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Umbrella Pay might sound like it is money to keep for a rainy day but it is payment from a company, referred to as an “Umbrella Company” who will ensure contractors, supply workers and freelancers have a regular payment even when you are between roles and there is no contracted work for you. Umbrella pay models are also often a good solution to the IR35 legislation.

You might be new to contracting or unsure of IR35 and its implications. Getting to grips with the options available to you as a contractor are super important, regardless of which country you are based in. We can guide you through the UK umbrella pay and how umbrella pay works in this article.

Tax Efficiency

While some umbrella companies promise higher take-home pay, we advise that working through an umbrella company does not have better tax efficiencies than a limited company. An umbrella company does, however, offer some great benefits vs a PAYE job.

Are Umbrella And PAYE The Same

PAYE tax is almost the same under both an umbrella pay through an umbrella company and a PAYE agency. The amount of tax calculated and paid is the same regardless of whether you are with an Umbrella Company or a PAYE Agency.

In both circumstances, you, the freelance contractor with desirable skills, will be hired as an employee by a PAYE agency or by an umbrella company. Your full details and tax details will be added to the PAYE agency’s payroll or the umbrella company.

Their payroll system will process your income, and PAYE taxation will be applied. So, what is the difference You can choose through whom you wish to process your income.

If you decide to go the PAYE agency route, you will work through that PAYE agency. They will process your salary through their payroll as PAYE. They will also be in control of determining which contracts you take on, for how long you will take on these contracts and when you will work.

If your decision is to go the umbrella company route, the employee will work through that umbrella company, and they will employ you. They will process the salary through their payroll as PAYE. This means that they will not be fully in control of determining which contracts are taken on, the duration of these contracts or even the times when the employees are on duty. Contractors that are employees under the protection of an umbrella company will have contractor-type freedom combined with the flexibility of choosing which contracts they wish to work on, the degree of the scope of work and when they want to execute the work.

It is very important to remember that with both PAYE and umbrella, even though someone is a contractor in your eyes, in the eyes of the HMRC, they are considered employees inside IR35.  They will receive statutory benefits such as sick pay, holiday pay and maternity/paternity leave.

Another important difference between the two, in addition to the freedom of choice difference stated above, is the continuity of employment. With the very attractive freedom of choice that comes with choosing an umbrella company, there comes a single handy tax code. This is not the case with a PAYE agency. This can translate into many long term challenges for the worker as a contractor if they ever consider applying for a loan or mortgage as they will have constantly broken employment.

How Does Umbrella Pay Work?

As clarified above, the worker will pay tax in exactly the same way as a permanent employee. There are no tricky formulas and no creative accounting.

A deduction for relevant National Insurance contributions, as a percentage of earnings, will be made. All companies will deduct the exact same percentage.

The Apprenticeship Levy will also be deducted. This UK tax is used to fund apprenticeship training and is payable by all employers, as a percentage of their payroll, if they have an annual pay bill of more than £3 million.

An umbrella company may have a pension scheme, which is optional. Those contributions will also be deducted on the payslip.

We explain holiday pay in a separate section below as there are two options. Based on that explanation, holiday pay might be deducted or repaid.

When it comes to income tax calculations, it can be more complicated. Here are some examples to show the different thresholds and the different taxation percentages:

Every working person in the UK, a tax code. This will determine their relevant tax-free pay. So, for example, the UK standard tax code for 2019/20 was 1250L. This code meant that you could earn £12,500 in the 2019/20 tax year as a tax-free amount. You only have to start paying income tax after you cross that threshold.

Once you are over that tax-free threshold, then every pound and penny earned after that will have the taxation percentage of 20% applied to it. This is applied to it until the next threshold is reached, viz £37,500.

If all your hard work pushes you over that threshold, then every pound and penny you earn between £37,501 and £150,000 will be taxed at 40%.

Lastly, if you are having a cracker of a year and you cross the £150,000 threshold, you will be taxed at 45%.

The only difference you should see in any Take Home Pay figure is the margin retained by the umbrella company. If you have been offered a higher take-home pay, then this should be a red flag.

It is strongly recommended to avoid Employee Benefit Trusts, and Contractor Benefit Trusts as these are under investigation by HMRC.

Holiday Pay

Holiday pay will be displayed on your payslip on a separate line.

Umbrella companies generally follow standard rulings with regards to holiday allowances. The HMRC guidance stipulates that it be calculated at 12.07% of the taxable salary. This amount will be taken from your contract rate.

This amount can be repaid to you every time a payment is made. By making a decision to choose this scheme, it will result in there being no retained holiday pay capital available when you do take a holiday.

The other option would be to request the umbrella company to arrange for retaining a holiday allowance for you. This will give you the ability to view any holiday allowance you have accrued and reclaim it as and when you require via their H.R. handbook published procedures. From a taxation point, it should be noted that if you opt for this particular decision, then the holiday pay is taxed at the point where it is retained, not at the point it is repaid.



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