By operating through a PAYE umbrella company, a freelancer/contractor turns into a member of workforce, of an organisation. An umbrella company raises an invoice, each week or month, and shares it with an agency based on the timesheet shared by a freelancer/contractor. Once the invoice is verified, an umbrella company makes the payment to a freelancer/contractor, after deducting the applicable national insurance contributions (NIC) and income tax. Operating through an umbrella company is very simple and a freelancer/contractor must review his/her for IR35, a tax legislation that is intended to tackle tax evasion.
- What is a PAYE Umbrella company?
- Who should use a PAYE Umbrella company?
- How Umbrella Company works?
- IR35 and Umbrella companies
- How to avoid Umbrella company traps for freelancer/contractor?
- Is Umbrella Company a sensible option for you?
What is a PAYE Umbrella company?
A PAYE Umbrella Company is a Solution that enables you to 'join' the company as a PAYE member while maintaining your contractor status rather than working as an employee. It's also a good solution for those who want to be contractors but cannot be self-employed due to legal restrictions.An umbrella company establishes you as a legal employee and takes care of all the paperwork. It's the simplest option for most contractors, as there are no unexpected tax payments, and because you have one continuous job relationship, it's also much easier to get essential things like loans and mortgages.
Once a freelancer/contractor turns into an umbrella company employee, they will be required to provide form P45 or P46 along with administrative information such as personal details, bank account number, and National Insurance (NI) number. An umbrella company will process the payment after deducting National Insurance contribution (NIC) and tax – hence, there will be no need to hire an accountant. An umbrella company is administered by Her Majesty's Revenue and Customs (HMRC), and by operating through an umbrella company, a contractor receives the payment after the company has subtracted the fee to be paid to an umbrella company. Additionally, a freelancer must authenticate the payslip generated by an umbrella company.
Who should use a PAYE Umbrella company?
- Contractors who are new and want to get a feel of self-employment before incorporating their own limited company.
- Contractors whose hourly rate is less than £15.
- Contractors on a three-month or shorter assignment Contractors in the public sector.
- Contractors whom their agency or end-client has informed that they are within IR35.
- Contractors who are not presently interested in running their own limited company.
How Umbrella Company works?
Let’s understand the working of an umbrella company – the work arrangement will usually be as follows:
- An umbrella company signs a contract with an agency.
- An agreement is signed between an umbrella company and a contractor/freelancer.
- The work performed by a contractor will be verified by the umbrella company on the basis of the timesheet submitted.
- Key Responsibility Areas (KRA) of a contractor include sharing the timesheet with an agency and sharing a copy with an umbrella company.
- An invoice is sent to an agency for the work carried out by a contractor (hourly basis) by an umbrella company which might also encompass the applicable rewards.
- Post the receipt of an invoice; an agency is liable to send it to the end client. Usually, an invoice encompasses the cost per hour of work performed.
- After authenticating the invoice, the agency will take delivery of the payment from the client.
- Based on the terms of the payment agreement, the agency will give the amount to the umbrella company.
- A contractor will receive a payslip describing the deductions (tax and National Insurance (NI)) before payment.
- As a final point, a contractor will be given compensation, with all applicable deductions, from an umbrella company.
Benefits of working through an Umbrella company
Working through an umbrella company has numerous advantages, including safety from compliance disagreements. Let’s understand the benefits of operating through an umbrella company:
- A contractor is eligible for additional benefits such as group pension schemes, contractor mortgages, childcare vouchers, employee rewards schemes, contractor accommodation, foreign currency exchange, along many more.
- A contractor will not be required to hire an accountant for National Insurance contribution (NIC) and taxation purposes – an umbrella company is liable to deduct these before processing the payment.
- Work more, earn more! Since contractor billsan umbrella company for the number of hours worked, they are empowered to work 24 hours by an umbrella company. Generate an invoice for the work performed, and get paid!
IR35 and Umbrella companies
The IR35 regulation administrate whether a freelancer is deemed as an employee for tax computation. The IR35 status, of a freelancer, for each contract, will determine whether they are ‘inside IR35’ or ‘outside IR35’ – this will be determined through the working provision and contract signed with each company. In case a freelancer is ‘inside IR35’, then in such a scenario, the entire earnings will be paid off as salary only – here, operating through a pay-as-you-earn (PAYE) umbrella company will be a useful alternative. On the other hand, if a freelancer is ‘outside IR35’, then he/she will be eligible to take advantage of remuneration, along with bonuses, by establishing their own limited company – such an arrangement decreases the tax burden significantly.
How to avoid Umbrella company traps for freelancer/contractor?
A freelancer/contractor can escape from such a trap by just following the below-mentioned instructions:
- It is a trap if a freelancer/contractor is guaranteed to receive 80%-90% of the invoice total in hand. As per the HMRC guidelines, this is lawfully not possible – this is controversial as the minimum income tax rate is 20%, and the payment is also subject to NIC deductions.
- It is a trap if only a percentage of the earnings is remunerated through payroll and subject to pay-as-you-earn – this reflects that a contractor is only paying tax on a certain percentage of the income received from an umbrella company.
- It is a trap if a contractor obtains payment through loan, credit, or investment payment. At this point, an umbrella company will assure that the pay is not subject to National Insurance contributions or income tax.
- It is a trap if the payment is received through numerous corporations before it is credited into a contractor’s account.
Generally, contractors are communicated that the plan is HMRC compliant; however, it is mostly incorrect. Such arrangements can be tremendously risky, and HMRC continuously encourages United Kingdom citizens to disregard tax avoidance arrangements. If a contractor is a party to such arrangements, then, they are expected to be evading tax and, as a result, will pay fine and additional tax.
Is Umbrella Company a sensible option for you?
While employing an umbrella service is not the most tax-effective way for a contractor to work, it is the simplest way to get paid and requires substantially less amount of administration than being the director of your own limited company.
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