IR35 reform is only a matter of weeks away, coming into effect on April 6th 2021. It will mean that many contractors who currently work through their own limited companies will be forced to review their options. Some may choose to work through an umbrella company going forward.
Crawford Temple is the CEO and founder of Professional Passport, the largest independent assessor of payment intermediary compliance, and in this article, he outlines what an umbrella company is and how the umbrella model works.
In as few words as possible, an umbrella company is a company that employs contractors to carry out temporary assignments. The contractors often work through recruitment agencies for an end client, with the contractors paid PAYE income in the same way as an employee.
Due to IR35 reform in the private sector, a number of organisations are insisting that workers deemed to be ‘inside IR35’ move to either PAYE through the recruitment company or work via an umbrella company. Many recruitment companies do not operate their own PAYE arrangements for their contracting workforce and in these cases, they will rely on umbrella companies.
Contractual terms offered by umbrella companies do vary and we would always advise that you read and understand the key terms.
As a contractor, you will be an employee of the umbrella company so you will have the same employment rights as any other employee. Such benefits include auto-enrolment into a pension, where you meet the qualifying criteria, as well as statutory benefits such as sick pay and maternity or paternity pay.
Your pay will be operated through PAYE with all tax and National Insurance deductions made at the point of payment, just like all other employees.
Working through an umbrella company for a series of assignments also gives you continuity of employment, which can help if you are seeking a mortgage or loan.
This is an area where many contractors new to umbrella companies become confused.
The rate paid to the umbrella company is not the rate you get paid.
If you are paid by an agency directly, then the rate they offer you (commonly known as the PAYE rate) is the amount, before your tax and NIC, that you should receive. But this PAYE rate is not the true cost to the agency of paying you. In addition, they have to pay employers’ NIC, holiday pay, the apprenticeship levy and contributions into a workplace pension. As such, the real cost to them of taking you on may be significantly more.
When the agency contracts with an umbrella company, and you are employed by the umbrella company, they should pass the umbrella company the full costs of your employment – that is, the PAYE rate plus all the associated employment costs (from the funds they themselves have received from the end client).
They will often uplift the rate to also cover the margin cost of the umbrella company. This is commonly known as the limited company rate or uplifted rate. Where the rate has been uplifted correctly, your take home pay from the umbrella company should be no less than you would receive had you been on agency PAYE.
If you have a PAYE rate and an uplifted rate provided by your recruitment company, many responsible umbrella providers will produce a pay comparison for you.
It is also worth noting at this point that all umbrella companies have to operate within the same tax rules, meaning there should be very little difference between the take home pay you are offered. Should you be offered significantly more take home from a provider, beware, as this could result in HMRC coming after you at a later date for unpaid taxes. If that were to happen you would end up with less overall than if you had paid the correct taxes in the first place.
Generally, umbrella companies will provide 28 days holiday as part of the employment contractual terms. This is one of the costs that is covered in the uplifted rate provided to the umbrella company.
This equates to 12.07% of your gross taxable pay and should include both salary and any bonus element of your pay.
Umbrella companies will retain this money to pay to you when you are either on holiday or not working, although the majority of contractors prefer to have this paid to them immediately. If that is the case, you will be asked to confirm your request in writing before this process is applied. You must remember that were you to request advanced holiday pay this will mean that you have no funds held back for times where you are on holiday or out of work. You are able to change it back at a point in the future should you wish.
If you decide to have the umbrella retain the holiday and pay it out on request, you must make sure that you understand the ‘holiday year’ that the umbrella operates. All companies, not just umbrella companies, have a ‘holiday year’ (for example, January to December) and you must take any holiday entitlement during that year or it is lost.
The rules relating to expenses for contractors operating through umbrella companies have seen many changes over recent years and are different from the normal expenses rules:
There are two types of expenses that can be claimed:
In the case of those you wish to have reimbursed from your general earnings, and keeping things as simple as possible, these tend to only be mileage allowances to temporary workplaces (i.e. not the normal site you visit). If you have other allowable expenses such as train fares or subsistence, these must now be claimed through your self-assessment tax return.
Agency reimbursed expenses, where the money is additional income and not general earnings, can typically cover any category of expense, as long as it is to a temporary workplace and wholly, necessarily and exclusively for business.
Your umbrella is likely to require a detailed expense claim form from you in addition to the one submitted to the agency. This is simply because the umbrella must demonstrate to HMRC why the expenses are allowable for tax purposes, something the agency or end client doesn’t have to do.
If you feel you are likely to have either category of expenses, it is worth discussing this at the outset with your umbrella to ensure they can accommodate these and you are aware of their processes for claiming.
Umbrella workers will generally work under the Agency Workers Regulations. This means that you should receive the same pay and holiday entitlement as a comparable full-time employee. Your gross taxable pay should be equal to or greater than a comparable employee after you have had the correct holiday entitlement applied. Where the holiday entitlement is greater than 28 days, the umbrella will adjust the percentage being deducted for your holiday accordingly.
Since the IR35 reform was introduced in the public sector in 2017, a proliferation of schemes have been set up purporting to be umbrellas and offering a higher take-home pay. If you are tempted to unwittingly engage with one of these disguised remuneration schemes you could face significant future tax bills once HMRC discovers that.
The message is clear and take home pay should not be one of the criteria used to select an umbrella company, given they should all be within a few pence of each other.
It is worth reiterating HMRC’s official guidance, that warns contractors to check the following to find out if you may be engaged by a disguised remuneration scheme:
As the clock ticks towards IR35 reform in the private sector, if you are one of the many contractors weighing up umbrella working, it’s important that you carry out your due diligence and ask key questions. Understanding the warning signs when looking at the providers in the market is likely to help you determine if it is a genuine and compliant umbrella or a scheme that’s best avoided.