The contractor becomes an employee of the umbrella company for completing series of assignments with various agencies or clients
The below page will help you understand on how an umbrella company works for contractors and what it involves.
What is an Umbrella or Employment Business?
Simply stating using an umbrella company is a simple, risk-free alternative to setting up and managing your own limited company. Umbrella company acts as an employer for contractors and freelancers who work on fixed term assignments.
The umbrella company engages contractors by way of contract of employment, offering full employment rights. It then contracts out the services of the contractor to the agency or end client. The umbrella company will then collect the contractor’s earning from the agency or client and pays a salary to the contractor after deducting umbrella margin, tax and national insurance.
The contractor always remains an employee of the umbrella company for the series of assignments they undertake. Hence there is no administration or paperwork required as everything is dealt by the umbrella company. This structure is suitable for contractors who are just starting out, expected to contract for a short duration like six months or earning less than £15/hour.
Regardless of the benefits, an umbrella company is not the best solution for everyone. There is an extensive dependency on the umbrella company as they are responsible to collect money on your behalf and then pay you. As a contractor, nothing is under your control. Apart from control, the biggest drawback is its less tax-efficient to operate via an umbrella as ultimately you are an employee and subject to Tax & NI. Further your status may also appear as less established in the eyes of your client or agency.
How Umbrella Works?
CONTRACTOR BECOMES AN EMPLOYEE
UMBRELLA COMPANY SIGNS A BUSINESS CONTRACT
The umbrella company will then sign a business to business contract with the contractor’s agency or end client
CONTRACTOR COMPLETES A TIMESHEET
The contractor will complete a timesheet for the agency or the client weekly/monthly depending on the billing agreement and submit an identical timesheet for the umbrella company along with any expenses to be claimed
COMPANY THEN RAISES AN INVOICE
The umbrella company will then raise an invoice to the agency or the end client.
COMPANY PROCESSES PAYMET TO THE CONTRACTOR
After the umbrella company receives the payment from the agency or the end client, it will process the payment to the contractor through PAYE after deducting the necessary tax, NI contribution, employer’s NI and the umbrella margin. The umbrella company pays the tax and NI deducted directly to HMRC.
CONTRACTOR RECEIVES A PAYSLIP
The contractor receives a payslip detailing the amounts deducted and payment processed
In some cases, contractors operating through an umbrella company may be able claim tax relief on expenses they incur provided they are wholly, exclusively and necessary for fulfilling the duties of employment. The umbrella company will normally assess your eligibility to claim expenses and ask you to keep or submit receipts for each expense claimed.
Following a new legislation by HMRC, post 6th April 2016 no compliant umbrella company will be able to process travel and subsistence expenses as tax free if you are subject to Supervision, Direction and Control (SDC).
For a quick guide to what you can claim through umbrella company, please click here.
There are lot of umbrella companies in the UK, that advertise themselves as compliant when they are not and lure contractors with advertisements like ‘approved by HMRC’, ‘special dispensation with the Inland Revenue’ and ‘tax-free expenses'. HMRC can always challenge such umbrella companies and you can land up with a huge tax bill.
For the above reasons, it’s important to work with a compliant umbrella company. DNS Accountants recommends using the umbrella services of Reliasys Limited.
Why DNS for Limited Company Contractors?
DNS Accountants provides a specialist fixed fee accounting services for Contractors & Freelancers across a wide range of business sectors. We are accredited by respected contractor associations like IPSE, FCSA and Contractor UK and have a very high client retention rate of 98%.