There have been so many questions by new contractors about umbrella companies and the way that they work that I thought I would put together a help guide. Hopefully it will answer most of the questions that crop up:
All umbrella companies will process your payments through PAYE (Pay As You Earn) as the assumption is always made that you will be working inside IR35. As such you will be liable for income tax and both employee’s and employer’s national insurance. More information on income tax can be found here: http://www.hmrc.gov.uk/rates/it.htm and here: http://www.hmrc.gov.uk/rates/nic.htm for national insurance.
You will be advised that you can claim expenses which will either be charged direct to your client or will be processed as a tax benefit. You can only claim expenses which are approved by the Inland Revenue.
All of the above means that, it does not matter which umbrella company you use, your net earnings should be the same provided that all Inland Revenue regulations have been followed. The only difference should be the fees that your umbrella company charges.
Most umbrella companies will mention a ‘dispensation’ and the term is sometimes used in advertising. A dispensation will not tell you which expenses can be claimed it is merely an accounting tool for your umbrella company. Under normal accounting practise all expenses that a company processes have to be recorded on a P11D form which is sent to the Inland Revenue; an umbrella company’s dispensation means that this form will not be required for those expenses that they have listed. The dispensation does not relieve the contractor of any responsibility at all regarding the provision of receipts – they will be required if you are the subject of an Inland Revenue investigation. Nor does it mean that you can legitimately claim more expenses through one umbrella company than another, they have to be Inland Revenue approved and must be supported by receipts. To quote the Inland Revenue:
"I can confirm that contractors cannot automatically claim £21 per day (or any other amount) for each day they are at work. It is also worth saying the Inland Revenue would not give general approval of a company's expenses policy. A dispensation would never cover large amounts of unsupported expenditure"
Most umbrella companies will also have a calculator on their websites to give you an illustration of your earnings. You may find that they will return different results. If a calculator does not ask you for details of your expenses it may assume a figure based on some sort of average, therefore the figure you are quoted will only be accurate if the figure assumed is exactly the same as the expenses that you incur. Therefore, you should always check that you are comparing like with like and, remember, the calculators are for illustration purposes only and will always give an estimate rather than a quote.
Also, bear in mind that you are the customer of the umbrella company and as such you should be able to leave at any time without penalty. During your research you should check whether there are any ‘hidden costs’ and you should obtain confirmation in writing.
Lastly, if the scheme being offered seems too good to be true then it very probably is and you should contact the Inland Revenue directly if you are unsure about any of the information that you are being provided with