The pros and cons of using an umbrella company for contractors

Like them or loathe them, umbrella companies are part of the employment supply chain. While some contractors go out of their way to avoid umbrellas, others prefer the simplicity they bring, and most accept it’s a means to an end to ensure the mortgage is paid.

Here’s my round up of the pros and cons of umbrella companies, writes James Poyser, CEO inniAccounts and offpayroll.org.uk. 

Pros of using umbrella companies

The pros of using umbrella companies include: 

They’re straightforward

It’s pretty easy to get paid via an umbrella company. You simply complete a timesheet and in return you get a net payment to your bank account, after tax. No invoices, no tax returns, no accounts. Simple.

You don’t need to worry about cashflow for tax

Even before both the IR35 off-payroll changes of 2017/2021 and the influx in ‘forced’ umbrella working, there were plenty of contractors outside IR35, who used umbrella companies.

One of the reasons why is that setting aside cash to pay future PAYE, VAT, Self Assessment and Corporation Tax bills can be a challenge for some, potentially leading them into hot water with HMRC for missing payments. Whereas with an umbrella company, you don’t need to worry about setting cash aside for tax bills (as long as the umbrella is doing their job correctly).

Employment rights

The term “zero-rights employment” has been bandied around a lot in the post-IR35 reform world. But this isn’t the case if you’re working via an umbrella company. You do have more rights than you may think, and they include:

• Protection against workplace discrimination
• Holiday pay (but see ‘cons’ section below)
• Rights to use the same facilities as perms from day one - including canteens, childcare/creches, car parking, gyms etc. In effect, all those things you avoid as a business owner operating outside IR35!
• After 12 weeks there are several benefits which you’ll get equal access to, meaning you should look at the benefits similar perms get, and use this as your benchmark. Your 12 week rights include equal access to:
  • Pay - including basic, holiday pay, commission, overtime, shift allowances and individual bonuses, which means that come bonus season, you shouldn’t be missing out.
  • Holiday pay above the minimum
  • Sick leave
  • Hours / breaks
  • Access to perm jobs - you can access and apply for internal vacancies
  • Parental time off - including antenatal appointments, mat/pat/adoption pay

As an umbrella employee, you have access to employment tribunals if you think you are being denied your rights.

They allow supply chain specialism

Payroll and employment are complex. Umbrella companies allow agents to outsource the complexity to a specialist. This is a good thing -- the use of specialists in the supply chain should be good for productivity, and competition should drive up quality. This doesn’t always transpire in real-life, but nonetheless there should be a role for payroll specialists.

Continuity of employment

Some think having a single employer covering multiple contracts makes it easier to get a mortgage. In reality, you’ll probably need to switch umbrella when you switch contract, as different recruiters have different commercial relationships with umbrellas, so even if you wanted to stay put with your brolly, chances are you can’t. If you’re looking to remortgage simply find a contractor-friendly mortgage broker. They understand umbrella companies and can sell your case directly to the underwriter. One broker in particular has spoken out, helpfully, about just how much umbrella company employment helps, or hinders, your mortgage application chances.

Cons of using umbrella companies

The cons of using umbrella companies include: 

You ultimately pay for everything

Nothing comes for free with an umbrella company. Holiday pay? It comes from your contract day rate. Employer pension contributions? From your contract day rate. Employment costs, like Employer’s National Insurance? From your contract day rate. The cost of running the brolly and keeping recruiters referring business to them? From your contract day rate too!

Unfortunately, our tax system isn’t cut out for the way work is done these days, and it’s no more apparent than when you use an umbrella company. This leads to lots of back-and-forth with agents and umbrellas, confusing payslips and, more often than not, a sinking feeling when you get your net pay.

Complex payslips, where money has a habit of going walkies

Over the years, I’ve audited thousands of umbrella payslips and it never fails to surprise me how complex and leaky umbrella payslips are.

