Umbrella Company Definition / Meaning / Explanation. What Are They?

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Umbrella Company Definition
Umbrella Company Definition

Umbrella Company Definition

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We look here at the umbrella company definition or meaning with an explanation of what they are.

Umbrella Companies sprung up after the implementation of IR35 in 1999.

Prior to that most contractors used Limited Companies.

They were able to get the many tax advantages of using them, including claiming for expenses, equipment etc. as well as travel to work.

This had been the case for many, many years – decades, in fact.

Disguised Employees

This all changed when The Times printed a story in 1999 about companies who made their staff redundant on the Friday and started them again as freelancers on the Monday.

They did the same job at the same company even using the same desk and PC.

It is advantageous for the company as they had a more flexible workforce and save on certain things like Employers National Insurance.

It is good for the new contractors as they are able to use Limited Companies to offset expenses against tax that they were could not do before as permanent employees.

HMRC Lost Out on Tax

So, everyone was happy – except HMRC and the Treasury – who both lost out in tax receipts.

It was a great story for The Times but it had profound long term effects on the contracting or freelance profession.

When there are stories in the Press like this Governments of all hues like to be seen to be doing something.

The New Labour Government of the time, under Tony Blair, called these new contractors ‘disguised employees’ – and they were right.

Not Genuine Contractors

These were not genuine contractors.

They didn’t incur any more expenses than they did before in doing their jobs.

Everything was just the same except that they paid less tax for doing the same job.

So, the Government decided to legislate to get the press off their backs.

Brought in IR35 Tax

They brought in the IR35 laws to stop companies pulling this stunt.

However, like most laws that are rushed in, it caught other contractors in the IR35 net who had been operating as proper contractors for years and years.

It looked like many contractors would now have to pay the IR35 tax. They would now no longer be able to operate through Limited Companies.

This would have a huge effect on their income.

Birth of Umbrella Companies

Umbrella Companies arrived as a solution to this.

Before IR35 in 1999, Umbrella Companies were almost non-existent.

After IR35 came in they proliferated and there are now hundreds of them.

How they operate is that they make contractors into employees of the umbrella company. That’s the umbrella company definition.

Disguised Contractors

Just as those original contractors who caused IR35 were considered to be ‘disguised employees’ those operating through the new umbrella companies were effectively disguised contractors.

They are disguised as employees.

This meant that they were now able to claim some expenses that permanent employees couldn’t claim.

Chancellor Osborne

Chancellor Osborne cut back on some of these when he ruled in his budget that umbrella company contractors, who are inside IR35, could no longer claim travel and subsistence expenses.

However, it is still marginally better, financially, for contractors to use umbrella companies rather than pay the IR35 tax.

The Umbrella Company does virtually all the admin for the contractors.

All they need from the contractor is a Timesheet plus any expense receipts.

They will do the rest.

The umbrella company definition is that they do everything for the contractor.

They extract the tax, after expenses are deducted, pay the contractor and send off the tax and national insurance receipts to HMRC.

Umbrella Company Definition – Costs of Using an Umbrella Company

As he, or she, is an employee of the umbrella company, they do not have to charge, or pay, VAT.

For this they charge the umbrella company contractor a monthly fee.

However, the contractor saves on fees that he, or she, might previously pay to an Accountant.

So, there’s not that much difference in outgoings whether you use an umbrella company or accountancy firm.

Why Contractors Use Umbrella Companies

So, what type of contractor uses an umbrella company rather than a limited company?

Those who are inside IR35 would normally use an umbrella company.

Those who are worried that they might be inside IR35 use them too.

They would rather sleep well in their beds at night without worrying that they might be the victim of an IR35 investigation.

That could take years and could cost them tens of thousands of pounds in back tax, interest and penalties.

Also, those contractors who don’t like admin and who just want to concentrate on their contracting careers, use them too.

Government Likes Umbrellas

The Government likes the umbrellas for very good reasons.

Firstly, it is much easier to legislate for a few hundred umbrella companies rather than hundreds of thosuands of contractors.

Secondly, their admin is much smaller as the umbrella companies do all the work in extracting tax from contractors.

Thirdly, HMRC gets huge checks from the Umbrella Companies on a regular basis.

So, it looks like contractor umbrella companies are here to stay.

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