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Umbrella Company – How Does It Work

Umbrella CompanyWhen a contractor enters into an agreement with a client or an employment agency, the umbrella company becomes the contractor’s employer for tax purposes. This offers an alternative to establishing a Limited Company by the contractors themselves. Further, if the contractor’s agreement is outside the purview of IR35, it becomes a very cost effective operation.

The umbrella company issues the invoice on contactor’s behalf and pays him/her after receiving the payment from the client or the agency. The money received by the umbrella company will depend on the timesheet of the contractor that is signed by the line manger. The timesheet forms the record of the hours and days of work put in by the contractor. Whereas some umbrella companies would want a copy of the contractor’s timesheet to raise the invoice, some others would want the client or the agency to upload the contractor’s timesheet details on to an online system.

The payment schedule for the contractor will depend on the agreement that the client has entered into with the umbrella company. Some umbrella companies pay on the date of receipt of payment, whereas some others pay on a monthly basis. Typically, the client or the agency will advise the contractor as regards date of transfer of funds to the umbrella company. The contractor can then liaise with the umbrella company for getting the money transferred to his/her account. Along with the payment to the contractor, a payslip containing the details of tax as well as national insurance contributions, expenses claimed, the fee charged by the umbrella company and net earnings is also provided.

If the contractor is working within the purview of IR35, he/she is liable for both the employer’s and employee’s national insurance. These details will be separately indicated on the payslip. Contrary to many claims, the only difference in the contractor’s earnings when it comes to different umbrella companies is the fee charged by them. Tax does not change because the contractor is paid through PAYE and Inland Revenue determines all deductions to be made.

Contractors are eligible for claiming expenses incurred as part of their work. These claims are also processed by the umbrella company. Such claims that are paid by the agency or client are reimbursed in full to the contractors. The expenses on which tax is not required to be paid are deducted from the taxable income. Contractors cannot make use of such claims to reduce their tax liability. The claims have to be allowed by Inland Revenue and the expense must have been personally incurred and attributable to the work being executed by the contractor for the client.

All umbrella companies have a dispensation. Contractors must be aware that the expenses that they are allowed to claim are not determined by umbrella companies’ dispensation. It also does not preclude contractors from maintaining the receipts. It permits umbrella companies to process some of the expenses without the need to maintain a record on P11D which they are supposed to do according to standard accounting practices.

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