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An umbrella company is a company that exists to employ workers to fulfil short term contracts and pay their National Insurance and Income Tax. Unlike a normal employer, employees are not hired to fulfil a role, instead employees are potential self-employed workers who have won their own short term contract, and choose to become employees of the umbrella company so that the umbrella company can carry out their payroll in return for a small fee.
As a result, the worker is never classed as self-employed for tax purposes. In order to provide payroll services, the umbrella needs to act like a normal employer. They engage with the end client as a supplier, invoice the end client for the work, and pay their employee a wage through the PAYE system. Often there can be a recruitment agency in the middle of the end client and the umbrella company.
Because of the short term nature of their employment the employee remains in their own eyes (and that of their client) “self-employed”; even if technically they aren’t. They often have full control over their working patterns and holidays, with their employment by the Umbrella being largely passive.
In the past, large numbers of contractors had opted to open a Limited Company in order to engage with the client and pay their taxes. This was largely driven by the tax efficient way directors and shareholders could extract money from that company, boosting their take home pay.
However from 2017 the UK government cracked down on the use of Limited Companies through legislation commonly known as IR35.
In essence, this legislation required end clients using contract workers to define if their contractors were actually defacto employees. If they were, then the worker was deemed inside IR35 and would need to pay tax on all their earning through the PAYE system (which Umbrellas use as standard).
With penalties for getting their decision wrong, most employers blanket classed their workers as “inside IR35”, forcing tens of thousands of contractors to close their Limited Companies, and move to Umbrella Companies instead.
In response to the surge in Umbrella Companies on the market, various accreditations arose to help contractors distinguish between good and bad umbrella companies.
While these accreditations help contractors learn more about umbrellas, it’s important to remember that there is currently no official regulator of Umbrella Companies, meaning the accreditations on offer are currently private.
An accredited Umbrella Company is therefore an Umbrella that has undergone and passed an audit with a private regulator and promises to uphold their principles (which vary from accreditation to accreditation) in return for a fee.
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As a contractor that’s been forced to move away from operating a Limited Company, towards using an Umbrella Company, it’s often not by choice that you would want to close your Limited Company.
The first choice of many is therefore to keep their Limited Company and make it dormant (where it doesn’t trade) in order to preserve it for when they find a contract deemed outside IR35.
In some instance though it is highly unlikely to be the case (for example you work in the public sector) and as such closing your company is the best route to take, simply to save yourself the burden of accountancy costs.
There are three main ways to close your personal services company in this scenario.
1. By far the cheapest method of closing your Limited Company is through dissolution – If you have no creditors, debtors or assets, you can make the company dormant for 3 months and then apply to have the company dissolved using a DS01 form or by applying for dissolution online.
If you’re caught by IR35, then you must process your contract value through PAYE. This means that the tax efficient payment methods available to directors and shareholders of a Limited Company are unavailable to these contractors.
Due to the cost of filing accounts, processing PAYE and time taken to invoice, most contractors will opt to find an Umbrella Company to process their payroll for cost reasons. Some end clients or agencies may even refuse to engage with a contractors Limited Company.
However in the event that an agency or end client will work with a Limited Company, provided they use the PAYE model, then you are able to use an accountant to process your payroll.
Most normal high street lenders will expect payslips as proof of income. This is a problem for many self-employed workers because they are not employees and therefore do not produce payslips.
There are however ways to enable self-employed workers to prove their income.