What is an umbrella company? A guide for self-employed contractors

Contractors have a number of options when it comes to getting paid and making sure they pay their taxes correctly. One of these is umbrella companies. 

They’re particularly useful for new contractors or those planning to work on shorter assignments and don’t want to deal with the administrative burden of filing taxes themselves. Let’s take a closer look at how they work and why a contractor might choose to use one. 

• What is an umbrella company?
• Why would you use an umbrella company? 
• How you get paid by an umbrella company 
• Umbrella companies and IR35
• What happens when you join an umbrella company?

What is an umbrella company?

An umbrella company, or PAYE umbrella, is a company that self-employed contractors can join as an alternative to setting up (and working through) their own limited company or remaining a sole trader. 

When you join an umbrella company, you become their employee. The umbrella acts as an intermediary between you and your recruitment agency (or end client). It deals with administration (like accountancy and taxes) and means you don’t have to take on the responsibility of running your own personal service company. 

Why would you use an umbrella company?

Running a limited company can be challenging and won’t always be the best choice for contractors. Some contracts won’t allow you to remain a sole trader, and if they do, filing your own taxes can be fiddly. 

So in some instances, an umbrella company might give you what you need. For example: 

• short-term contracts – if you’re a new contractor, you might not want the hassle of setting up a limited company straight away – and dealing with everything alongside it, like registering with Companies House. Likewise, if you know you’ll only be contracting for a short time, you won’t want to go through the process of setting up a limited company only to dissolve it in the future
• reduced administration – you can reduce administration by using an umbrella company. It means you won’t have to keep company records, file VAT returns, and keep up with all the other responsibilities you would have as a limited company director
• employment rights – as an employee of the umbrella, you can get statutory sick pay, holiday pay, maternity and paternity pay, and a workplace pension (unless you opt out). Technically, this means enjoying the flexibility of self-employment while also experiencing the same benefits and security of permanent employees

How you get paid by an umbrella company 

When it comes to getting paid, the contractor keeps timesheets showing the days and hours worked and rates used, which they give to the umbrella company. 

Then they pay you through PAYE, deducting the below: 

• income tax
• employee National Insurance contributions
• employee workplace pension contribution
• student loan repayments (if applicable)
• any other deductions that you’ve agreed to or are legally required to pay

You should also be aware that umbrella companies do charge fees for membership. This can either be a fixed fee, weekly or monthly, or a percentage of your earnings. This percentage is usually capped, though. 

Umbrella companies and IR35

A contractor can work on contracts both inside and outside IR35, as IR35 status applies to contracts and not to the contractor themselves.

You can still run a limited company and work on inside IR35 contracts. You can even run a limited company and work through an umbrella company at the same time.

However, umbrella companies are particularly useful for contracts deemed to be inside IR35. As we’ve mentioned previously, it’s a simple way to ensure you’re paying the right amount of income tax and National Insurance contributions. 

You may want to use an IR35 contract review service to make sure you know whether you’re inside or outside the rules and how you need to be paying tax and other contributions. 

When it comes to contracts that are outside IR35, in some cases using an umbrella company isn’t the most tax efficient option to pay yourself, so you might choose to create a limited company. Though as we’ve mentioned earlier, umbrella companies can be useful if you’ve just started contracting or will only be contracting for a short period of time. 

Working through an umbrella company: a step-by-step guide

1. When you secure a role, your umbrella company signs a contract with your recruitment agency (or end client). You’ll also need to sign a contract with your umbrella.
2. You agree to the time spent on site working on projects and document this in timesheets, which you pass to your manager to sign.
3. You pass your timesheets to your umbrella (and recruitment agency if you have one), who invoice the client.
4. When your umbrella gets the payment, they’ll process your payroll. You’re paid a salary, which deducts income tax, National Insurance contributions, pension contributions, and the umbrella fee. You can reclaim allowable expenses, which your umbrella should process too.
5. Your umbrella gives you a payslip that shows your take-home pay as well as all the deductions.

Use this as a guide only and keep in mind the right choice for you will depend on your circumstances – it’s best to research your options and speak to a professional if you’re not sure.

Let us know in the comments below if you’ve chosen to work through an umbrella company. 

Other self-employment guides: 

• Setting up a limited company 
• How to do a self-employed tax return
• How to file company accounts
• What’s the difference between a sole trader and a limited company