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An umbrella company is a company that acts as an employer to Agency contractors who work under a fixed term contract assignment, usually through a Recruitment Employment Agency in the United Kingdom. Recruitment agencies issue contracts to a limited company as the agency liability would be reduced. It issues invoices to the recruitment agency (or client) and, when payment of the invoice is made, will typically pay the contractor through PAYE with the added benefit of offsetting some of the income through claiming expenses such as Travel, Meals, and Accommodation.

Umbrella companies have become more prevalent since the British government introduced so-called "IR35" legislation that creates tests[1] to determine employment status and ability to make use of small company tax reliefs.

Contents

Managed Service Companies (MSC) and Umbrella

Managed Service Companies (MSCs) are composite company structures. In these structures, individual contractors will be the shareholders of the company but do not participate in the management of the company. Company will be managed by service provider. But the contractors would receive salary and the dividends.

An umbrella company is often confused with a Managed service company (MSC). Umbrella companies will not fall under the definition of MSC. For a company to be a Managed Service Company it must fulfil all four conditions of Section 61B (1), Chapter 9, Part 2 ITEPA. Umbrella companies do not satisfy the third condition.

i.e.,

“The payments received by the worker are greater than they would have received if all of the payments were treated as employment income of the worker relating to an employment with the service company.”[2]

As umbrella companies do not pay dividends and consider whole income as employment income, they are not Managed service companies.

In the view of HM Revenue & Customs (HMRC), MSCs existed due to the lack of application of "IR35" in this sector. Also, it was identified as the cause of lack of compliance. In December 2006, the UK Treasury introduced draft legislation called "Tackling Managed Service Legislation," which seeks to address the use of "composite" structures to avoid income tax and National Insurance on forms of trading that the Treasury deems as being akin to being "employed." After a period of consultation and re-draft, the new legislation became law in April 2007, with additional aspects coming into force in August and fully January 2008. PAYE umbrella companies are effectively exempted from the legislation, which also seeks to pass the possible burden of unpaid debt (should a provider "collapse" a structure) to interested parties, e.g., a recruitment agency that has been deemed to encourage or facilitate the scheme. Since the introduction of the Managed Service Company (MSC) legislation in the 2007 budget, umbrella companies have become prominent in the UK market. Another viable option for contractors is to start their own limited company. Starting a limited company involves paperwork and additional responsibilities.[3]

Taxes

All umbrella companies use the same PAYE calculations to ascertain how much tax should be paid. The only difference between Umbrella Companies will be the fee that they charge and the level of service that they offer to their customers.

Dispensation

One of the most frequently associated concern with umbrella companies is the dispensation scheme.[citation needed] Its often thought that an umbrella company with dispensation is better than others as it has a special agreement with HMRC.

Dispensation is a notice from HM Revenue & Customs (HMRC) that removes the requirement of employer (umbrella company) to report expenses and benefits to HMRC. The umbrella company can also agree to pay the expenses by scale rates. This requires the company to conduct a survey of employee expenses and pay them based on rates derived from the survey. If the umbrella pays by scale rates they need not have to verify the expense bills (receipts) and report it to HMRC. The onus is on the contractor to maintain the receipt and submit it to HMRC.[citation needed]

Dispensation with scale rates in some sense is disadvantageous to contractors.[4] As one of the claims is that dispensation is risky, in the event of investigations from HMRC, umbrella companies without dispensation will need to produce receipts and defend how they verified bills. Hence they come in handy as a first line of defence for contractors. As dispensed umbrella companies are not maintaining the receipts, complete responsibility lies with contractors. Contractors will lose this if they opt to go with a company which has dispensation agreed.[citation needed]

Expenses

Some of the most common "allowable" expenses include: Mileage & general travel expenses, Hotel & accommodation expenses and Professional Subscriptions. Food and subsistence is rarely allowed to be claimed, as it is the HMRC's opinion that you would eat regardless as to whether you are working or not. The exception to this rule is if you were staying away from home as part of your work.[citation needed]

Whilst many of the umbrella companies advertise similar offerings, much of the detail should be checked by the user. Often expenses are used as a selling point with potential abuse of "dispensation" (HMRC issue documentation to employers as a more effective way to record Expenses rather than as a method of generating more income) agreements. It is the independent contractor who will be liable should HMRC decide, for instance, that expenses have been incorrectly claimed.[citation needed]

The 2008 HM Treasury pre-budget report[5] reported on the consultation on the use of travel expenses in conjunction with being employed via Umbrella Companies.[6] The document questioned the validity and fairness of allowing business expenses in this form suggesting that an overarching employment contract was not a form of employment that allowed travel and subsistence expenses. HMT decided that the legislation would remain as is but suggested additional HMRC policing would be carried out to reduce cases of non-compliance. HMT issued the results[7] of the consultation in December 2008.

Charges

Umbrella companies normally charge a small fee for processing contractors' payroll. Most of the umbrella companies advertise two types of charges.[citation needed]

Gross charge: fee that is deducted before tax. This is the actual charge that umbrellas deduct.

Net charge: for marketing reasons many umbrella companies list their net charges i.e. equivalent charges of Gross charge ‘after tax’. This is to make charge appear small.

Calculations of net charge are simple. For example, if an umbrella charges gross 26.5 per week before tax. The net equivalent of this amount is, If contractor is a basic rate tax payer (i.e 20% tax) : 26.5-0.2x26.5= 21.2 pounds. If contractor is a higher rate tax payer (i.e 40% tax) : 26.5-0.4x26.5= 15.9 pounds. There is small faction of umbrella companies that charge a percentage of contractor’s earnings e.g 15% of contractor earnings.

Notes

References

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