Umbrella Companies Demystified for Data Freelancers

If you are a Data Freelancer, you may have noticed some roles being advertised that require you to register with a PAYE umbrella company. In this article, we’ll explain what an umbrella company is, how they process your payroll, the advantages and disadvantages of using an umbrella company, and the alternative options available to you.

What is an umbrella company?

An umbrella company is a payroll intermediary that sits in the supply chain between the agency/end-hirer and the contractor/freelancer (worker). Umbrella companies ensure that temporary workers (contractors and freelancers) pay the correct amount of tax and National Insurance Contributions (NI) and help all parties comply with UK tax law.

If you are a Data Freelancer working in the United Kingdom, a compliant umbrella company will help you get paid correctly and on time. However, as we summarise in the rest of this article, there is a lot of information to consider.

When should an umbrella company be used?

When working outside IR35, the most tax-efficient payroll method is working as the director of a limited company because you are eligible for minimum wage salary payments with dividends. Contracting with a limited company is still popular in the UK. However, legislation referred to as “off-payroll working” was introduced into the public (2017) and private (2021) sectors. Off-payroll working resulted in fewer contractors working outside IR35 and opting to use an umbrella company for contracts inside IR35.

If you are inside IR35, you are legally required to be paid in accordance with HMRC’s tax system – Pay As You Earn (PAYE), and this is what umbrellas operate. As explained later in this article, there are plenty of advantages to using umbrella companies for payroll.

How does an umbrella company work?

Initially, umbrella companies may sound confusing. However, they're more straightforward than you may think. Should you be required to use an umbrella company for your payroll, the following steps will apply before you can be legally paid.in

• Before accepting a role, you should be told by the agency or end client whether it is inside or outside IR35.
• If the assignment is inside IR35 and you accept the position, you may be required to register with an umbrella company (assuming you are happy to do so).
• Recruitment agencies usually have a Preferred Supplier List (PSL) - a list of umbrella companies they recommend you join. However, it would be best to do your due diligence before registering with an umbrella company. Using a non-compliant umbrella company, even by mistake, could result in serious penalties from HMRC. Therefore, ensure the umbrella company you join complies with UK tax laws. A good way to ensure your umbrella is compliant is to check if they have professional accreditation from a regulatory body. While the umbrella company marketplace is currently unregulated, the Freelancer and Contractor Services Association (FCSA) is the UK's leading professional body dedicated to ensuring the supply chain of temporary workers is compliant. To earn FCSA accreditation, an umbrella must undergo a series of audits and assessments to prove they abide by the strictest compliance and quality standards.
• When you have selected an umbrella company, ask them for a free take-home pay calculation. This will provide you with an accurate indication of your pay retention and should provide you with a breakdown of the deductions that’ll be made to your assignment rate and your projected net take-home pay.
• The only income umbrella companies generate is from the margin they deduct each time they process your payroll. Typically, a weekly margin will vary between providers, but you should expect something in the region of £15 to £25 per week. As the margin only applies when you are paid, you can remain on an umbrella company’s books while you’re between work without paying a “fee”.
• To register with an umbrella company, you must provide some personal information (usually online or over the phone), including full name, address, date of birth, NI number, bank account details and assignment information. Once you’ve provided this information, the umbrella will need proof of your identification (passport) and your Right to Work in the UK (if you are a non-UK national). The umbrella company will also send you a Contract of Employment, which you must read. Only sign and return the Contract of Employment if you are fully satisfied with its content. Once you have completed these steps, you are ready to be paid by the umbrella. Ask them about the processes involved, as these will vary between providers. For example, some umbrella companies will require you to manually email signed timesheets to them. Others will have an online portal/app where you can enter this information.
• Once you’ve registered, you’ll be required to work on your assignment as normal and submit timesheets for the hours you have worked (unless the agency is self-billing). If you are unsure whether your agency is self-billing or requires you to submit a timesheet, please contact your agency or umbrella company, who can provide further information.
• When it’s time for you to be paid, your end client will send your assignment rate to your recruitment agency, and your agency will pass this to your umbrella company. The umbrella will then make the following legal deductions to your assignment rate before sending your net salary to your personal bank account:
  
  ↳ The umbrella company’s margin
  ↳ Income tax
  ↳ Employee’s NI
  ↳ The employment costs – Employer’s NI and the Apprenticeship Levy.
  ↳ Holiday pay*
  ↳Pension contributions – You can choose to opt out of pension contributions later. However, as your employer, umbrella companies must legally enrol you into a pension. Most umbrella companies follow the minimum contribution set by the government – 5% employee and 3% employer.
  ↳ Student loan repayments – Only apply if you are paying back a student loan (type 1 or type 2).