When you follow the flow of money through the payslips you’ll often find hidden deductions or lines that don’t add up, meaning many umbrella companies are potentially skimming cash from their workers. Sometimes, in my experience, it’s a couple of pounds a week that you’re out of pocket, often it’s tens of pounds. This ‘leakage’ impacts brollies of all sizes and unfortunately, it’s endemic.

The great holiday pay vanishing act

To me, the big picture is that umbrella holiday pay is borderline nonsense.

If you negotiate a contract day rate, chances are any holiday pay will have to be accounted for in this rate, so it’s wooden dollars. It’s taken out of your rate, to be given back to you with the badge “holiday pay” applied.

There are two ways that holiday pay can work via an umbrella company. In the first instance, you’re automatically paid holiday pay every week/month, in lieu of actually taking the time off. In this case you can be sure that you’re getting everything you’re entitled to. In return, you’ll need to make provisions should you decide to take time off, as you won’t get paid when you do.

The second method operates in the way our perm colleagues are accustomed to. You take some time off as annual leave, up to your allowance, and you still get paid. There are two things to remember though. First, someone must pay for this holiday pay - and it’s you. Your pay will be depressed for the other 46 weeks of the year to fund this.

Secondly, keep tabs on your allowance and make sure you use it. Should you not use it, come the end of the year, or when you change assignment, many umbrella companies (including the well-known brands) have a habit of pocketing this pay, which could leave you thousands out-of-pocket.

No protection should your umbrella company go bust

If an umbrella company goes bust, chances are any unpaid earnings and holiday pay will be lost. This happens more often than you think. Some umbrella companies pay unviable commissions to agents, other umbrella owners have been known to commit VAT fraud, and some brollies are simply incompetent. When they fall behind on VAT or PAYE, HMRC will move in to liquidate the company.

You’re on the hook if your umbrella company is really just a tax fraud in disguise

If your umbrella company is committing tax fraud - perhaps by unwittingly enrolling you into a loan-type scheme, or by simply not paying PAYE over to HMRC - then you could well be on the hook for a life-changing sum of money. If you’re new to umbrella companies, you’d be wise to read up on the loan charge for the dangers of working with rogue ‘umbrella companies.’

It’s hard to switch umbrella company mid-contract

If you’re part way through your contract and you’re having problems with your umbrella company (common day-to-day issues include late payments, incorrect tax codes, unexplained deductions, and poor customer service), you might decide to switch.

However, often recruitment agents will say this isn’t possible, citing several nonsense reasons, or even trying to charge a fee!

The reasons why agents often don’t support the switch is because it can mean more paperwork for them, and importantly, they’ll probably get the commission they’ve just earnt from the umbrella clawed back. So do your research and go into this with your eyes open.

Other umbrella company cons

There are other cons which are less about day-to-day matters, and more about the umbrella industry and the umbrella business model itself. If I didn’t mention these cons, I’m confident I’d be at the thick end of a keyboard warrior or two! So, for completeness, here they are:

Use of contract / assignment rates

It’s simply bonkers that umbrella rates are advertised as a ‘contract/assignment rate’ before employment costs are deducted. Meaning, from the rate you see advertised, you need to deduct Employer’s NI, holiday pay, pensions, etc. This doesn’t happen for perm roles, and it doesn’t even happen for temp roles in other sectors. So why does it happen here?!

Most of the umbrella’s margin goes back to the recruiter

On average, around half of the fee you pay the umbrella goes back to the agent in commissions and incentives. In effect, you’re indirectly paying your agent, as well as the fee they get from the end-client!

Preferred supplier lists

You might have a preferred umbrella company, but unless it’s on the recruitment agent’s preferred supplier list (PSL), you won’t be able to use it. While a PSL can be used to drive up compliance, the main use of a PSL is to safeguard commission payments to the agent -- umbrellas who agree to pay are allowed on the PSL.

Your daily rate is the only source of revenue for an umbrella company

If you takeaway nothing else from this article, this is the final, key fact to remember:

The only source of revenue for an umbrella company is your negotiated daily rate.

To cover their running costs, growth plans, commissions, legal fees, and just about anything else, they must turn to your daily rate.