While the contractor completes assigned work for the end client, the umbrella company legally employs them. The umbrella company signs a contract with the contractor and another with the recruitment agency or end client. The umbrella company processes payments, deducts the correct taxes, and pays the contractor. This saves administrative time and effort for the other parties.
Umbrella companies operate in the U.K. The model isn’t common in other jurisdictions, though similar models exist in some countries.
What does an umbrella company do?
Contractors can begin working with an umbrella company by following these steps:Â
Signup: The contractor signs a formal contract of employment with the umbrella company, making them its legal employee. This contract gives the worker employment rights, like holiday pay, sick pay, and pension contributions.
Client engagement: The umbrella company signs a business-to-business contract with a recruitment agency or the end client. This contract outlines the contractor's assignment, deliverables, and payment terms.
Work: The contractor carries out their assignment, tracking both hours and deliverables.
Timesheet submission: At the end of each payment period, the end client approves their timesheet. The contractor then submits their approved timesheets to the umbrella firm.
Invoicing: Using the approved timesheet, the umbrella company invoices the recruitment agency or end client the full rate for the contractor's work.
Payroll processing: Once the end client pays the invoice, the umbrella company processes payroll. It deducts all necessary employer costs, including National Insurance contributions, the Apprenticeship Levy, and a fee.
Payment: After deducting all employer costs, the remaining amount becomes the contractor's gross pay. From this, the umbrella company deducts pay-as-you-earn (PAYE) tax and employee National Insurance contributions. The final amount is the contractor's net pay. Â
Benefits of using an umbrella company
In the U.K., the umbrella model offers benefits for both independent contractors and the companies that hire them. For contractors, the advantages include:
Convenience: Contractors don't need to set up and manage their own limited company, handle invoicing, chase payments, or file tax returns. Instead, they do their work, submit a timesheet, and get paid.
Employment rights: As employees of the umbrella company, contractors are entitled to rights that are unavailable to sole traders. Some of these rights include statutory sick pay, maternity or paternity pay, and holiday pay.
Continuous employment: Working through one umbrella company across end-client assignments creates a continuous employment history. This can help when applying for credit, as it shows a stable income history that could otherwise be difficult to prove.
For end clients and recruitment agencies, the benefits include:
Less admin work: The umbrella company takes on all payroll and HR duties for the contractor. This means the hiring company doesn't have to calculate taxes or manage other HR tasks.
Easy compliance: The model helps reduce the risk of worker misclassification. This is valuable in the U.K., where IR35 legislation imposes strict rules on determining a contractor's tax status. By making the contractor an employee, the umbrella company takes responsibility for PAYE, reducing the risk of penalties for the end client. An umbrella company is sometimes called a PAYE umbrella, because it supports PAYE tax compliance.
Risks of using an umbrella company