Umbrella companies: what you need to know
What are umbrella companies?
An umbrella company is a company that employs contractors who work on temporary contract assignments, often through a recruitment agency. It offers the flexibility of being a contractor, along with the stability and benefits of being an employee.
From a contractor’s perspective, umbrella employers provide you with full employment rights, all statutory benefits, including holiday pay, maternity pay, paternity pay, sickness pay, pensions, and adoption pay.
A contractor is an employee of his or her chosen umbrella employer. With that relationship comes a responsibility for the umbrella firm to provide HR support to its contractors in the same way as any employer.
When it comes to pay, umbrellas consolidate this from multiple hirers into one single pay packet, which is particularly important for anyone who gets called to work at short notice, at changing locations for various clients on different days. Rather than lots of separate pay packets, just one payment takes care of it all so that contractors can focus on their work.
Is IR35 a concern when operating through an umbrella?
No, an umbrella firm is a contractor’s employer, and therefore a contractor is an employee. IR35 is only applicable to self-employed contractors working through an intermediary, usually their own personal service company. By virtue of being employed by the umbrella, there is no IR35 status to warrant concern.
What risks do non-compliant umbrella schemes pose to contractors?
Since the new off-payroll legislation hit the public sector, we have seen a proliferation of schemes that aggressively target professional contractors to sell their product of higher take-home pay. Sometimes, these schemes label themselves as “umbrella”, but they are not legitimate. They “work” by paying a small portion of contractors’ earnings via PAYE and then disguising the remaining and more considerable part of a contractor’s income as something else – often an offshore loan. Other examples include shares, annuities, employee benefit trusts and capital advance schemes. HMRC regularly issues Spotlights to warn about tax avoidance schemes, which you can find on their website
Most of these schemes will result in significant future tax bills once HMRC catches up with you. Anything that sounds too good to be true almost certainly is.
Will a contractor be held liable if the scheme is non-compliant?
Anyone joining a non-compliant scheme is likely to end up personally liable to pay their tax and National Insurance contributions that would have been due on the disguised income – any unpaid monies quickly adds up.
By using avoidance schemes, individuals are putting themselves at very significant financial risk personally; the HMRC will backdate any charges for unpaid taxes to the date they signed up to the scheme. With any fines and interest added, the tax bill could potentially be very significant.
Contractors will be all too aware of just how damaging the loan charge has been and what a devastating impact it has had on the lives of many innocent contractors who were unwittingly lured into toxic schemes.
Thousands of contractors are now facing the reality of the loan charge
The BBC recently published an article about a contractor who had previously used a company to manage his admin and tax affairs – although unbeknownst to him at the time, it was, in fact, a tax avoidance scheme.
John, as he has been named for the article, is one of an estimated 50,000 people who have been caught by the controversial loan charge. As a result, thousands of people like John are now under immense pressure to repay significant tax bills from using these tax avoidance schemes.
How do contractors spot non-compliant schemes?
HMRC’s official guidance warns contractors to check the following to see if you may be engaged by a disguised remuneration scheme:
- The company promises that you can keep 80 – 95% of your income and be tax compliant
- Only a fraction of your salary is paid through payroll and subject to PAYE (indicating that you are only paying tax on some of your income)
- You are paid using a loan, credit or investment payment, and the company claims this isn’t subject to income tax or National Insurance contributions (this is tax avoidance)
- The payment from your umbrella company is routed through various companies before it comes to you and comes in various separate payments instead of one
- You’re told you do not have to declare the scheme to HMRC
In essence, the key message is to ensure that your chosen umbrella pays 100% of your income through PAYE. Any business that splits your income so that it isn’t all taxable or offers an unrealistic level of retained income is unlikely to be doing so compliantly with UK tax regulations.
What should contractors do if they’re unsure of a scheme’s compliance?
The simplest thing to do is to change to another provider which will pay 100% of your income through PAYE. Don’t forget that many schemes have compelling marketing literature, and at first glance, they might appear to be genuine investment opportunities. Some will state that they have tax counsel opinion that their arrangement is compliant or that they fall out of the scope of tax avoidance.
Whatever their claims are, a healthy level of scepticism is wise. There is no reason to enter into contrived arrangements which seek to reduce your tax bill. It is far simpler – and less stressful – to choose a provider that pays 100% of your income through PAYE. That way, you won’t have to worry about sizeable future tax bills.
What should a contractor do if they realise they’ve been working through one of these?
HMRC advice states that any contractor who thinks they may be involved in an arrangement promoting tax avoidance should withdraw immediately and settle your tax affairs. To speak to someone about getting out of avoidance, contractors can email firstname.lastname@example.org.
Is there a stamp of approval for contractors to look out for?
Umbrella firms have been in existence for some 20+ years, and it would be advisable to choose a compliant umbrella firm with a good track record. Look out for the FCSA Accredited Member seal of approval. To achieve FCSA accreditation, applicants, i.e. accountants and umbrella firms, must undergo a rigorous assessment of their business services, operations, policies and processes, all of which are independently examined to ensure adherence to published FCSA compliance standards.
FCSA assessors are themselves regulated accountants and solicitors, which means they can only recommend a “pass” if genuine. FCSA only appoints assessors who are leading experts in our sector.
A true umbrella will:
- Employ you
- Give you all statutory rights & benefits of employment (holiday pay, sick pay, pension etc.)
- Give you the flexibility to work for numerous different end-hirers
- Consolidate your pay from numerous hirers into one pay packet
- Process the full amount of your gross pay through PAYE