Many of us know the term ‘umbrella company.’ But what does it really mean?
To start out with, freelancers and contractors play a vital role in our society and will continue to play a large role in our future workforce. As the nature of work continues to evolve, new challenges will arise that require the development of new talent.
Umbrella companies fill in a gap in the market. So that more of us can more easily shift towards a more flexible work environment that allows for a diversity of work styles.
For this, an umbrella company functions as a business-strategy tool and structure that allows companies to extend their operations and services with ease. It is a type of parent company that can hold several subsidiary businesses under one roof.
Business owners substitute control over the company for reduced workload and complexity. Let’s explore this further: This article will help you understand how umbrella companies work: benefits, risks, and operational guidelines. So you can make an informed decision on whether it’s right for your business. Let’s answer the question, ‘what is an umbrella company?’.
Table of Contents:
Quick Summary: What is an Umbrella Company?
This overall guide is a speedy overview of the topic, and this Quick Summary section gives you an even faster snapshot.
While not an exhaustive business-level discussion, we’ve cracked open the most mission-critical data as efficiently as we could, to give you a thorough glimpse. At a glance, here are some other things to know about what an umbrella company is:
- 🌞 An umbrella company allows you to hold and manage several subsidiaries under a single corporate entity. This can be useful for complying with tax relations, employee benefits, insurance and other UK laws
- 🌞 Umbrella companies take responsibility for deducting payroll, other essential deductions, and overseeing essential benefits.
- 🌞 They work similarly to Professional Employer Organizations (PEOs). The main differences they are shorter-term and work in tandem with specific recruitment companies.
History of the Umbrella Company Structure 🗊
We can trace the history of umbrella companies back to the formation of the IR35 legislation.
At one point in time in the UK, contracting was full of many more loopholes. Contractors were incentivised to exploit legal loopholes in order to reduce their tax burden and pump our profits. This inevitably pushed the liability down the chain, onto the shoulders of company employees.
In 1999, the IR35 was created to let the government give proper tax to what they called “disguised employees”. The term meant contractors who would receive payments from clients using intermediate companies, that did not involve direct transfers of cash.
Because contractors owned the companies that were paying them, this income wasn’t taxable. The profit that was made would be tax — but the revenue had no tax liabilities at that point in time. All the time, the HMRC (Her Majesty’s Revenue and Customs) realised that its treasuries were losing from this arrangement.
Thus, the IR35 came into being.
Reason for Umbrella Companies Being Used
But it advantaged the government but disadvantaged contractors.
Contractors were no longer able to get tax benefits in the same manner that small businesses would. And the government enforced “tests” to figure out if contractors could qualify. With the extra complexities of hiring this way, umbrella companies blossomed into being.
Umbrella companies began to act as middlemen — used by recruitment agencies to bypass the contracting steps and hiring on their behalf. With this arrangement, agencies or contractors could use umbrella companies as stand-in bases. Through these bodies, they could make travel expense claims, overnight claims, and more, as long as clients were directly being supervised.
Managed Service Companies
This form of company was also introduced by the IR35 for a brief time.
Managed Service Companies worked in a specific manner — amalgamating 5-8 separate contractors intoa single Ltd. Company entity. Typically, this offshoot of the umbrella company works by issuing the smallest possible salary, paying out the rest as dividends.
This method was popularly used until a 2008 legislation came into place to stamp down on tactical dividend payment streams. It decided that Managed Service Companies were, in effect, avoiding taxation.
Nevertheless, to this day, an umbrella company can very powerful in helping public and private companies — as well as entrepreneurs — get around the legal issues of having multiple employees working for one company. In other words, they help people to hire quickly, without having to pay set up payment and legal infrastructures all at once.
At the more complex level of things, an umbrella company is a very common business structure that corporations and online businesses can choose to use in order to protect their assets from legal claims. In other words, an umbrella company protects the assets of several related companies from being sued for the same thing. But they are also used by entrepreneurs in order to protect their businesses from lawsuits and other legal issues that arise when there are multiple businesses operating under one roof.
Advantages of an Umbrella Company
Above, we briefly covered the top pros and cons of umbrella company-use by businesses. But business owners will be interested in more detailed applications and use cases. In this section, we explore these aspects.
