Umbrella Company Explained – Why Use an Umbrella Company

umbrella company explained
Umbrella Companies and how they work

Umbrella Company Explained

An explanation of what an Umbrella Company is for New Contractors and a history of the Umbrella Company for all Contractors

Umbrella Company

The Contractor Umbrella Company came about as a result of the IR35 legislation that the Government introduced in 1999.

Many companies were making permanent staff redundant on the Friday and re-employing them as contractors on the Monday.

The company saved money and made themselves more flexible. That’s becasue these were staff that they could more easily fire in a downturn.

The new ‘disguised employees‘ could then claim all sorts of expenses and so were better off.


Who lost out?

The Government did in terms of tax intake.

The Government decided to legislate against these ‘disguised employees‘.

However, a lot more than these contractors are inside IR35 now.

Many contractors who had been operating in limited companies are now inside IR35 too.

Changed Minds

At first the Government admitted that there were contractors caught in the IR35 net that they hadn‘t intended to be caught.

However, the Government saw how much extra tax they were getting. So it became more difficult to persuade them to drop it.

There was a new phenomenon and that was the set up of the Contractor Umbrella Company.

Contractor Umbrella Company

Instead of contractors being paid by directly by their agencies through their limited companies and offsetting expenses against tax, many of those who considered themselves caught by IR35 (or who didn‘t fancy the hassle of a potential investigation), went into an Umbrella Company.

These Umbrella Companies allow a certain level of expenses for contractors, as long as there are receipts.

The Chancellor recently cut this when he stopped contractors who are inside IR35 claiming travel and subsistence expenses.

The agency then pasy the money to the Umbrella Company and the Umbrella Company pays the contractor.

Umbrella Company Payroll

The Umbrella Company handled the payroll. It handled the expenses and it handled the annual tax bill. So they were a boon for contractors who just wanted to concentrate on the job in hand and leave the administration to the Umbrella Company.

They would also be able to claim a small level of expenses against tax. They couldn‘t do this if they were cinside IR35.

Professional Contractors Group

In 1999 the Professional Contractors Group (now IPSE) started up to fight the new IR35 tax and to campaign to scrap it.

Although they lost the majority of the set piece High Court battles over this, funded by IT Contractors, they won a mountain of small battles generally at the Special Commissioner and General Commissioner level.

They claim that IR35 is a failure when they managed to get information after a Parliamentary Question that the Government garnered only £12.5m through the IR35 tax.

Umbrella Company Bonus

However, the big bonus for the Government was not the amount they garnered in the IR35 but in the hundreds of thousands of contractors who asre now using the new Umbrella Companies.

There are now hundreds of Umbrella Companies processing contractors‘ income each week.

Many people thought that the Umbrella Company was a temporary phenomenon.

The Professional Contractors Group certainly thought it would be.

Their vision would be to have IR35 scrapped and contractors to work and claim expenses through limited companies again as before.

Looking At IR35

Indeed they secured a promise from the Conservative Party just before the last election that they would ‘look at‘ IR35 again when they came to power.

The PCG (now IPSE) rushed out a Press Release telling contractors this just before the 2010 election.

After the election, the Conservatives did look at it and decided that it was fine as it was.

Indeed they were worried that any scrapping of IR35 or major change to it would see contractors setting up Limited Companies in greater numbers and the Umbrella Company concept would be damaged as a consequence. That’s because many contractors would leave their Umbrella Companies to set up Limited Companies.

Liking Umbrella Companies

The working party looking at this saw this as a bad thing.

The Government liked the Umbrella Company concept.

If IR35 was abolished then contractors would dump their Umbrella Company, set up limited companies, claim more expenses and pay less tax.

Less Tax

If the Conservative Government were to give IPSE and contractors what they wanted they would receive less tax at a time when they are making massive cuts to services.

It was never likely that they would abolish IR35.

It would be like turkeys voting for Christmas.

The Government would far more like to deal with, and legislate for, several hundred Umbrella Companies than hundreds of thousands of contractors in Limited Companies.

So, it looks as if Umbrella Companies are here to stay.

The Government likes them and the Government wants them. They get more tax from contractors inside an Umbrella Company than they would if those contractors are in a Limited Company.

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Have a look at our Contractor Job Search section.