In the UK, there are two main ways that you can operate when setting up as a contractor. You can go down the route of setting up a limited company or you can work under an umbrella company. But what is an umbrella company and how do they work?

 

What an umbrella company is

An umbrella company is essentially what you could describe as an intermediary. They are a ‘middle man’ type company who are responsible for dealing with the collection of invoice payments from your clients. Essentially, umbrella companies are governed by Her Majesty’s Revenue & Customs (HMRC), because under an umbrella company you are essentially an employee of the umbrella company and you pay tax via PAYE, just as you would if you were an employee of any other company. Tax is deducted from your payments before you receive them, so there is no need to submit self assessment tax returns, which is one of the advantages of this way of working.

Advantages of working under an umbrella company

One of the biggest advantages that contractors will find from working under an umbrella company is that the administration is vastly reduced. There are no tax returns to submit, no paperwork has to be filed with Companies House and the umbrella company deal with chasing up any unpaid invoices with your clients. This means that you have more time to focus on working and so can potentially earn more money. Working under an umbrella company also means that you as a contractor will not be affected by IR35. IR35 is a huge issue for contractors in the present day but working with an umbrella company completely cuts out this risk. You will also receive payslips which makes life easier when trying to apply for mortgages, loans and other financial products, as often lenders are reluctant to provide finance until you have 3 years of accounts if you operate as a sole trader or a limited company.

Disadvantages of working under an umbrella company

There is one major disadvantage of working under an umbrella company and that is tax. If you are a contractor who pays tax via PAYE, you are not entitled to the same tax advantages and reliefs as someone who is operating as a limited company. Umbrella companies do not decide what tax reliefs you are entitled to – this is completely down to HMRC to decide even though some umbrella companies claim to be able to file for certain expenses with HMRC but this is not the case. Another disadvantage is that because the umbrella company are providing a service to you, they will take a cut of your income. So not only do you pay more tax than you would do if you operated your contractor business in a different way, but your earning are also reduced due to umbrella company fees. This is why working under an umbrella company is only usually favourable if reducing paperwork is more important to you than saving money.