Working as a self-employed professional can be difficult as there are many complications that just don’t exist when working as an employee. However, it is possible for contractors to become employees under an umbrella company and therefore remove the difficulties associated with self-employment while retaining the flexibility of contracting.
How umbrella companies work
An umbrella company is effectively a stand in employer for contractors. It employs contractors and in doing so simultaneously takes on all administration for the contractor and processes their payments, or in other words, pays them a wage. For its services, an umbrella company takes a fee which is deducted before the contractor is paid their wages. The contractor does not work for their client directly but rather they provide their services through the umbrella company. In some cases, the contractor will use an agency to source clients rather than sourcing them themselves. In this scenario, the client will pay the agency which will pay the company for the contractor’s services after deducting their own fee.
As the worker is paid a salary by the company, income tax is deducted from the wages in the normal way through Pay As You Earn (PAYE). This is done automatically by the company, which also deducts National Insurance before paying the worker. Therefore, the money received by the contractor is their end pay after tax. In terms of reducing tax, for self-employed individuals who find themselves in a higher tax bracket, using an umbrella company can lessen their outgoings for tax as they would then pay tax via PAYE as an employee.
A contractor can claim appropriate expenses when working through an umbrella company. This can minimise the amount of tax the contractor pays as the expenses due are paid to the contractor separately from their salary and are therefore not affected by income tax. This is not a way of cheating the system and avoiding compulsory tax; all expense claims must be legitimate in the eyes of the law, something which these companies are very careful about. Allowable expenses refers to any necessary expenses incurred by the contractor to perform their duties and can include things such as travel, food and drink, training and accommodation. Working through such a company makes this whole process much easier for the contractor who merely submits all receipts and details of any expenses incurred to the umbrella company who then pays these expenses to the contractor alongside their salary.
Umbrella companies offer contractors security and flexibility and remove all the hassles which self-employment is notorious for. As any contractor will know, it can be very stressful ensuring that you are completely tax compliant and mistakes, however honest, are not treated lightly and can incur devastating financial penalties. This type of company takes on the responsibility for the contractor thereby giving them peace of mind that they are minimising the amount of tax they pay but legitimately and legally. They will also chase up payments from clients on your behalf as you are paid by the company rather than the client. Usually, all details can be exchanged very easily and contractors can submit their timesheets and expenses information online. You can also set up a contributory pension scheme as a contractor working for an umbrella company.