📖 Use Case 1: UK Tax and HMRC Regulatory Compliance
So what is an umbrella company? You’re a business owner who wants to hire freelancers long-term across different countries. You don’t want to manage the legal complexities of VAT and the differing tax laws. However, you expect to make long-term hires.
It’s first worth repeating one of the disadvantages of using an umbrella company — namely, you’ll need to ensure that the company is compliant and not operating unscrupulously. Certain umbrella companies make claims that they cannot meet. However, if your chosen umbrella company is legitimate, you’ll be able to efficiently make payroll payments that are in line with HMRC and UK tax law regulations.
A trusted umbrella company operating inside of the proper frameworks will aid your business without compromising it legally — which would otherwise risk investigative auditing into your company finances. Corporations that want to avoid fines and hope to sell through acquisition in the future will want to avoid any permanent red flags on their record.
Ultimately, it is down to the leadership team to choose only complaint umbrella companies. Steer clear of tax avoidance schemes. And it is very recommended that you choose only Freelancer and Contractor Services Association (FCSA) accredited umbrella companies.
📖 Use Case 2: No Obligation Hires
You want to hire quickly. You may hire short or long-term. But you want the freedom to close a contract once the freelancer — or even the umbrella company itself — is no longer needed for your project.
In this case, umbrella companies offer “no tie-in” periods. When using them as standard, they deduct their commission for each payroll transaction processed through them. This means you shouldn't have leaving or registration fees. Simply use the umbrella company when needed as your go-to payroll company.
For instance, say you need an umbrella company for one month out of every quarter — you can use them for that period and leave when the job is over. Rejoin and exit whenever you please without hassle.
Alongside this is ease of use with the actual freelancer payroll. The typical experience of running a limited company involves many substantial responsibilities. Even if you have a simple accountancy approach, there will still be important repetitive tasks. However, umbrella companies simply ask that your staff complete timesheets (this could be digitally, if using a freelancer site like Upwork).
📖 Use Case 3: Maximum Options for Freelancers
You’re a freelancer. You’re seeking work opportunities — but you want a maximum variety of options: different projects, variable time scales, multiple companies, overlap of projects based on completion and job success rather than fixed hours.
Once again, an umbrella company works as a wide net for you to catch many kettles of fish.
Visit a site like Freelancer.com, Upwork.com and Fiver.com. These sites officially market themselves as ‘job marketplaces’ — but this isn’t the full story. Unlike something like Indeed or Monster simply list jobs and provide ways to contact businesses offering work.
But the freelancer sites listed above go a step further, with fewer traditional employee Benefits. They manage the full hiring process on both sides of the field. For instance, Upwork lets you set up a client profile, a freelancer profile, or both. If you choose to hire (by registering for a client profile), you do not need to register with Companies House. And if you work as a freelancer, all contracts are mediated through Upwork directly.
⭐ We wouldn’t classify these freelancer sites as umbrella companies, but there is some overlap. Upwork, for instance, officiates hundreds of thousands of jobs: their advertisement; messaging between clients and freelancers; and the eventual commitment, review, completion, and feedback for job hires. Freelancers can create profiles and build reputations that attract greater opportunities. Note the following:
- Simple registration — Freelancer sites simply need to verify who you are, which means submitting your ID. If you do not have a British passport, you may need to prove your right to work in the UK, even if you are applying for jobs abroad. Documents required may include your address and National Insurance number.
- Employee perks — Umbrella companies allow you to have traditional benefits such as Maternity/Paternity Pay and Statutory Sick Pay. This a deciding difference between an umbrella company and something like Upwork.
- Employment continuity — Let’s say you sign up with an umbrella company as a freelancer. You’re able to use them as a portal to work with numerous businesses (clients). However, you keep an aspect of Continuity of Employment because your sole employer is the umbrella company. On the client/contractor side of the fence, continuity helps with securing credit for things like mortgages or even selling your UK business.
- Minimal fees — Umbrella companies make a profit on the margin as deducted from your gross pay (ie. whatever you make before tax). The typical margin for most umbrellas is £15-30, which is substantially less than most contractor accounts if it was going through a personal services firm.
Perks for contractors:
✔️ Fast Expansion and Market Penetration - If your firm is a specialist, an umbrella company can help you target a wider market. You can also expand into new industries with ease if you decide to venture into unrelated lines of business
✔️ Reduced Risks - With an umbrella company, you don’t have to take on the full burden of running a new business. You only take on the risks that come with the new line of business.
