Umbrella Company Tax And Pay
Navigating the intricate landscape of UK tax legislation is no easy feat, especially for contractors. Amidst the myriad of regulations, one term stands out prominently: Umbrella Companies. But how does umbrella company tax and pay work?
In this comprehensive guide, we delve deep into the heart of umbrella companies. Whether you’re an aspiring contractor or a seasoned veteran seeking clarity, this guide aims to empower you with the knowledge to make informed decisions and remain compliant.
Umbrella Company Payslips
Contractors are employees of their umbrella company and, as employees, should receive a payslip for every contractually agreed payment cycle. For both new and experienced contractors, understanding an umbrella company payslip may be challenging; it’s not easy to follow how pay has been calculated or what deductions have been made.
Your umbrella company payslip should include your personal details, including your name, employee number, National Insurance number and tax code. It will also list any deductions from your gross income, taxes (Income tax and national insurance contributions), student loan payments, and pension contributions. Once these deductions have been calculated, you’ll be left with your net income, otherwise known as your “take-home pay”.
A contractor working through an umbrella company will also receive an invoice reconciliation alongside their payslip. The reconciliation breaks down the deductions from assignment income to determine the contractor’s gross pay. It is intended to ensure contractors have visibility of the invoices raised to the fee payer and the statutory and non-statutory deductions umbrella companies make.
To calculate an employee’s gross pay, umbrella companies deduct statutory employment costs and their margin from the assignment income (the amount the fee payer is invoiced). The employment costs include Employers’ National Insurance contributions (NICs) and the Apprenticeship Levy. Employer’s pension contributions are also deducted if applicable. Once these costs have been subtracted, you’re left with your gross pay.
The margin is the only deduction retained by the umbrella company; all other deductions are made on behalf of either HMRC or a pension provider.
i) Assignment Income
The assignment rate is the amount the umbrella company invoices the end client. It consists of employment costs, the umbrella company’s margin, and the actual wages payable to you (your gross pay).
ii) Umbrella Margin (Fees)
Margin is the technical term for the fee that umbrella companies charge contractors. It’s an administration fee (usually around £25 per week), covering the costs of running the payroll, insurance for the contractor, and other operational expenses involved in running a business.
The margin is commonly charged to you as a fixed weekly amount, or in some cases, it is a percentage deduction with a maximum cap based on your weekly gross agency rate (although percentage margins are rare nowadays). For example, if you become an employee of an umbrella company with a £22 per week margin, you will see a £22 deduction on your weekly payslip.
Umbrella company margins only apply when you’re paid; if you are between contracts but remain on an umbrella company’s books, the company will not subject you to any costs.
iii) Employer's NICs
All UK employers, including umbrella companies, are required to make Employer’s National Insurance Contributions to HMRC. As the umbrella company employs contractors but receives no benefit from the work performed, the contributions are passed to the contractor. They are calculated as 13.8% of your earnings above the Lower Earnings Limit.
iv) Apprenticeship Levy
The Apprenticeship Levy is a small tax levied on UK employers to fund new apprenticeships. All employers with annual pay bills of £3m or more must pay the Levy at 0.5% of the company’s total wage bill, minus a fixed £15,000 yearly allowance.
For contractors, your umbrella company is your employer, and it must, by law, pay all employment taxes based on income generated by its employees. Umbrella companies pay these statutory employment costs from the funds received from your agency or end client. As the apprenticeship levy is one of these statutory costs, it will appear on your payslip alongside other statutory costs, such as the Employer’s National Insurance.
v) Workplace Pension Contributions
As an employee of an umbrella company, you are eligible for a workplace pension. The minimum amount payable is 8% of your gross pay: 3% employer and 5% employee contributions. As employer contributions are deducted from the assignment rate, most contractors opt out of workplace pensions in favour of their salary sacrifice schemes.
vi) Salary Sacrifice Pension Contributions
A salary sacrifice pension contribution is where an umbrella worker exchanges part of their gross income to receive contributions directly into their self-invested personal pension (SIPP). This deduction is made before PAYE and NICs, making it a hugely attractive option for contractors.
