Contractor Umbrella Company Explained
All self employed contractors and freelancers have to choose between operating through a Limited Company or a Contractor Umbrella Company. There is also teh choice between Offshore Umbrella Companies and Onshore Umbrella Companies. Few contractors operated through Umbrella Companies until 1999. It was the advent of the IR35 tax that sent contractors into Umbrella Companies. Prior to that they virtually all worked via Limited Companies.
Umbrella Companies allow contractors, who are caught by IR35 (or who just don't want to do all the admin), to claim a limited amount of expenses against tax. Typically they can claim benefits that a normal permanent member of staff can't claim, like travel expenses to work and overnight expenses if they are staying away from home.
How Do Umbrella Companies Work?
All the contractor has to do is input his or her time sheet every week and the Umbrella Company does the rest. They invoice the client, they deduct the taxes and send them to HMRC and they pay the contractor. The umbrella company deals with the contractor's recruitment agency.
The contractor has an employment contract with the umbrella company and pays PAYE. Umbrella company prices vary and you should compare companies. Get several quotes as rates vary. Umbrella companies to avoid are those that make you pay a penalty fee for leaving them.
Among those freelancers that use umbrella Companies are IT Contractors, construction workers, nurses, locum doctors, veterinary nurses, supply teachers, hgv drivers and other agency workers.
Are they good or bad? That's not really the question. It is whether they suit you or they don't suit you best.
HMRC and Umbrella Company Contractors
The contractor doesn't have to do his or her VAT or keep their own books or hire an accountant.
Previously there were permanent workers who got paid less and paid the full whack of tax without deductions and then there were contractors who got paid more and were able to claim a lot of expenses against tax.
Now there are Umbrella Company Contractors. They get paid a full contractors' rate but they pay tax like a permanent employee - with the added bonus of being able to claim some expenses against tax too.
Charges and Fees
The Contractor Umbrella Company employs the contractors and charges them a monthly fee for looking after their admin and their affairs. However, the contractor saves on the money that they would have paid an accountant.
The Government appear to like this arrangement as the Umbrella Company collects the taxes and sends HMRC a massive amount of tax regularly. That's why HMRC don't mind letting contractors get away with a few expenses.
Umbrella CompanIes Pros and Cons - Best for Contractors
The main advantages of using umbrella companies is that you don't have to worry about an IR35 investigation, you can claim some expenses in deductions against tax, you get all your admin done for you and don't need to worry about chasing your agency for payment, or doing your own VAT returns or your end of year accounts. You may well get certain contractor insurances thrown in and may get other benefits like pensions, sick pay, maternity pay and holiday pay. You just pay the umbrella companies charges and costs once a month.
85% - 90% Umbrella Company Alternatives
The disadvantages are that you will have to pay more tax than other contractors meaning that there is less in your pocket. Although rats of pay are similar, their take home pay is less. It is reckoned that an umbrella company contractor pays an average of £10,000 a year more in tax than a Limited Company contractor who gets paid in dividends. It could rise to maybe £15,000 to £20,000 more than contractors using offshore umbrella companies, tax efficient limited companies solutions or limited partnerships for contractors where the contractor is self employed.
All of these are legal as HMRC admitOnshor. offshore umbrella companies, have more risks than others. They are tax avoidance rather than tax evasion. Umbrella Company contractors choose safety and a hassle free life against greater returns on their money earned.
Umbrella Companies Reviews
Umbrella Companies came to the fore with the advent of IR35 in 1999. There were hardly any contractors in Umbrella Companies before then. Now there are more than 200,000 freelancers using Umbrella Companies by the end of 2014 - which is quite a hefty rise in 15 years.
In the beginning it was thought that they were a device for contractors who were caught by IR35 to be able to claim some expenses against tax. It was thought that the Government would abolish them. Indeed they put the kibosh on Managed Service Companies.
Umbrella Companies Favoured by HMRC
Gradually, however, it dawned on people that HMRC actually liked Umbrella Companies. Those companies did a lot of their work for them. They deducted the tax of over 200,000 contractors and sent it to HMRC. HMRC could deal with a few hundred Umbrella Companies rather than chase individual contractors.
We've seen how much effort they've had to put into IR35 cases against individual contractors many of which they have lost. So, to receive those regular tax payments from the Umbrella Companies was a big bonus. If contractors were able to claim a small amount of expenses which they could offset against tax that was a small price to pay for all the effort saved and all that lovely extra cash they get from the Umbrella Companies.
