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The step by step process of how an umbrella company works

As a contractor you may be aware that using an umbrella company is one of the main methods of receiving your pay, but what do umbrella companies actually do and why are they needed?

Umbrella companies act as an intermediary between the contractor and their recruitment company. They fulfill an important role in the contracting market, so it is important for contractors to understand how they operate.

Here is a step by step breakdown of the umbrella company process:

How an Umbrella Company Works - Umbrella Exchange

STEP 1

Upon joining, the contractor will sign an employment contract directly with the umbrella company. At this point the contractor becomes an employee of the umbrella company. The umbrella company will be their employer.

STEP 2

At the same time the umbrella company will enter into a contract with the contractor’s recruitment company to offer the services of the contractor.

STEP 3

The contractor performs their work and either weekly or monthly, submits a timesheet detailing their hours and if appropriate also forward their out of pocket expenses to the umbrella company.

STEP 4

The umbrella company will invoice the recruitment company for the hours the contractor has worked.

STEP 5

When the umbrella company receives payment from the recruitment company, they will pay the contractor through Pay As You Earn (PAYE) deducting the correct tax and National Insurance contribution amounts on the contractor’s behalf. A pre-agreed umbrella fee will also be deducted and any other deductions (e.g. pension contributions) will be made. If the contractor has claimed certain allowable expenses these will also be reimbursed.

Like a permanent employee, the contractor will then receive a payslip detailing the deductions that have been made.

STEP 6

At the end of the tax year, the umbrella company will provide the contractor with a P60 (End of Year Certificate) and P11D (detailing any expenses claimed).

Why do contractors use umbrella companies?

Umbrella companies are principally responsible for organising payment for your work. However there are a number of additional advantages that make them such an attractive option, particularly for time-pressed contractors.

umbrella company benefits for contractors

Umbrella company benefits for contractors

Umbrella companies offer contractors a simple and straightforward means of receiving their pay. As well as streamlining administration, tax and National Insurance payments, other benefits for contractors include:

  • Fast and simple set up. Start billing and start contracting in less than 24 hours
  • Ability to carry out a number of temporary contracts but receive one convenient payslip each month or week
  • They can offset allowable expenses against their tax liabilities
  • No unplanned tax bills relating to their timesheets at the end of the year with accurate calculations and payments made on their behalf
  • No director duties or legal company requirements to adhere to
  • Access to many statutory benefits typically associated with being in permanent employment such as, sick pay, holiday pay and maternity pay
  • No need to worry about IR35 and SDC regulations – the contractor is already taxed as an ’employee’ so these rules do not apply

Further reading:

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