Understanding ‘Umbrella Companies’

I’ve just been preparing an explanation of how Umbrella Companies work to a Bectu member. Just writing it down is a reminder of what an obnoxious arrangement this is when you move people onto these – and this is what employers are doing in response to IR35 tax changes.

The key thing to understand: this is a needlessly complicated way of employing someone. Employers offload tax-investigation liabilities & quietly put costs onto employees -in my experience, many workers can’t get their head around this complexity and just say “whatever”….

To understand this properly, let’s look at how an ordinary PAYE worker is paid (these are my own, slightly shonky graphics so please bear with me on this)
Emploee Status explained
As you can see, it’s actually quite complicated but most workers aren’t bothered by that because they only need to worry about what happens with the ‘payslip’ – in that picture. An ordinary payslip makes employment very easy to understand.

Compare it with the way that a Self Employed Sole Trader is employed. Overall, if anything, the arrangements are less complex, but it is more daunting from the worker’s point of view.

Understaning self employed tax

So far, so complicated, right?

Now let’s look at what happens when an employer says….

  1. I have employed you in the past as a self-employed sole trader (see that second graphic) – I am one of a number of companies who engage you
  2. For MY work, I’m now going to pay you through an Umbrella Company
  3. That Umbrella Company will engage you as a PAYE employee – I don’t really care about what is happening in the rest of your working life – I’m doing this, take-it-or-leave-it.

So, before we even look at whether being employed through an Umbrella Company is an attractive thing (spoiler alert: It totally isn’t!) this is a hand-grenade into a freelancer’s working arrangements.

Even being put onto plain old PAYE as a direct employee of the company would be much more preferable.

If there’s one thing that policymakers hugely underestimate in my view, it is the levels of anxiety that this kind of thing creates. People I’ve spoken to universally hate it. It causes stress and ultimately, those workers often just resign themselves to it and hope that their finances will look after them. A state of anxious inertia.

As a side note, I think that people employed through payroll companies are under psychological pressure to delay starting a pension – when they see all of the deductions they’re expected to shoulder, they will understandable take the option to at least keep the employer and employee pension contribution in their pay packet (even if it’s slightly less tax efficient in the long run).

So now let’s move onto the main course. How do ‘Umbrella’ Payroll Companies work?

Let’s take an example of someone who worked for a company and was on a £20k salary. Imagine an employer who said “I will move you onto an umbrella payroll company and I absolutely guarantee that you will suffer no detriment of any kind (in my experience, employers never say this during these exercises by the way).

Here’s how it works:

Understanding umbrella companies

… and here’s the scenario for our lucky £20k worker who is guaranteed no detriment.Understanding an umbrella company - the numbers

The headline figure that this worker is quoted by the end-engager needs to be 30.9% higher if the change is to involve no detriment. And the ordinary employee will also be getting £400 paid into their pension that I haven’t even accounted for here as I was focused on take-home pay for the purposes of this post.

Comparision chart - direct employee v payroll company

If you accept the headline wage rate without doing this calculation, someone on around £26,000 a year will be losing around £3,670 – about 14% of their income – to finance this chicanery.

If anyone wants to challenge my figures here, they’re welcome to – I’ve not run them through an accountant, but I’m reasonably confident that they’re correct. And if anyone wants to draw up a ready-reckoner for this so that people can compare a normal salary offers with the headline figures people are given when they start to work for an umbrella company, I’d be very grateful!


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