What is a payroll umbrella company and why might I need one?

What is a payroll umbrella company?

A payroll umbrella company is a company that employs freelance workers who often work on numerous different assignments, at various locations, either through agencies or directly for end-clients. The payroll umbrella company enters into an employment contract with the worker and a service contract with the agency or end-client.

This way of working is suitable for freelance consultants, contractors, interim managers and other independent professionals working in the public sector, and for those working for particular organisations in the charity/not-for-profit sector (see this article on trading formats). If working on multiple assignments you could work through a payroll umbrella company for public sector assignments and your own limited company for private sector assignments.

What are the main differences between working through a limited company and working through a payroll umbrella company?

When you own a limited company, you and your company are separate legal entities. You are both a director and an employee of your company. The fees that you earn while on assignment belong to your company, and out of these fees your company pays all its running costs. The most significant of these running costs is the salary that it pays you, and which you receive after deduction of the appropriate tax and NI. Of course, you also own your limited company so you may also pay yourself dividends out of the profits.

When you work for a payroll umbrella company, you enter into a contract of employment and so become an employee of the umbrella company. The fees you earn while on assignment are paid to the umbrella company, but are ring-fenced as your funds and are used to pay salary, employment costs and any allowable personal expenses (the umbrella company does take a small margin to cover its expenses). You do not own shares in the umbrella company and are one of many such workers employed by the company.

Reasons for working through a payroll umbrella company

Since 6 April 2017, all public sector departments have been responsible for assessing the IR35 status of the freelance workers they employ and, if it is decided that a freelance assignment falls within IR35 (which it will in most cases), it will in reality no longer be practical to work through a limited company.

Although it is still possible to work through a limited company, HMRC have made the process extremely onerous for all concerned. It is complicated, non-tax-efficient, expensive to operate, and not generally favoured by the public sector departments. For this reason most public sector employers are now insisting that individuals work through a payroll umbrella company.

Read more in our comprehensive guide to contracting in the public sector, which details the changes in full and how it affects you as an independent professional.

While working through a payroll umbrella company:

  • Your earnings will be consolidated and appropriate taxes will be paid in full regardless of the number of assignments carried out through that umbrella company
  • You will build up an employment history, which is helpful when you require references for access to mortgages or other finance, or to support property rental agreements.
  • Your agency/end-client does not have to handle that all the compliance issues that come with employment (payroll, VAT, scrutiny of expenses, etc)
  • In certain circumstances, you may also find that you no longer need to file a personal tax return.
  • Competex Pro will insure you for Professional Indemnity and Public Liability as standard.

Next resource: Working through a payroll umbrella company: The mechanics