✔️ Greater Profit - With an umbrella company, you can expand your portfolio of products and services with ease. You can also use this model to diversify your business into unrelated lines of business. This can help you to expand your profit margin and earn higher revenues in the long run.
✔️ Better Growth Rate - When you choose to expand your business through an umbrella company, you can grow exponentially. You don’t have to deal with the burdens of expanding your business, which can lead to a better growth rate.
✔️ Better Diversification - When you decide to expand your company’s portfolio with an umbrella company, you can diversify your portfolio into unrelated lines of business. This can help expand your revenue and increase your profit margin.
Disadvantages of an Umbrella Company
Let’s run through some of the drawbacks of using an umbrella company.
Less tax efficiency compared to Limited Companies (ie. as a Director of a Ltd. firm)
It’s a well-known disadvantage — umbrella companies are not as tax efficient, compared to payments being handled through a combination of dividends and salary through a limited firm. The majority of umbrella staff members will hold on to 60-70% of their take-home pay. But contractors working via limited firm’s (not through the IR35 however) will likely retain a larger percentage.
PAYE is a standard payment framework for permanent staff. For this reason, it isn’t as ideal an option for contractors due to the National Insurance Contributions and taxes it incurs.
Reduced control of personal finances
With more power comes more stress, and with reduced stress is less control. Umbrellas pay out salaries after handling the deductions for you. But you’ll have less say in the intricacies of managing your personal finances compared to running your own Ltd. company.
Less favourable Employee Benefits compared to permanent positions
Running a business BR and umbrella company gives employees rights to Statutory Employee Benefits — which is useful. Nonetheless, you will find many corporations offering their permanent employees much more attractive benefits, for instance, sick pay or — for longer time horizons — annual leave, with additional incentives, some personable and others more industry-standard.
More complexities along the payment chain, more points of failure
Although the total input required from either the client or freelancer is very minimal (in effect, just submitting timesheets), the fulfilment chain is substantial. Both the recruitment agency, client and umbrella need to successfully cooperate to fulfil payroll. More points of failure mean more Ken break along the way – this may or may not be the umbrella’s failure.
An unknown proportion of umbrella companies will deliberately mislead their clients by advertising exaggerated calculations of take-home pay. Rookies to this process may stumble upon a company falsely advertising and promising greater payroll outcomes compared to other services on the marketplace – is recommended to stick to FCSA-accredited umbrellas.
Ultimately, they make up their money by deducting it from the margin. The only room for these payroll services to improve your take-home figure — assuming that they are compliant with tax and HMRC regulations – is to alter the margin. In most instances, any promises of unusual ratios are dishonest. All compliant as well execute payrolls in precisely the same way — PAYE. This leaves the margin as the only thing impacting what is retained each month.
Almost all umbrella employees cannot claim expenses
A supervision, direction and control framework was introduced in 2016. Since then, 99.9% of contractors using umbrellas can longer claim subsistence or travel expenses. In essence, HMRC saw that umbrella workers could claim expenses that weren’t available to permanent workers — since this became apparent, the 2016 legislation was put into place to prevent it.
Indeed, expense claims were once a strong motivator for contractors taking the umbrella company route. But with the supervision, direction or control of assignments, they can no longer claim expenses. Ultimately, most umbrellas no longer provide expenses as a service.
What are Professional Employer Organisations (PEOs) & What is IR35?
Professional employer organisations (PEOs) are a type of umbrella company that functions as a middleman for a collection of related companies. The PEO bridges the gap between the client companies and the client’s employees by managing their benefits and payroll. This type of umbrella company is mainly used by large corporations that want to manage their benefits and payroll for multiple locations.
A domestic professional employer organisation (DPEO) is a type of umbrella company that is registered in a country that allows such a company. DPEOs can be registered in any country that allows such types of companies. These types of umbrella companies are mainly used by large corporations that want to manage their benefits and payroll for a handful of locations within a specific country.
An international professional employer organisation (IPEO) is a type of umbrella company that is registered in a country that allows such a company. IPEOs can be registered in any country that allows such types of companies. These types of umbrella companies are mainly used by large corporations that want to manage their benefits and payroll for multiple locations across multiple countries. IPEOs are typically favoured by corporations that operate in multiple countries or industries with a global presence, such as healthcare, financial services, and technology companies.
