Umbrella Companies – How the Supply Chain Really Works

If you’re new to contracting you may have been offered a choice between umbrella employment, and being paid directly by your agency. It should be a straightforward choice but there are some details that are often misunderstood. In this guide we’ll lay out how the supply chain works, so you’ll better understand what you’re choosing between.

What is Agency PAYE?

This is where your agency pays you directly, through their own payroll. The “PAYE” rate starts at your gross pay and does not include any of the costs the agency has to pay. For example, the agency pays Employers NI and Apprenticeship Levy on top of what they pay you in addition to providing business insurance cover.

Each contract you work on for the agency counts as a separate engagement, so you potentially have a series of short engagements even if you only worked for a single agency. You’ll have access to limited employment rights; for example, you’ll probably be entitled to holiday pay, but you’re unlikely to have access to statutory sick pay or maternity/paternity pay due to the short, temporary nature of the engagements. Agency PAYE is generally used by contractors who don’t expect to be contracting in the long term, as they are less concerned about employment rights and continuous employment.

With agency PAYE the supply chain is very simple.

  • The agency supplies you to their client, who pay them a fee for the work you complete.
  • From this fee the agency pays you and covers any associated costs, like Employers NI and Apprenticeship Levy.
  • The balance is the agency’s profit margin.

 What is Umbrella Employment?

Umbrella companies provide employment to contractors, so you’ll have one single period of employment even if you work on many different contracts for many different agencies.

This continuous employment means you have additional rights and benefits over Agency PAYE. These include statutory payments like sick pay and maternity/paternity pay, access to a workplace pension and paid holiday. A single period of employment also makes it easier to obtain references and access credit and mortgages. You may also be able to claim for certain business expenses.

Umbrella employment is more often chosen by those who intend to work as contractors in the longer term, as it allows them the flexibility and freedom of contracting with the benefits and security of employment.

In this case the supply chain is a little more complex.

  • The umbrella company employs you and charges the agency for your services, who in turn charge their client.
  • The client pays the same fee to the agency for the work you complete.
  • The agency takes their profit margin and pays a “contract rate” to the umbrella, which should include your pay plus an uplift for the associated costs that the umbrella company has to pay as your employer. These include Employers NI and Apprenticeship Levy. The “contract rate” should be higher than the “PAYE rate” mentioned above, because it includes these extra costs, which are now paid by the umbrella company rather than the agency.
  • The umbrella pays you through their payroll, having covered their costs in the same way the agency does with agency PAYE. In both cases, the amount you are paid should be roughly the same.

Where the confusion arises

The most common confusion about umbrella pay arises when the contract rate paid by the agency to the umbrella company is confused with the contractor’s pay. If you’re conducting research online you may come across examples of contractors (and even some trade unions) who believe that umbrella companies deduct employer’s national insurance from contractors’ pay.

If contractors are led to believe that the contract rate is their pay rate, they may choose umbrella employment in the expectation of higher pay. When they discover that this is not the case they will be understandably upset. This is why it’s important to understand what’s happening right from the start.

When everything works as it should, agency PAYE and umbrella employment pay roughly the same, but contractors can get additional rights, protections and benefits as employees of umbrella companies.

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