Limited company or Umbrella company – part II

Following the IR35 application changes in the public sector, recent conversations with recruitment agencies and public sector parties has shown a shift in their recommendations to contractors.

Many now advise contractors to jump ship from their limited company into the conglomerate of an umbrella.

A survey of more than 1,500 contractors found that of the contractors who chose to leave the public sector after the IR35 application reforms came in, 17% did so after being told to use an umbrella company.

The number of umbrella companies operating in the United Kingdom has grown rapidly in last decade. A large number of web based umbrella companies has emerged after the implementation of IR35 tax rules.

Why so?

Working through a limited company has many benefits over using an umbrella company, but with introduction of IR35, majority of these tax advantages are now gone. For contractors falling outside this intermediary legislation, a limited company is the best option even today. An umbrella company will be a better option for contractors caught by IR35.

Should you consider joining an Umbrella Company?

If contracting is new for you an umbrella company may be the ideal way to start.

Contractors inside IR35 will prefer umbrella companies over limited companies because of less administrative hassle involved

In the past umbrella companies proved to be a costly option considering all the tax advantages that come with limited companies. However, introduction of IR35 made is a viable option as this legislation removed majority of tax benefits associated with limited companies.

What is an Umbrella Company?

An umbrella company a large limited company operates on behalf of contractors from various industries.

Umbrella companies offer self-employed contractors the ability to carry out work for their chosen organisation and the umbrella company will simply invoice that organisation on behalf of the contractor.

Your financial affairs are handled by the umbrella; so there’s less paperwork and financial management. Most weeks you’ll merely be submitting a timesheet, and the company will manage the rest. However, this means you’re missing out on any tax planning opportunities.

Umbrella companies process invoices for contractors and receives payments from clients on behalf of these contractors. It then computes tax and NI contributions, deducts them along with company’s service fee, and sends the remaining amount to contractor’s bank account.

Working under Umbrella Company

If you register yourself in an umbrella company, you will become an employee of the umbrella service provider. The client will send money to your umbrella scheme where they will deduct tax, NI contributions, service charges and the remaining amount will be sent to you. In this whole procedure, you job is only to submit timesheets and expense receipts on weekly or monthly basis.

You’ll receive a salary that has been subject to PAYE tax and National Insurance. The fact your payments are being handled by a second party naturally introduces a level of risk; as you are reliant on the umbrella collecting money from your client or agent and using it to pay you.

Setting up PAYE (pay-as-you-earn) with your agency

PAYE is basically the money that gets taken away from your wages for tax. This system is how you pay both your income tax and national insurance (NI). Every time you’re paid, your boss takes your tax and NI from your wages and sends it on to HMRC.

Some agencies operate their own PAYE for their contractors.

With this option, you will be paying maximum tax and NI contributions on every cent that you earn through this settlement. On top of that, you can’t claim even valid business expenses. This is the reason that majority of contractors avoid this option.

Advantages of an Umbrella Company

There are a lot of positive things that engage contractors to join an umbrella company.

It gives an alternative route to those contractors who are not in the position to set up their own limited company for one reason or another.

An umbrella scheme is a viable option if your contracts will come under IR35 tax rules.

The admin work will be done by professional staff of the company, so you are completely free for your contract.

Disadvantages of Umbrella Company

Although using an umbrella company might seem like a hassle-free method for a contractor to carry out work for an organisation there are a number of downsides. Firstly and probably most importantly are the financial matters.

There is the delay of payments. The contractors come outside IR35 tax rules pay more tax burden as compare to operating via limited company.

Umbrella Companies offer very limited amount of control over financial matters and you will be totally dependent on your service provider. Most umbrella companies act in an agency style, imposing charges or service fees on the contractor.

They may take a percentage of the money earned by the contractor through his work with the organisation. Therefore meaning that the contractor will end up taking home less money than he or she would otherwise have earned.

The umbrella company also dictates how the invoices are dealt with. Generally speaking this means that the umbrella company will use a PAYE system to pay the contractor, treating them as a temporary employee of the company. So as well as being subject to the commission charges levied by the umbrella company, the contractor will also be subject to Tax and NI contributions.


The type of your work matters a lot while deciding about the best possible business structure. If you think that the contract jobs you take will be caught by IR35 tax rules, then there are no benefits of setting your own limited company as you still have to pay full tax and NI contributions. In this case, an umbrella scheme would definitely be a feasible option.