IR35 Rules — The “Intermediaries Legislation”
We spoke briefly about the IR35 in the History section above. A bit more detail on the specific rules:
Your chosen umbrella company should have permission to operate in accordance with IR35 legislative requirements. IR35 visitation acts as recognition of self-employed contractors and business owners (sole traders) who were shirking higher income tax brackets.
Previous to this, sole traders were able to dish out a lower salary to themselves — thereby getting around national insurance and income tax contributions — by issuing the remainder as dividends. When HMRC spotted this as the type of tax avoidance, they put in place IR35 to scrutinise “off payroll-workers” who were exploiting this loophole. Since legislation, registered umbrellas need to stay within national insurance, income tax, and salary boundaries as per the IR35.
The Intermediaries Legislation (IR35) is a tax and employment law that was passed in the United Kingdom in 1999 to combat tax evasion by third-party intermediaries who are not exempt from paying taxes. The IR35 legislation states that an intermediary is any person who offers services as a professional third party and who provides those services as part of another entity’s business.
It came into effect in 1999, included as part of Gordon Brown’s (Chancellor of the Exchequer’s) Budget. The legislation declared that policies would be enacted to avert tax avoidance through what the law called (personal service companies). The IR35 is formally known as the “Intermediaries Legislation”, but is the company refer to the specific Inland Revenue (now the HMRC) budget PR number 35 – in other words, this was the 35th news release by the Inland Revenue. The press release was headed with the title Countering Avoidance in the Provision of Personal Services.
The UK introduced the intermediary legislation in order to combat the growing problem of tax evasion in the country. Third-party intermediaries not exempt from paying taxes (known as IR35s) were at the centre of this problem. The intermediary legislation was introduced to ensure that intermediaries who provide professional services to other businesses pay taxes just like a company would.
With increasing tax evasion and the need for more revenue for the government, it is more and more important to understand the laws and regulations related to SMEs (Small and Medium-sized Enterprises). The regulations, tax laws, and financial literacy are all important for the success of any business. The government has made it a priority to ensure that their regulations aren’t burdensome to small businesses and that they are able to meet the needs of their customers.
Rules to follow while filing an IR35 return under UK law
⭐ Anybody being employed through an umbrella company doesn’t need to be concerned with their IR35 status because they will be taxed like a permanent employee (PAYE). This means that if you want to handle an assignment that falls inside of that legislation, an umbrella company could be your easiest route for payroll.
The best way to understand IR35 is to look at how it works in practice. Below we have detailed steps to follow while filing an IR35 return under UK law. Before filing an IR35 return, you must determine whether you are an intermediary or a client of an intermediary. The best way to do this is to review your own work. If you perform work as a consultant, lawyer, financial advisor, or another professional service, you are likely an intermediary.
If the work is not professional, you are probably a client. If you are an intermediary, you will have to file an IR35 return. For an intermediary, you work may be self-employed, or you may be an employee working as an intermediary for your own business. If you are a client, you may want to hire an intermediary to provide professional services for you. However, a client who hires an intermediary for its own services does not need to file a separate IR35 return.
How to Find an Umbrella Company
There are many ways to find an umbrella company. First, you can conduct a thorough search online, or talk to other business owners and professionals in your industry. You can also contact business brokers that specialize in search and selection services for corporate structures, such as corporate structuring and incorporation agents. But you should start with verifying that it is accredited.
Accreditation 1 📛 - FSCA
What is FSCA (Freelancer and Contractor Services Accreditation)?
Freelancer and Contractor Services Accreditation is a policy that aims to provide clarity and create a uniform set of standards for the contracting industry. It applies to any company that offers freelance services and contractors, including virtual assistants, freelancers, contractors and job-hunters looking for contracted work opportunities or temporary staffing solutions.
The FSCA policy aims to ensure that contracting businesses meet strict criteria in order to ensure that contract workers are protected against unfair practices like blacklisting, wage theft and other violations of labor rights. By implementing these standards and best practices into your company’s processes from day one, you can greatly reduce the risk of being blacklisted by a contractor who feels they have been mistreated.
The Freelance and Contracting Industry (FSCA) Policy is the result of consultation between the Freelance Association (FGA) and the Association of Professional Controllers (APC). The FSCA Policy was created to provide clarity, consistency, and uniformity in the industry. FSCA was created in response to concerns that the contracting industry lacked clarity and was operating in a “Wild West” environment where bad actors were not held accountable.
