Umbrella company disadvantages
There are plenty of advantages and disadvantages using an umbrella company for your payroll. Below we have listed the most common disadvantages – in the eyes of some UK Contractors.
Lower take home pay compared to contracting through a limited company (outside IR35)
This disadvantage is pretty important. It’s no secret that contracting through a limited company (outside IR35) is the most tax-efficient way to operate as a contractor, and the best way to legally maximise pay retention.
Unfortunately, umbrella companies operate PAYE payroll – and contractors using an umbrella company are paid in a very similar way to permanent employees. This means that contractors who use an umbrella for the first time could see a significant reduction in their pay retention – if they used to contract through a personal service company (PSC). Contractors using an umbrella should expect to retain roughly 55 – 70 percent of their pay.
Employment costs (Employer’s National Insurance Contributions and the Apprenticeship Levy) come out of the assignment rate, and this can sometimes cause some confusion – and we’re not surprised. You must consider the employment costs and ensure they’re taken into account when negotiating with a recruitment agency or direct with an end-client – if you explore the possibility of using an umbrella company.
Lack of control over finances
Umbrella companies process payroll (PAYE). Therefore, contractors are paid like permanent employees, their salary is sent to their bank account, and they receive a payslip. While some may see this as efficient and welcome it – others will dislike the lack of financial control.
It’s unlikely you can claim expenses
Since the government introduced supervision, direction and control (2016), a huge majority of umbrella company employees were not eligible to claim expenses.
Nowadays, most umbrella companies will not even have any expenses procedures in place. This is because almost every contractor is in some way subjected to supervision, direction or control when undertaking their assignment – thus making them unable to claim expenses.
Reimbursed expenses are different – and these pay be repaid if agreed with the umbrella, recruitment agency and end-hirer.
There are non-compliant umbrellas out there trying to target honest, vulnerable contractors
While a majority of umbrella companies are compliant and offer legitimate payroll services for UK contractors, some are operating tax avoidance schemes that could land contractors in serious trouble with HMRC. Never be tempted to use a tax avoidance scheme that offers unrealistically high take home pay (sometimes upwards of 90 percent). And, make sure the umbrella company you choose is compliant.
Tax avoidance schemes take advantage of loopholes in UK tax law and pay contractors more of their salary – without the correct tax and National Insurance deductions. As soon as the government is made aware of these types of scheme, the Directors will shut the company and do a runner. They’re almost impossible to catch – so guess who HMRC will come after to pick up the bill of unpaid taxes? That’s right – the contractor.
Also, legislation called the Loan Charge states that HMRC can retrospectively claim unpaid tax from contractors and freelancers who have engaged with tax avoidance schemes – even by mistake.
We appreciate that using an umbrella company may be disappointing for contractors used to operating outside IR35. However, if you’re inside IR35, you’re legally required to pay your fair share of tax and National Insurance Contributions.