How do Umbrella Companies Work?

Umbrella companies are sometimes confusing for those new to flexible working, especially around what they do and how they work.

But it’s pretty straightforward and easy to understand. Essentially, umbrella companies are one part of the employment supply chain and provide crucial services to flexible workers and the companies engaging them. In this article, we’ll explain what an umbrella company is and how umbrella companies work, as well as clear up some myths.

What is an umbrella company?

In short, an umbrella company is an intermediary between an end client who needs a worker, the recruitment agency trying to fill that role and the worker. Umbrellas offer contractual employment services to flexible or temporary workers.

What do umbrella companies do?

By providing employment contracts and the statutory benefits that permanent employees receive, umbrella companies also give flexible workers access to the same legal protections as permanent employees – the best of both worlds.

They also ensure that those flexible workers have the right amount of income tax and national insurance deducted from their earnings and paid to HMRC, meaning that the tax office collects the tax it’s owed.

Ultimately, umbrella companies are employers of freelance and self-employed workers.

How does an umbrella company work?

Once you’ve found an umbrella company that works for you, and you’ve signed the contract of employment, you’ll become an employee of that umbrella company.

The employment contract gives you all the statutory entitlements and benefits that other permanent workers get, including annual leave entitlement and pay, statutory sick pay and paid parental leave.

You’ll have some responsibilities related to each contract that you agree with a recruitment agency; the most important is completing a timesheet so that the umbrella company can invoice the end client or recruitment agency for the work you’ve done.

When the invoice is paid, the umbrella company will take care of your income tax and national insurance contributions, as well as any other deductions from your pay (for example, as an employee, you’ll be enrolled in a pension scheme). You’ll also pay the umbrella company’s margin.

All deductions will be listed clearly on your payslip, which you’ll be issued each time you’re paid.

Who needs to use an umbrella company?

Essentially, any worker that operates flexibly may benefit from using an umbrella company.

That means contractors or freelancers from office professions such as IT, project management, or creatives like copywriters and designers, but also vital frontline services workers like teachers, cleaners and public transport staff.

What are the pros and cons of using an umbrella company?

There are some considerable benefits to using an umbrella company. The provision of statutory employment rights and entitlements, which self-employed workers do not have access to, is one. Another is that the umbrella company takes care of all your tax obligations for that assignment.

The continuous employment contract can also be beneficial – especially if you’re considering buying a house, as mortgage providers look at your employment status as part of their lending criteria.

In return for this, umbrella companies charge a margin for their services. This margin covers the umbrella company’s operating costs and overheads, ensuring that it can pay its staff while providing a valuable service to flexible workers.

Also worth bearing in mind is that contracts are temporary and can be short, so if you prefer the stability of permanent employment, umbrella working might not be suitable for you.

Why do umbrella companies get negative press?

Most umbrella companies comply with legislation and provide an essential service for flexible workers.

As an unregulated industry, though, there have been instances of tax avoidance schemes operating in the guise of a compliant umbrella company. Non-compliant operators are in the minority, though, and not representative of the industry as a whole.

We’ve published a more in-depth article on how to spot non-compliant umbrella companies and what to do if you think you’re involved in a tax avoidance scheme.

Myths and facts about umbrella companies

As umbrella companies operate in a complex industry, some uncertainties have evolved into myths:

Myths

"Umbrella employees don't get employment benefits or rights"

This isn’t true; umbrella workers get all the employment rights that permanent employees do.

"You're inside IR35 when working via an umbrella"

IR35 legislation doesn’t impact umbrella workers, as they are employees rather than contractors working through their own limited company.

Facts

Umbrella company employees have their tax obligations taken care of by the umbrella company.
When working via an umbrella company, you get the freedom of self-employment with the security of being a permanent employee.

So, umbrella companies provide essential services to flexible workers and businesses across the UK. By providing statutory entitlements alongside a range of other benefits to self-employed workers, they offer the freedom of self-employment with the simplicity of employment.

At Parasol, we offer trusted and compliant umbrella solutions. To find out more, please speak to one of our friendly experts.