vii) Basic (Statutory) Pay
As your employer, Umbrella companies must pay you a minimum wage. This ‘basic pay’ is calculated as the hours you have worked in each billing cycle multiplied by the National Minimum Wage.
viii) Holiday Pay
Umbrella company employees are entitled to holiday pay, calculated as 12.07% of your gross income. It’s important to note that this is not an additional payment; the figure is incorporated into the assignment rate.
ix) Commission
The final element in an umbrella company calculation is commission (or bonus). It is calculated as anything owed to the contractor above the basic pay and holiday pay, and acts as a balancing figure between these two pay elements and total taxable income.
x) Income Tax
Like permanent employees, umbrella companies pay the contractor’s wages via PAYE. The required tax and NICs are made at source and paid directly to HMRC.
xi) Employee's NICs
H3 Text Template
xii) Student Loan Repayments
If applicable, contractors employed by an umbrella company will make student loan repayments via PAYE, just like traditional employees.
Umbrella Company Tax
Umbrella companies process two types of taxes: those for an employer and those for an individual. Employer’s taxes are covered in detail in our Umbrella Companies and National Insurance guide.
Contractors working through an umbrella company will have their individual earnings processed through PAYE. HMRC determines PAYE calculations; umbrella companies have no say in the methodology and formulae used.
HMRC has four tax brackets based on total taxable income:
- Those with a taxable income below £12,570 benefit from a tax exemption, otherwise known as the Personal Allowance.
- If your taxable income is between £12,751 and £50,270, you’re subject to the basic rate of 20%.
- If your taxable income is between £50,271 to £150,000, you’re in the higher-rate band, taxed at 40%.
- Finally, the Additional rate levies a tax rate of 45% for incomes above £125,140
For many contractors, the ‘£100k abatement’ must be considered. For earnings over £100k per annum, the tax-free personal allowance is reduced by £1 for every £2 over £100k that is earned. This adjustment is made through the contractor’s tax code.
The tax code used to calculate your net pay will be the one supplied to the umbrella company on your P45, provided directly by HMRC via a P6 coding notice, or arrived at as the result of you completing a new starter checklist. If you believe your tax code is incorrect, you must contact HMRC to ask them to send an updated tax code to your umbrella company
Umbrella Company Pay
The difference between an assignment rate, gross pay and taxable income is a common cause of confusion amongst workers new to umbrella employment. Contractors working Inside IR35 via an umbrella company are advised to understand the different types of pay quoted during negotiations, as the actual rate they receive could be less than expected.
i) Assignment Rate
The assignment rate, sometimes called ‘umbrella income’ or ‘contract rate’, is the amount the umbrella company invoices the end client. It is calculated based on the number of hours worked by the contractor multiplied by the hourly rate agreed during contract negotiations.
The assignment rate is not the same as a PAYE salary-based rate and is not the amount the contractor receives. It includes employment costs, such as the Employer’s National Insurance, holiday pay, apprenticeship levy, employer’s pension contributions and the umbrella company’s margin.
ii) Gross Pay
Gross pay, or gross income, refers to the total amount a contractor is owed before tax and any allowable deductions are removed. To calculate gross pay, umbrella companies deduct statutory and non-statutory employment costs from the assignment income (the amount the fee payer is invoiced).
These employment costs include:
- Employers’ National Insurance contributions;
- The apprenticeship levy;
- Employer’s workplace pension contributions (if applicable); and
- The umbrella company’s margin.
Once these costs have been deducted, you’re left with your gross pay.
These employment costs are why rates for Inside IR35 roles are usually quoted higher than rates for Outside IR35 roles; they need to consider these deductions.
iii) Taxable Income
To calculate taxable income, you start with gross pay and then subtract certain allowable deductions. These deductions are usually limited to pension contributions for contractors working via an umbrella company.
Once these allowances have been deducted, you’re left with the money you pay tax on.
iv) Net Income
Net pay, or ‘take-home-pay’, is the amount received after deducting all taxes from your taxable income. It is the amount paid to the contractor’s bank by the umbrella company.