• When it is time to pay you, your umbrella will send your net salary to your personal bank account, and you’ll be issued with a payslip showing the deductions, etc.
• The same process remains while you are an employee of the umbrella company. Should you wish to leave the umbrella company, simply contact them with your plan and request a P45 document. Compliant umbrella companies will never charge any hidden fees, such as costs to join or leave.

*Calculated at 12.07% of your assignment rate, umbrella companies must show holiday pay on your payslips legally. They do this by reallocating part of your assignment rate as holiday pay, meaning you are no better or worse off. This is important to understand before accepting a role because you will need to negotiate a rate of pay you are happy with because this will include your holiday pay. Most umbrellas will process your holiday pay every time they pay you. However, others will offer you the choice to have it accrued and paid in a lump sum later (thus deducting 12.07% as holiday pay from your assignment rate and paying this to you later – a method of saving money amongst contractors and freelancers).

Have you noticed that some agencies offer two rates of pay – an agency PAYE rate and an umbrella rate?

Contractors and freelancers who use an umbrella company will notice deductions on their payslips called the "employment costs", which consist of the Employer's National Insurance and the Apprenticeship Levy. Why should these deductions come from your pay?

Firstly, you must understand the employment costs before joining an umbrella company. By working through an umbrella, they process your payroll, but you do not work for them as you will be completing work for your end client. Therefore, the umbrella cannot cover the Employer's National Insurance and the Apprenticeship Levy, which are passed to you. However, most end-clients and recruitment agencies will offer any worker who needs to use an umbrella company an inflated assignment rate to allow for the employment costs, as the employment costs will never be taken from your gross rate of pay – meaning you should never be out of pocket. If you have any questions about the employment costs and assignment rate, speak with your recruitment agency/end client before officially accepting the role and joining an umbrella company.

It's rare, but some recruitment agencies will allow you to use their in-house payroll (agency PAYE). If this is an option, the employment costs will not apply, and as a result, your actual pay rate is likely to be lower than if you are required to use an umbrella company.

What are the advantages and disadvantages of using an umbrella company?

Like most important decisions in life, there are advantages and disadvantages of using umbrella companies for your payroll. Below are the most common pros and cons that you should consider.

Advantages

• Compliance with HMRC's rules and regulations - Most umbrella companies will ensure you remain compliant with HMRC by paying the correct tax and NI. However, be careful. Unfortunately, a small number of "umbrella companies" are actually operating as tax avoidance schemes and engaging with these could have serious consequences. It's wise to pick an umbrella with an FCSA accreditation. Also, you do not need to worry about IR35 because you will be paying taxes like an employee, meaning you comply with HMRC.‍
• No tie-in period - No tie-in period exists when you use an umbrella company, and the umbrella's margin only applies when you are paid. Generally speaking, umbrella companies provide a valuable, low-cost service.‍
• Minimal ongoing administration - Registering with an umbrella company can take upwards of 15 minutes. However, once you have completed the registration process, there is little else you need to do to be paid correctly and on time. You may need to submit timesheets - speak with your umbrella to understand their processes to eliminate the risk of late payments.‍
• Employee Benefits - When you register with an umbrella, you become an employee of theirs. As a result, you will have access to Statutory Employee Benefits, including Sick Pay and Maternity/Paternity Pay.
• ‍Continuity of Employment - As your employer, you can use the same umbrella company for multiple assignments, giving you "continuity of employment". Initially, this may not sound advantageous. However, it is. Continuity of employment allows you to show lenders such as mortgage providers and banks that you have the same employer - increasing your chance of obtaining credit.‍
• The sector is crowded, allowing you to benefit from freebies - There are hundreds of umbrellas in the UK. As the market is so saturated, umbrellas are adding little extras to their service to entice you to join them over the competition. For example, it's common for umbrella companies to offer employees access to a reward scheme such as Perkbox. Such a scheme will save you money when shopping on the high street or eating out at your favourite chain restaurants if this interests you, as your umbrella before joining if they have an employee reward scheme in place.‍
• Low cost - Umbrella company margins vary but are usually under £75 per month (cheaper than an accountant). In exchange, you will be paid compliantly and can access plenty of extras.‍
• SafeRec – Despite being new to the market, SafeRec has already had a massive impact on the sector. Powered by Artificial Intelligence (AI), SafeRec is revolutionary software that provides umbrella company employees with a payslip audit every time they are paid (assuming the employee is registered with a SafeRec Certified Umbrella Company). The audit will review all the deductions on the payslip and will present results that will help you understand if you have been paid correctly or if any unscrupulous or unexplained activity has occurred with your salary. It’s easy for an umbrella to say they are compliant, but now, SafeRec gives umbrellas the chance to prove it. If a payslip audit is something you’re interested in receiving every time you’re paid, consider only using a SafeRec Certified Umbrella Company.

