Umbrella Companies

Umbrella Companies: Guide by DNS Accountants

How do you square a circle?

It’s easy: You combine self employment, independence and flexibility with security and longer term employment without upsetting HMRC. That is to say, you keep everyone happy at the same time, employers, contractors and HMRC.

Wishful thinking? No, it is what Umbrella Companies do.

Here is the scenario:

You want to be self employed or go freelance as a contractor. You use an agency to find work with different employers. But you don’t know what kind of contracts you’ll find: longer term work with one employer or a number of short term contracts with varying employers.

In the past, many self employed contractors set up limited companies to take their money out as salary and dividends, and they did the same for family members. This allowed them to reduce their tax and National Insurance payments. Compared to contractors who operated as sole traders, they kept more of their money.

Umbrella companies

Understandably, HMRC did not like this loss of tax revenue especially in cases where contractors effectively worked as employees with only one employer on long term contracts or consecutive short term contracts. In April 2000, ‘Intermediary Legislation,’ known as IR 35, came into force with the goal to counter tax avoidance by the use of so-called ‘personal service companies.’

IR 35 created a great deal of extra paperwork for contractors and added a layer of uncertainty as no one knew in advance which tax rate HMRC would decide on.

The current coalition government decided to review IR 35 because of this undue administrative burden and the resulting restriction of market flexibility for contractors and employers. Currently, the outcome of the review process is still uncertain.

Enter Umbrella Companies:

Depending on the business you have set up or are thinking of setting up, joining an Umbrella Company may be more advantageous to you than creating a Limited Company or operating as a Sole Trader.

The role of an Umbrella Companies is that of an intermediary for self employed contractors. It acts as their employer thus lifting the IR 35 burden from their shoulders without restricting the flexibility and autonomy contractors would normally enjoy.

Umbrella Companies also reduce the administrative burden for contractors: They invoice for work done and pay contractors after deduction of PAYE and NI contributions. This in turn provides contractors with benefits that sole traders don’t enjoy, and it keeps HMRC happy.

How to select an Umbrella Company?

Before signing up with an Umbrella Company, it pays to do your own due diligence. Any reputable company should be able to provide you with appropriate documentation to back up their marketing and service claims.

For your peace of mind, here are seven core topics that you should address:

  • Is the Umbrella Company UK based, HMRC compliant and properly audited? This will ensure that the company is not part of a tax avoidance scheme.
  • Is the employment contract issued by the Umbrella Company HMRC compliant? Does it include the usual benefits – holiday and sick pay, maternity leave, pension provisions and minimum wage?
  • Does the company operate a HMRC approved ‘expenses dispensation’ scheme?
  • Do they offer relevant professional insurance cover (Professional Indemnity, Public Liability, Employers’ Liability)?
  • How do they charge for services they offer? Are their charges fixed or a percentage of your earnings? Are they weekly or monthly, gross (before tax) or net (after tax)? Do they charge entry or exit fees related to minimum term commitments? Be sure to establish this to be able to compare like for like.
  • How frequently will you get paid? How long is the delay between time sheet submission and payment transfer to your account?
  • Finally, what level of service and support does the Umbrella Company provide? After all, you are paying them so you should have easy access and full support for any questions or issues that may arise.

Taxes and Expenses

Contractors working through an Umbrella Company pay PAYE and Class 1 NI contributions and can set ‘allowable expenses’ against their tax bill. All expenses must be "wholly, exclusively and necessarily" incurred for work.

The main allowable expense items include:

  • Mileage allowances
  • Cars and fuel
  • General travel expenses
  • Hotel and accommodation expenses
  • Food and subsistence when staying away from home as part of your contract
  • Professional subscriptions
  • Equipment and clothing provided they are "wholly, exclusive and necessary" for the contract
  • Business calls

All allowable expenses must be receipted. Umbrella Companies operating ‘expenses dispensation’ schemes will also accept a certain amount of non-receipted expenses. However, for the contractor to avoid unpleasant surprises from HMRC, it is important that these dispensation schemes are HMRC approved. At the end of the year, contractors should be issued their P60.

The choice of operating with an Umbrella Company over setting up a Limited Company or working as a Sole Trader will depend entirely on the type of contract you will be able to find. Advantages for contractors opting to work with an Umbrella Company are that they don’t have to shoulder the administrative burden; they maximise their net income without falling foul of IR 35 rules.

Advantages for employers are that they have a flexible work force and no long term commitment while contractors keep their independence in spite of being all but in name longer term employed by one employer. And HMRC both receives PAYE and NI contributions without burdening the contractor with IR 35.

This is as close to squaring the circle as you can get.

Also See: Complete guide on Directors Loans Accounts

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About the author
Blog Author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.

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About the author
Blog Author

Sumit Agarwal
Sumit Agarwal (ACMA ACA India), the Managing partner of dns accountants is a highly respected accountant with expertise in helping owner-managed businesses.


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