An umbrella company is a specific type of payroll processing business in the UK. It acts as a proxy for an employment agency so independent contractors can enjoy the benefits reserved for employees under the law. The term “umbrella” denotes that the company provides a specific administrative function that benefits a number of related parties, shielding them from certain liabilities and expenses.
Ordinarily, an employment agency is hired by a client to staff a project. The agency goes out and recruits independent contractors to work for the client. Under the typical arrangement, the independent contractor signs a contract with the agency or client that requires him to work on a temporary basis and pay all of his own employment taxes without the benefits a full-time, permanent employee would receive. To set up insurance, deduct business expenses, and receive certain tax benefits, the independent contractor has to set-up his own company and pay himself as an employee rather than execute the contract in his individual capacity.
If the employment agency staffs a client project with 50 independent contractors, that is potentially 50 separate companies the contractors might set-up to process their payments. This is cumbersome for both the agency and the contractors. An umbrella company is designed to relieve this burden for both parties. It provides payroll services for the employment agency, but more importantly it serves as a substitute for all of those individual companies that the contractors would ordinarily organize.
The employment agency assigns the independent contractor contracts to the umbrella company. Umbrellas treat contractors as employees. They deduct employment taxes, provide benefits and insurance, and basically function as the employer that details the employees' services out to the agency that, in turn, details them out to the client. Functionally, the contractors submit their time sheets to the umbrella company, the company bills the agency, and the agency bills the client.
Using an umbrella company provides significant benefits to the independent contractor and the agency. The contractor no longer has to worry about setting up and managing a company. He gets all of the same benefits as a regular employee while maintaining his flexibility as a contract worker. Further, he is allotted benefits priced to the entire umbrella workforce, rather than to a one-person company. This ultimately provides the contractor with access to benefits he might not otherwise be able to afford.
The agency can focus on recruitment without worrying about payroll processing for hundreds of separate entities. Most importantly, as employees of the umbrella, employment taxes are taken out of contractor income upfront. This removes the liability the agency can experience by paying workers as independents, since contractors are responsible for paying their own employment taxes. Contractors often neglect to make proper tax payments, subjecting the entire employment chain to government scrutiny.