How umbrella companies work

If you’re a freelancer or contractor working on temporary assignments, an umbrella company can offer a simple way to get paid—without setting up your own limited company. But before you join one, it’s important to understand how the model works, and whether it suits your circumstances.

What Is an Umbrella Company?

A compliant umbrella company acts as an intermediary between a worker and an employment business, such as a recruitment agency or the end client. The umbrella company employs the worker, processes their wages through PAYE, and ensures that all the necessary deductions—such as income tax, national insurance contributions, and pension contributions—are made correctly.

This business model has become a key part of the umbrella company market, especially following the rollout of off-payroll working rules (IR35) in the private sector. For many temporary workers, it provides a more straightforward alternative to managing their own personal service companies.

How the Process Works

1. The umbrella company signs a contract with the recruitment agency or client.
2. The umbrella company employs the contractor and provides them with an employment contract.
3. The worker submits timesheets for the hours worked.
4. The recruitment agency pays the umbrella rate, which includes the worker’s pay plus any associated employment costs (such as employer NICs, holiday pay, and the apprenticeship levy).
5. The umbrella company deducts all necessary amounts (income tax, national insurance, pension, etc.) and pays the worker their take-home pay (also known as home pay).

The final amount you receive will be based on your gross pay minus all statutory deductions, as set out in your key information document.

Employment Rights and Benefits

When an umbrella company employs you, you become an employee—not self-employed. This means you’re entitled to statutory employment rights, including:

• A written employment contract
• Paid holidays
• Access to a pension scheme
• Protection under relevant employment law

Being employed in this way can offer more security than working as a self-employed contractor.

Pros and Cons of Using an Umbrella Company

Advantages:

• You don’t need to manage your own limited company or worry about company admin.
• All taxes and national insurance are handled for you.
• You’re protected by employment rights, including sick pay and holiday entitlement.
• It can help ensure IR35 compliance for roles affected by off-payroll rules.

Disadvantages:

• You’ll pay a margin fee for the umbrella’s payroll services.
• Your home pay may be lower than if you worked through a limited company.
• You have less control over how your income is managed.
• Some umbrella companies operate non-compliant schemes that pose a tax avoidance risk.

What to Watch Out For: Compliant vs Non-Compliant Umbrella Companies

The umbrella market has grown rapidly in recent years, but not all providers follow the rules. Non-compliant umbrella companies may promote tax avoidance schemes, misrepresent gross pay, or fail to pay the correct amount of holiday pay or employer NICs. Some even disguise wages as loans or other payments to reduce PAYE tax liability—putting workers at risk of HMRC enforcement.

To stay safe, look for compliant umbrella companies that are transparent about:

• The full breakdown of the assignment rate
• All employment costs and deductions
• Your tax code
• Your rights as an employee

You can also check if the provider is a member of the Contractor Services Association (CSA) or under the watch of the Employment Agency Standards Inspectorate (EAS).

Is an Umbrella Company Right for You?

Many contractors have used umbrella companies for over two decades, especially those in temporary work or shorter assignments. They work well if:

• You want a quick setup without the responsibility of running a limited company
• Your role falls inside IR35
• You value the security of employment rights

However, if you work on long-term projects, have multiple clients, or want more control over your finances, a limited company might offer better home pay and tax efficiency.

Final Thoughts

Choosing the right way to get paid is a big decision. If you’re unsure whether to use a compliant umbrella company, set up a limited company, or operate as self-employed, speak to a specialist who understands the tax law and supply chain risks. With the right advice, you can avoid non-compliance, protect your employment rights, and find a structure that suits your goals.

Source: HM Revenue & Customs | 03-02-2025