Many of the practices that lead to violations of labor rights have remained in place due to widespread misunderstandings about the laws governing the industry. The major goals of FSCA include increasing awareness of the laws and regulations that govern the freelance and contracting industries, standardizing best practices so that all companies can operate under a common set of guidelines, and creating a single source of information for the public and the industry to rely on for information and education.
Accreditation 2 📛 - ASPCo
What is ASPCo (Association of Professional Staffing Companies)?
ASPCo is the only industry-wide association organization for professional staffing firms. It’s free to join, and membership includes access to educational programs, networking events and industry resources. As a membership-based organization,
It serves members by offering various benefits including:
- 🗊 Matching job seekers with staffing assignments at member companies cooperation between members on employment policies and procedures
- 🗊 Shared legal agreements on codes of conduct and ethics
- 🗊 Access to a network of staffing professionals who share common interests and challenges
- 🗊 Freelancer and Contractor Services Accreditation is a policy that aims to provide clarity and create a uniform set of standards for the contracting process
What are the advantages of using an umbrella company?
You essentially gain the same advantages as you would being a regular permanent employee or employer.
- ✔️ Staff members gain entitlements to company benefits such as pension schemes.
- ✔️ Both entities have protections under British employment law.
- ✔️ You have flexible options to work as a sole trader, choosing short or long-term contracts — or both.
- ✔️ You won’t need to fish for and negotiate contracts yourself.
- ✔️ HMRC allows you to claim some basic expenses.
- ✔️ Your overall advantage that umbrella companies give you is highly simplified taxes.
Your umbrella company becomes your legal employer. In this capacity, they are obligated and responsible for correctly calculating, processing and issuing your national insurance and tax contributions — each of which is directly fed from your monthly income.
How about the disadvantages of using an umbrella company?
Working via an IR35-ready umbrella company offers a lot of convenience on the front end. But contractors will find that this convenience comes at a cost when you compare it to creating your own limited company:
- ❌ Reduced control of your business’ operations
- ❌ More choice in your clientele or rates
- ❌ Fewer expense claims available on your tax return
- ❌ You cannot leverage private accounting expertise
- ❌ Owing to IR35 requirements, your income will be taxed according to regular income tax rates, which are greater than corporation tax rates and varies according to what you earn.
What does FSCA cover?
FSCA covers all types of freelance and contracting work, including any work that is performed by independent contractors and any work that is performed by employees (whether full-time or part-time). It applies to virtual assistants, independent contractors, and contractors working with a remote or distributed workforce such as contractors who use a managed service or other third-party service provider model. FSCA covers a range of subjects including worker protections, contractor obligations, interpretation of contracts, payment and professional business invoicing, dispute resolution, and more.
Who is covered by FSCA?
Any company or individual that offers freelance services and contractors, including virtual assistants, freelancers, contractors, and job-hunters looking for contracted work opportunities or temporary staffing solutions.
What is the purpose of ASPCo?
Reportedly, to be the leading association and forum for the staffing industry. In order to serve its membership, ASPCo will ensure that the industry’s needs are understood and served by providing actionable insight, education, and networking opportunities. To be a model leader in the industry through our commitment to ethical business practices, advocacy, and professionalism. This organisation commits herself to stringent compliance and codes of conduct – specialising in sectors requiring greater amounts of protection, such as umbrella firms.
Closing Thoughts 📘
What is an umbrella company? In a nutshell, an umbrella company is a single corporate entity that manages a fleet of business units under single ownership. It is a convenient way to expand a company’s portfolio of assets and services without redundancies, red tape, and market capital expenditure.
You can use an umbrella company to help expand your company’s portfolio of products and services without running multiple organizations. This structure can be useful if you want to diversify your business and grow into new, unrelated lines of business.
The main disadvantage of using an umbrella company is that it limits the number of companies that a person can have. Umbrella companies can be used to protect the assets of a company that is involved in several different industries.
All in all, umbrella companies can be a useful way for business owners to handle growth and expansion, especially when it comes to expanding into international markets. However, it’s important for business owners to do their research before selecting an umbrella company. An experienced business structuring attorney can help identify the best option for your business structure, and protect your interests during structuring.