Disadvantages

• PAYE - While compliant, Pay As You Earn (PAYE) will not provide the same take-home pay opportunities as contracting outside IR35 with a personal service company (PAYE).‍
• Minimal control of your finances - Many PSC contractors like having control over their finances and a "hands-on" approach to running a business. By using an umbrella, they do most of the administration for you, and you will receive your pay into a personal bank account with a supporting payslip. Some will like this simplified approach to contracting, while others will not.‍
• Dependence on supply chain to operate efficiently - One of the most common complaints that umbrella companies receive from employees is "I wasn't paid on time". However, this is only sometimes the fault of the umbrella. As your assignment rate is being passed down the supply chain, it takes just one party to make a mistake for your payment to be delayed.‍
• While most have your back, some act unethically - Most umbrella companies offer compliant payroll. However, many unscrupulous tax avoidance schemes have entered the marketplace and are difficult to identify - putting you at risk of non-compliance. You must carry out thorough due diligence when searching for an umbrella, and if you have any doubts about a provider - do not register with them. The government's website has plenty of advice for contractors and freelancers interested in working through an umbrella company.‍
• It's unlikely you'll be eligible to claim expenses - Since legislation called Supervision, Direction and Control (SDC) was introduced by the government into the sector in 2016, it's unlikely you'll be able to claim tax relief on travel and subsistence expenses (which used to be a major pull factor for umbrella companies). However, umbrella company employees can still claim allowable expenses - the same expenses that workers in permanent employment have access to (e.g. travel and accommodation for work trips).

Are there any alternative options available to Data Freelancers?

A majority of Data Freelancers will be presented with two types of assignments – assignments that are inside IR35 and assignments that are outside IR35.

For assignments inside IR35, an umbrella company may be the perfect payroll service for you. As explained in this article, using an umbrella company has plenty of benefits, including compliance, minimal administration, continuity of employment, and more. However, using an umbrella company is less tax-efficient than contracting outside IR35 with a personal service company (PSC).

If you work outside IR35, operating with a limited company (PSC) as the sole director may be your preferred option. There are plenty of specialist contractor accountancy providers out there who can assist you with this. However, while being the director of a limited company is the best way to maximise your pay retention, there are far more complex rules and regulations that you need to abide by.

Should you prefer something other than using an umbrella or working through a PSC, your recruitment agency may offer the agency PAYE as an alternative. Speak with your end client/agency and see what options are available before you accept your next data freelancing role.

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This article was written by the Marketing Department at Bluebird Accountancy – specialist contractor accountants based in the UK. For more information, please visit the Bluebird Accountancy website or call their friendly Sales Consultants on 0808 301 2389. Bluebird Accountancy is accredited by the Freelancer and Contractor Services Association (FCSA). Remember to tell Bluebird you found them through the Data Freelance Hub.