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.