or £27 for 14 weeks. Paid every fortnight or every four weeks, you can claim Maternity Allowance once you’ve passed 26 weeks of pregnancy and be paid 11 weeks before the due date.
If you don’t qualify for Maternity Allowance, you’ll automatically be assessed for Employment and Support Allowance.
Starting life with an umbrella company
Remember that you’re in charge of selecting your umbrella company, whether you switch to a different one, and choose the time you leave the umbrella company’s employment altogether.
Make sure that, at all times, you make the best choice for you.