Over the last 10 years, the popularity of umbrella companies has swelled considerably in the UK – and with the imminent changes to HMRC’s IR35 regulations, that trend is only expected to continue. Despite this, many people are still unclear as to what exactly an umbrella company does and how they work with regard to HMRC.

Fortunately, the situation sounds far more complicated than it actually is. Below is a handy guide which lays out the answers to the most common questions regarding umbrella companies, with a special focus on their relationship to HMRC. Umbrella companies are useful tools for self-employed workers in all industries, so for anyone still struggling to understand the particulars, this should prove essential reading.

What is an umbrella company?

Simply put, an umbrella company is a firm that acts as an intermediary between a contractor and an end client. They are most commonly used by self-employed people who still want the freedom associated with freelancing, but don’t want the lack of security (no regular wage, no statutory rights) or mountain of paperwork (tax returns and other legal obligations) normally associated with the lifestyle.

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What does an umbrella company do?

The umbrella company effectively takes on a freelancer as an employee, allowing them access to all of the aforementioned benefits of regular employment. They will liaise with the end clients and invoice them for services rendered, before paying the freelancer a weekly or monthly wage. This wage will already have certain deductions made to it, such as tax contributions, NICs, pension payments and, of course, the fee which the umbrella company charges the freelancer for the services they provide.

How does an umbrella company work with regard to HMRC?

When it comes to an umbrella company’s relationship with HMRC, this does not differ in any way from any other employer. The umbrella company (usually) collects timesheets from the freelancer (who is now technically their employee), invoices the end client and handles all the sums relating to the former’s tax obligations.

This means calculating how much income tax and what kind of National Insurance contributions they must pay, then deducting them from the payslip before it is passed on to the freelancer. They are also obliged to assess whether a freelancer is eligible for their pension scheme and automatically enrol them if so, but the freelancer can opt out of the scheme and retrieve their initial contributions if they so desire.

In the case of any taxation discrepancies, who is liable?

This is a slightly more complicated question to answer, since it may vary depending on the exact circumstances of the discrepancy in question. Having said that, the umbrella company is, generally speaking, responsible for making sure all of your tax obligations are met and your payments are made appropriately.

This does not mean, however, that you are immune to investigation by HMRC. Umbrella companies may handle your contributions, but you are always ultimately responsible for your own tax affairs and with certain facets of the process, such as submitting expenses, HMRC can choose to investigate the individual, rather than the employer. If you are found to have fraudulently claimed undue expenses, it is you and not the umbrella company who is liable to pay any penalties.

What is IR35?

IR35 contract rules were first brought into effect in 1999 to prevent individuals who were (for all intents and purposes) employees from creating limited companies to dodge their tax obligations. However, what started out as a scheme to clamp down on tax avoidance has since been expanded to include legitimate self-employed people, significantly reducing the financial advantages of that career choice.

How does IR35 affect self-employed people?

In April 2017, HMRC amended the rules surrounding IR35 contracts for those working within the public sector, placing the responsibility for determining whether or not the contractor was deemed to be “inside IR35” (and thus liable to pay PAYE tax) with the end client. Eager to avoid penalisation, many of these companies simply regarded all contractors as inside IR35 so as to be on the safe side, or worse still, cut off all ties with them altogether.

This left thousands of self-employed people all across the UK forced to pay significantly higher tax amounts, or, in the worst cases, without any work whatsoever. The rules are scheduled to change again in April 2020, at which point the IR35 dragnet will be expanded to include all workers in the private sector, too. This means that countless more self-employed people are likely to be adversely affected, either in terms of their take-home pay or in the amount of work available to them.

How are umbrella companies affected by IR35?

Given that IR35 applies only to self-employed people, those working with an umbrella company are not deemed to be “inside IR35”. That’s because freelancers and contractors who work with an umbrella company are regarded by HMRC as employees of that company, and therefore can escape all of the stress and potentially elevated costs associated with the upcoming IR35 rule changes.

Are all umbrella companies HMRC-compliant?

Unfortunately, there are some unscrupulous operators out there who are more interested in attracting freelancers with unrealistic offers than complying with their HMRC obligations. In an attempt to crack down on this illegitimate kind of umbrella company, HMRC recently published guidelines on their website offering tips on how to spot a fraudulent operation. In a scenario wherein you contract the services of a non-compliant company, the burden of responsibility to meet your tax obligations will ultimately fall on your own shoulders.

Are any umbrella companies HMRC-approved?

The idea that approval is given by HMRC to umbrella companies is a complete myth. As stated in the guidelines linked to above, HMRC cannot tell you whether an umbrella company is legitimate or not. As a result, any website which carries a “HMRC-approved” slogan is simply using marketing propaganda. Instead, it’s more useful to look for compliancy badges, read reviews from previous customers and contact the company yourself to get a feel for their integrity.

Finding the umbrella that fits

As those last two points amply demonstrate, there are a multitude of things to consider when making sure you fulfil your legal requirements to HMRC. Umbrella companies should make this ordeal far easier and less stressful – and the vast majority of them do – but there are some bad apples which could upset your applecart if you don’t do your due diligence before committing to their services.

Indeed, even among legitimate umbrella companies, there is still a wide variety of options on offer, with some providing more comprehensive packages and improved service in comparison to others.

The best way to find which one suits your needs is through the use of an umbrella comparison site like Umbrella Broker. With no horse in the race, we simply want you to get the best deal possible, which is why we let you measure companies against each other via several metrics. Take a look today.

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