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What is an Umbrella company?

An umbrella company, in the United Kingdom, is an establishment that hires provisional workers and empowers them to perform numerous short-range contracts for end-clients and agencies. An umbrella company manages taxation, National insurance (NI) contribution, payroll and other administration tasks, enabling a contractor/freelancer to focus on the work that actually matters. Once a contractor signs the agreement, he/she effectively turn into an employee of an umbrella company. A freelancer/contractor will be able to enjoy most of the benefits of a permanent employees. Instead of bearing the cost and difficulty of establishing a limited company, a contractor can easily work via an Umbrella Company. A contractor would neither be a company’s director nor have the accountability related to managing a limited company. The umbrella company provider would manage all these matters along with tax management. A contractor’s job would be to fill the time-sheet and regularly share it with an umbrella company he/she is working for – it is the responsibility of an umbrella company to raise an invoice to the end-clients.

Also Read: How To Compare Umbrella Companies For Contractors?

• The umbrella firm employs or hires a contractor
• The contractor turns into a permanent employee, and shares his/her work-timesheet with an umbrella company
• The end-client or agency pays the umbrella company charges for the contractor’s time on a particular assignment. Usually, the amount paid by an agency or end-client includes the contractor’s pay, the costs of employing the contractor, and the umbrella company’s profit margin
• The umbrella company subtracts their margin from the amount received and pays the contractor. This is how an umbrella companies fund their business activities – generally, an umbrella company’s profit margin is £20.00 to £30.00 for a once-a-week payment
• The umbrella company pays the contractor through a pay-as-you-earn (PAYE) process, just like any other employer would

Umbrella companies exploiting Britain contractors

Contractors, in the past, have claimed that umbrella companies are forcing them to give extra tax and administration fees. As of Feb-17, ~0.4 million individuals in the United Kingdom received payments from an umbrella firms. According to the Contractor and Freelancer Services Association, though an umbrella firm is an effective way to work, however, such companies have been exploiting Britain contractors. Many contractors have complained saying that umbrella firms have usually exploited them once they have signed a contract. Contractor’s say – "We think umbrella companies are cheating the contractors and earning money from their hard work.” Contractors have claimed that umbrella firms are subtracting day-off pays from their wages, and illegitimately compelling them to pay both the company and their own national insurance contributions.

Also Read: Claim Umbrella Company Allowable Expenses

• A contractor must cross-check his/her payslip to verify if only a portion of the income is reimbursed through payroll and subject to pay-as-you-earn (this indicates that a contractor is not paying the entire tax due as tax is paid on a portion of income received from a umbrella company)
• The payment received by a contractor is routed through various corporations such as trusts, partnerships before it is credited into a contractor’s account
• If an umbrella company guarantees a contractor 85%-95% of the wages and still be tax compliant – this is doubtful as the rate of income tax is 20% and NI contributions are also charged on earnings
• If an umbrella firm claims that the pay is not subject to National Insurance contributions or the contractor receives payment under the heads – credit, or loan

Usually, contractors are told that the structure is HMRC complaint, however, it turns out to be false. The above mentioned structures can be very risky and HMRC always continues to challenge tax avoidance arrangements. If a contractor is involved in such an arrangement, then, he/she is likely to be avoiding tax and perhaps could end up giving extra tax, penalties, interest, and NI contributions.

Most of the umbrella firms abide by the HMRC tax rules, however, there are certain umbrella firms that encourage provisions that state to be ‘tax efficient’ or ‘legitimate’ and offer contractors ways to keep most of their income, thereby, lessening the tax liability. Such provisions ultimately result in repaying extra tax, interest, and penalties, and are never HMRC sanctioned. Such agreements work in several diverse ways, however, umbrella companies adopting such practices typically claim to assist a contractor by letting them keep a greater portion of the income and decreasing the paperwork. Such umbrella corporations state that the payment is non-taxable as it isn’t measured as an income, rather a loan, credit, or to a degree something similar. But it must be noted that such payments are essentially no different to standard income, and it’s imperative to pay National insurance (NI) contribution and applicable tax.

Also Read: How to join Umbrella Company Scheme for Contractors?

• Firstly, a freelancer/contractor receives the payment in tranches – the first tranche of the payment is subject to National insurance and tax deduction
• Secondly, a contractor/freelancer receives the second tranche of payment without any National insurance or tax deduction – it might be possible that the second tranche is received from a different account number, possibly a trust etc.
• Finally, the second tranche of payment is reflected separately in the payslip and might be referred to as something apart from salary/wage. Here, no National insurance contribution or tax would have been deducted

A contractor must carefully read the contract and regularly check the payslip to ensure that there isn’t any misinterpretation of data and facts

Also Read: Calculate Your Take Home Pay with Umbrella Company

About the 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.