Independent contractors working at home or abroad will often use an umbrella company to manage their contracts with clients. As their name implies, umbrella companies can shelter you from unforeseen payment and compliance problems and will act as a go-between to connect all parties to the contract.
We have put together this guide for you that explains all that you need to know about umbrella companies.
What is an Umbrella Company?
When you set up a contract with your client, there are a few ways to organize payment and one of the easiest is to use an umbrella company. One way to think about it is that the umbrella company acts as your ally and partner to fulfil your contract.
This means that they will get your payment from the client and/or agency and in turn pay to you, after deducting owed taxes and other social contributions. As a result, you don’t have to monitor the process at all once you have submitted a payment request.
So, the umbrella company is a third-party intermediary working between you, your recruitment agency, and the end client to make sure that payments are made, and the client is satisfied. It removes the uncertainty of contracting, especially across international borders.
How Does an Umbrella Company Work?
The process of using an umbrella company is fairly straightforward. Assuming that you use an agency to find your clients for you here is how it works:
- Umbrella company contracts with your agency
- You as the contractor, also contract with the umbrella company
- You submit your timesheet/project deliverables to your agency and copy the umbrella company
- Umbrella company invoices the agency
- Agency invoices the client, and the client pays the agency
- The client pays the agency and the umbrella company is paid by the agency
- Umbrella company make necessary deductions and issues a receipt/payslip
- The payment is sent to your designated account
Because there are often three parties involved in your contract (you, agency, client) using an umbrella company to facilitate payment and contract fulfilment gives everyone peace of mind.
Take-Home Pay Using an Umbrella Company
You might wonder if using an umbrella company will affect your net take-home pay compared to contracting directly with clients. Because take-home pay is determined by deducting taxes and contributions, the net amount should be the same depending on your tax bracket.
The umbrella company will also deduct a percentage fee for their services, so that is a small reduction in take-home pay (unless you can add it to the bid for your client since they benefit as well from the security of using an umbrella company.)
There may be some differences if you are using a limited company which may have some effect on how taxes are calculated. The reason is that a limited company can take advantage of corporate tax and expense rules and increase its net income. However, there is the cost of hiring tax or accounting assistance that must be factored in.
Should You Use an Umbrella Company?
As a contractor, you may wonder why you should use an umbrella company. If you are used to set up your client contracts, have a reliable payment system, and are well versed in tax and contribution requirements, you may think it is unnecessary.
However, there are some real advantages in using an umbrella company as the intermediary for all of your client projects and contracts, as they can act as a third party to the transaction to ensure that everything goes smoothly. This saves the contractor the time and effort of managing their payments and compliance and offers a ready resource in case any issue arises.
An umbrella company does charge a fee for their services (a fixed percentage of your contract) but that should not be a deterrent for using this valuable contracting service when you consider the time and cost-saving in the event of potential non-payment of compliance problems.
Here are some of the benefits of using an umbrella company:
- Removes uncertainty from the payment process, especially with new clients or in foreign countries
- Increases client confidence in getting the service they pay for
- Ensures compliance with all tax and self-employment contribution requirements
- Automated submission of invoices and quick receipt of payments
- Can sponsor work permits or business visas for overseas contracts
- Will hold licenses needed in some countries for employing contractors
Alternatives to Using Umbrella Companies
There are viable alternatives to using an umbrella company, and they are worth reviewing as a point of comparison.
A limited company is your entity with you as director, that will serve as the business structure for invoicing, tax payments, and other corporate requirements. Some contractors like the idea of having their own separate business to contract with clients. This increases their autonomy and credibility, and provides some protection from liability.
When you work as a sole trader, it means you are self-employed as an individual. You will invoice under your name, and file taxes as a sole proprietor. In this case, the rates will be the same as if you were an employee. It is a way to remain independent but avoids all the complexity of a limited company.
With an agency using PAYE for your earnings and taxes, it is similar to working as an employee. The agency takes care of the administrative tasks just like an umbrella company. However, an agency may not offer the full spectrum of compliance assurance or the ability to deduct expenses. If you use an agency for recruitment it is simple to have them handle the payment process as well, and they will have some type of agreement with your clients so you won’t worry about timely payment.
Difference Between an Umbrella Company and Limited Company
The main difference between umbrella companies and limited companies is that the umbrella company is a third-party entity, and a limited company is your own separate business. An umbrella company is an intermediary that will facilitate client payment and withhold taxes and contributions on your behalf.
When you set up your own limited company it is essentially your entity and will handle all of the registration, incorporation, and then direct contracting and invoicing of your clients. Many contractors will need professional tax and legal assistance unless they are experienced working as a limited company.
Because of these differences, a contractor will have to make a decision. Do they want to ease working through an umbrella company? Or do they want the independence of starting their own limited company? There may be some risks to using a limited company internationally. These includes
- Permanent establishment which leads to taxation abroad,
- and labour leasing restrictions (since you are employing yourself in the foreign country).
How to Choose an Umbrella Company?
If you have decided on using an umbrella company the next step is to choose the best one for your situation. Here are the areas to focus on while choosing umbrella companies.
- Has the umbrella company been in business long and worked in multiple countries?
- How is their payment track record and timing to make sure you get your money without delay?
- Do they have a system for calculating taxes, contributions, and expenses to ensure that as a contractor you comply with the country’s laws?
- How much are their fees?
- How do they deliver their services, either online/automated or through an account manager?
Once you get these questions answered you can compare different umbrella companies and make your selection. During this process, it is a good idea to get references from other contractors.