HMRC and Limited Companies
However, it looks now as if the Umbrella Company has become the favoured vehicle of HMRC. It appears that they would like far more contractors getting out of Limited Companies and into Umbrella Companies. The reasons are obvious. The main reason is that the taxman gets an average of £10,000 extra on average from Umbrella Company contractors than he gets for those using Limited Companies in tax and NICs.
Recently the Chancellor has been cracking down on many of those contractors using Limited Companies - especially those in the public sector. He is also decreeing that senior employees (office holders) at private companies should not be using Limited Companies.
Indeed the Chancellor appears to be herding freelancers out of Limited Companies and into Umbrella Companies. So, it looks like 2015 will be a good year for the UK's Umbrella Companies.
To see an assessment of some of them see Which Umbrella Company?
Umbrella Companies Tax Relief
Umbrella Company Contractors punished by Chancellor, George Osborne, in his Budget this week are wondering what hit them.
They are also wondering whether it is still worth paying the monthly fee as their umbrella companies tax relief goes up in smoke.
In his budget the Chancellor said he was going to stop umbrella companies tax relief on travel and subsistence.
That was the main reason that UK contractors used umbrella companies rather than just pay the IR35 tax.
Umbrella Companies and IR35
Umbrella Companies sprung up after IR35.
Those contractors who were not caught by IR35 stayed in their limited companies.
Those who were caught by IR35, or who thought they might be, went into Umbrella Companies rather than pay the IR35 tax.
Umbrella Companies were able to get them tax relief on travel to work and subsistence while there, especially if they were working away from home and could claim for overnight accommodation and other overnight expenses.
Contractors became as permanent employees in umbrella companies and were taxed as such paying PAYE.
If IR35 was made to stop what they called disguised employees, with umbrella companies, contractors became disguised contractors, i.e. disguised as employees.
The umbrella company did all the admin and subtracted PAYE from the contractor, after tax relief for expenses was deducted, and sent regular mass payments to HMRC.
They thought that this put them in a good light with HMRC and they would still be able to claim umbrella companies tax relief for UK Contractors.
Umbrella Companies Tax Relief is Tax Avoidance
However, umbrella companies, which disguise contractors as employees for the purpose of tax avoidance, were a ruse and the Chancellor saw through it.
Many of those running umbrella companies looked down their noses at providers of offshore umbrella companies who they saw as purveyors of tax avoidance schemes.
A lot of it was sour grapes as the offshore umbrella company providers were taking what the onshore umbrella companies saw as their customers.
However, they were kidding themselves and the Chancellor showed what he thought in his budget, i.e. that umbrella companies are tax avoidance too - and he has put a stop to it.
Staying in Onshore Umbrella Companies or Leaving
Will, UK contractors stay in umbrella companies now that they can't claim umbrella companies tax relief on expenses?
Will they still pay a monthly fee to their umbrella company just to do the admin for them when they will be paying as much tax via the umbrella company as they would if they were permanent employees or were paying the IR35 tax?
The answer is that some will and some won't.
There is bound to be a haemorrhaging of contractors from umbrella companies now. Also, it will be harder to sell umbrella companies to new contractors now.
The Chancellor took the opportunity to financially bash contractors using limited companies as personal service companies. He has cut off their ability to claim travel and subsistence as well and as raised dividend tax for them so that it is no longer worthwhile for them to pay themselves in dividends rather than in salary.
Future for UK Contractors
So, what now for UK Contractors?
If Umbrella Companies and Limited Companies are less financially attractive to them, what other vehicles can contractors use?
There are two main options.
Offshore Umbrella Companies
Firstly there is the offshore umbrella company which can get contractors returns of 85% on the money they earn.
For more information on those click on Offshore Umbrella Companies.
A second, more recent option, for contractors anyway, is the use of limited partnerships.
Limited partnerships are something that other professions use but is fairly new to UK contractors.
However, limited partnerships have not been hit by the changes that the Chancellor made in his budget as he was not targeting them. He was targeting umbrella company contractors and limited company contractors.
For more information on limited partnerships click on Limited Partnerships for UK Contractors
Now that Umbrella Companies tax relief on expenses has been taken away, Contractors punished by the Chancellor are looking at these two options more and more. It's the same with limited company contractors too.