Part Two: Everything you need to know about umbrella companies

By Fay Capstick

Welcome to part two of our deep dive into the world of umbrella companies. Last week we looked at what they were, how they work and how much it might cost you to use one. This week we will move on to look at why your client might prefer you to use one, followed by a detailed look at the advantages and disadvantages of using them, what this means for your tax return and what happens to any of your existing limited companies.

Your agency or end client might prefer an umbrella

It is possible that the agency that you are using or your end client might prefer you to use an umbrella company. This is the option that we recommend to our contractors.

If you are working PAYE without an umbrella you become an employee of the recruitment agency, and they will be undertaking all of the paperwork and admin that the umbrella would be doing. This can be time consuming for them.

Our priority is finding the best solution for every candidate that we place, however at Parker Shaw we do not offer a PAYE option.

Employment costs, a source of confusion

You might have seen roles advertised with two rates, a ‘PAYE rate’ and an ‘umbrella rate’. This is a result of the worry among contractors of having to pay both the employers and employees National Insurance costs if they have been requested to use an umbrella company, and thus being short changed. These two rates mean that you will not be penalised, and the rate you get will be the correct higher one.

What are the disadvantages?

• The most tax efficient way of working is still to have your own limited company, working outside of IR35. However if you don’t want to have your own limited company, or find a contract that is outside of IR35, then an umbrella might still be the best option for you. An umbrella will always result in less take home pay than the limited company route. It should be noted that most contractors are now working under the umbrella option.

• Not using an umbrella and working through a limited company means that you will not qualify for benefits such as statutory sick pay and maternity/paternity leave.

• It is possible that you might be viewed as more experienced and professional within the industry if you are working through your own limited company, however this is changing as most contractors now go through umbrellas. And again, you can only use your own limited company if a role is outside of IR35, which is the minority now.

• Some umbrella companies have given the industry a bad name through schemes that essentially amount to tax avoidance. Whatever you do, make sure that you are fully compliant with HMRC regulations. HMRC are able to chase you for any tax they feel that they are owed due to avoidance, even if it was done by an umbrella who assured you that they were operating legitimately.

• It will be harder to claim any expenses when working through an umbrella.

• The TUC (https://www.tuc.org.uk/research-analysis/reports/umbrella-companies-why-agencies-and-employers-should-be-banned-using-them) has produced a report on the use of umbrella companies. It concludes that there are significant problems for workers associated with their use.

• An agency might have their own PAYE option. They will deal with all the tax calculations and then pay you your wage. This means you will get the same result as an umbrella company, without paying the umbrella fee. The drawback to this method is that you will not be considered a full employee, you would be an agency worker, and your rights to benefits and pension would be changed accordingly. However this isn’t always an option and many agencies will no longer offer it.

What are the advantages?

• The biggest positive is the umbrellas will do all the paperwork for you. No stress and no hassle. A win win.

• Insurance may be provided, which might save you money should you want this perk, but always get a separate quote to compare costs and benefits.

• Tax and national insurance are all done by the umbrella company. Therefore there is no tax return to file at the end of the financial year.

• As an employee of the umbrella company you will be entitled to benefits such as statutory sick pay.

• It is really simple to use an umbrella company. They are doing all the work for you, leaving you free from paperwork.

• You’ll be paid on time.

• The umbrella will do all the tax calculations for you, taking away any worry or uncertainty over what you owe HMRC and when.

• No more dividends: you will receive a gross weekly or monthly wage after the appropriate deductions have been made by the umbrella. If you had been used to working through a limited company you will find that you no longer get dividends.

• An umbrella is cheaper than the cost of hiring an accountant if you are working through a limited company.

• If your daily pay rate is a low one, it might be better to use an umbrella than to have the costs associated with setting up a limited company.

Why do some umbrella companies suggest they can pay me more?

To put it simply, they can’t. They should all be using the came calculation based on the tax code that has been generated for you. Any difference in take home pay projections should simply be down to the margin or fees that they umbrella is applying for using their services.

Again, the only method that the umbrella company have to generate their profit is through the fees that they charge you.

What happens to my limited company?

Don’t worry, you don’t have to wind up your limited company in order to use an umbrella company. You should be able to make your limited company dormant while you are working through an umbrella.

You can use it again in the unlikely even that you find a contract outside of IR35, though in reality an umbrella is such a good choice that you might just want to wind your company up.

Will I need to submit a tax return?

If your only income source is from the umbrella company then it is unlikely that you will need to submit a tax return.

Conclusion

Currently 34% of contractors are operating through umbrella companies, but Recruiter reports that 61% believe that there is no advantage to doing this (https://www.recruiter.co.uk/news/2022/04/freelance-workers-see-no-advantage-using-umbrella-companies), which is a very significant number. Therefore umbrella companies need to do better to educate contractors on the advantages of the services that they are offering.

We recommend the use of umbrella companies, but we only suggest using ones that are fully FSCA compliant. Further it is important that you shop around and compare benefits and services offered to get the best fit for you.

Ultimately the choice is yours to make based upon your own needs and circumstances. As with all things financial, it is always advised to get independent financial advice. However at Parker Shaw we have seen the benefits that using an umbrella company can bring to contractors.

Final thoughts

At Parker Shaw we have been at the forefront of the sector we serve, IT & Digital Recruitment and Consulting, for over 30 years. We can advise you on all your hiring needs. If you are looking for your next job in the IT sector please check our Jobs Board for our current live vacancies at https://parkershaw.co.uk/jobs-board.