Many Contractors choose to use the services of an existing ‘Umbrella Company’ – they are limited companies that employ Contractors. If you choose to do this, your contracts will be treated for tax purposes as if they are all inside IR35.
Umbrella companies deal with the payroll aspect of your employment and all your accountancy and tax issues and employ you (the Contractor) on a PAYE basis (called an ‘overarching’ contract). Rather than being paid directly by your clients, your payment will be processed by the Umbrella Company. You submit a timesheet, including expenses details, to the Umbrella Company, who bill the client.
The Contractor has an employment contract with the Umbrella, and the Umbrella holds the assignment contract with the agency or the client. Certain expenses (travel and subsistence) can be claimed that can reduce your tax bill and usually Umbrella Companies provide Employers Liability Insurance, Professional Indemnity Insurance and Public Liability Insurance as part of their fee; and offer contributory pension schemes, medical cover and other benefits. Umbrella contractors should receive statutory minimum workers entitlements, such as holiday entitlement, national minimum wage, rest breaks, maternity pay and so on.
There are a number of drawbacks:
- The tax burden for Contractors who use Umbrella Companies is far higher than for those who become company directors of their own Limited Company.
- All salary drawn through an Umbrella Company is subject to employers and employee’s National Insurance Contributions.
- HMRC have a 24 month rule that says if you have been based (or will be based) at a specific site (for 40% or more of your time) for more than 24 months, it is no longer regarded as a temporary place of work and you are therefore no longer entitled to claim business expenses.
However, there are some advantages
- Tax will be deducted at source, so you will generally not be required to complete an annual self-assessment.
- You may not be able to form a Limited Company if you have Visa restrictions.In this case an Umbrella Company could be a good option.
- If you are in-between permanent jobs and looking for a short-term solution, or new to contracting and are worried about understanding all the information you need to be aware of to operate legally (IR35, tax, NI etc), Umbrellas can be a good ‘safe’ option.