Through the recruitment process in the UK, an umbrella company acts as an employer to freelancers, sole traders and contractors who work under fixed contract assignments. These assignments are usually provided though recruitment agencies, and the agencies reduce their tax liability by issuing contracts to limited companies.
The umbrella company then issues invoices to the recruitment agencies, and once the invoice payment has been paid, the contractor is paid by the umbrella company through PAYE, with added benefits like certain elements of tax offsetting, including travel, accommodation and meal expenses.
Since the government introduced the IR35 tax legislation, umbrella companies have become more prevalent in the UK. Taking inspiration from the French version of IR35 (portage salarial), the British IR35 was brought in to determine contractors’ employment status and their ability to make use of small company tax reliefs.
How Umbrella Companies Work
Contractors first provide their umbrella company with their working timesheets, and in turn the umbrella company issues an invoice to the limited company (or client) for payment of those working hours. The client will always be the company or business for whom the sole trader or contractor works for, and this can be across all industries and levels of employment.
Umbrella companies are required to use the same tax (PAYE) calculations as other sole traders and contractors, however the only difference is will be the level of service they offer for their fee to their customers. There are a variety of ‘allowable’ expenses that umbrella companies claim for, and from hotel and accommodation expenses to mileage and general travel expenses, their popularity among contractors continues to rise. Food allowances can rarely be claimed, as the HMRC believes that a contractor would continue to eat, whether they’re working or not.
Auto Enrolment Explained
Although small companies don’t have to auto-enrol their contractors into pension schemes until 2014, larger companies have already begun the process. Contractors can choose to opt out of the auto-enrolment pension plan, for example if they already have a pension plan set up, but this can only be done once they have been auto-enrolled.
The service was set up to provide contractors with the same benefits as regular employees, seeing that the IR35 tax legislation makes contractors pay the same, and sometimes more, tax than regular employees anyway. If a contractor chooses to take advantage of their umbrella company’s pension scheme, they can benefit from their employer’s pension contribution, just in the same way as regular employees of that company.
Implications Of Auto Enrolment
Although contractors can take advantage of a funded pension from their umbrella company, as well as saving on tax and NI contributions, the amount of contribution and the fee it will cost the contractor will differ from company to company. To meet the increased costs, umbrella companies may decide to increase their rates. Furthermore, contractors that deal with multiple umbrella companies may end up having multiple pensions. Thus, a contractor would have to opt out of multiple pensions through umbrella companies in order to save for their retirement.
Brookson are a specialist accountancy that work with freelancers and self-employed professionals. Visit them to find out more.