An umbrella company becomes the employer of the contractor, for tax reasons, when you agree on a contract with an employment agency or a client. It is an alternative to you setting up your own Limited Company and, if your contract is outside of IR35 it is usually the most cost effective way for you to operate.
The umbrella company would then issue the clients an invoice on behalf of the contractor who would then pay the contractor once they have received the cleared payment from the agency or client. The amount the umbrella company receives will typically be determined by the timesheet that you have signed by your line manager as this is a record of your hours/days worked. Some umbrella companies will need a copy of this timesheet to raise and invoice and some will have an online system to which you can upload your hours/days worked directly.
When a contractor is paid is generally dependent on the agreement that they have with their umbrella company for payment processing for example some companies pay on the day the payment is received whereas some will make a payment once a month. The agency or client will usually be able to advise you of the date that they will transfer funds to the umbrella company and the contractor is then able to work it out from there. Once payment has been made to the contractor they would receive a payslip which will specify the necessary tax and national insurance contributions that they are required to have paid as well as their expenses claimed, the umbrella company fees and their net earnings.
As an independent comparisoncontractor contractor working inside of IR35 (see the IR35 article for more information on this) the contractors are liable for both employee’s and employer’s national insurance and these would always be displayed separately on the payslip. It is important to note that, despite many advertised claims to the contrary, the only variance in your earnings between different umbrella companies will be the fees that the company charges – tax will not change. The reason for this is that a contractor is paid via PAYE and all deductions made are determined by the Inland Revenue.
Contractors are allowed to claim expenses during their work, all of which are then processed by the umbrella company. Expenses that are paid by the agency or client will be refunded to the contractor in full and those which are not chargeable will be processed as a tax benefit, meaning that the taxable income will be reduced by the value of that expense. It is important for contractors to notice that this is not a way of reducing the tax bill as any claims must be allowable by the Inland Revenue and as such must be an expense to you personally that is 100% attributable to and 100% caused by the work you are doing for the client. For more information on these different kind of expenses please read the next article.
Umbrella companies all have a dispensation. You should be aware that this does not determine the expenses that you are permitted to claim and it does not preclude you from having to keep receipts. It simply allows the umbrella company to process certain expenses without having to record them on a P11D which they would have to do under standard accounting practice.
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