Who Needs A Contractor Umbrella Company?

If you are in need of contractor umbrella company, then you must be self-employed and working as a contractor in the UK.

But if you are involved in freelance work like a freelancer, you may be self-employed but not a contractor who is working contract jobs.

Confusing?

It must be because both of these terms are used quite interchangeably when describing self-employed individuals. As you may be wondering, these two types of self-employed individuals – “contractors” and “freelancers” – are not one and the same.

They are both correct in referring to non-traditional working styles but the differences become important in terms of taxation, business structure and government regulations – and of course when needing a contractor umbrella company.

Before getting into the understanding of the differences between UK contractors and UK freelancers, let’s first breakdown what it means to be a self-employed individual in the United Kingdom. Simply put, it means any individual who doesn’t work the traditional 9 am to 5 pm job under the traditional employer and instead works on his own.

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Contractors Vs Freelancers: Key Characteristics Of These 2 Types Of Self Employed Individuals

Self employed - income

Contractors

Contract workers are professional contractor that work on a fixed length contract to complete a job for the client. Working under the terms of this contract makes them a contractor. They are usually skilled workers who provide specific services ranging from paving, building, plumbing to IT and marketing services.

Normally, UK contract work is physical labour rather than an intangible service. It takes place in the client’s location during normal working hours or as agreed upon by the two parties. Contractors are hired to complete a job whether it is a physical labour job or an intangible service within a certain specific time period.

More than 50% or the majority of contractors use recruitment agencies to find clients. While there is the minority that directly find and work for clients, it is not too common as it is very competitive.

In terms of government regulations, taxation, etc. contract workers are treated as individual companies, or more commonly known as limited companies. Thus, they require the services of specialised companies such as a contractor umbrella company.

There is a lot of government regulations and taxation clauses that contractors need to abide by. To avoid being on the faulty side of HMRC regulations, the use of a contractor umbrella company is of the highest demand.

The following are some of the legal requirements for a contractor umbrella company to ensure that both contractors, their clients and the taxman are all holding onto their grounds properly:

  • UK contractors don’t necessarily bid for contracting jobs; however, they still are competing for roles with other interested contractors
  • Contractors do not have contractor umbrella company job perks or employee rights as normal employers would need to provide to normal employees
  • UK contractors raise invoices and send them to the recruitment agency they used to find a client or directly to the client for payment, or to the PAYE contractor umbrella company
  • UK limited company contractors must be paying Class 1 National Insurance and PAYE tax and any other additional tax under the HMRC’s annual self-assessment process
  • A contractor umbrella company is treated as the traditional form of employment

 

It is a notable fact that, most agencies or clients will not work with contractors who operate as a “sole trader” instead of a limited company contractor. This is because of the clauses in the Income Tax (Earnings and Pensions) Act 2003. It states that personal tax liabilities of sole traders are the responsibility of the hiring agency or client.

Freelancers

Freelancers professionals who are self-employed and provide their service for multiple clients which may or may not be in parallel. Typically, freelancers are paid as per hours or days worked.

While it is a form of contracting work, freelancing is more exclusively associated with intangible work in the creative or marketing industry. These contracting jobs include but are not limited to writers, journalists, designers, editors, and mostly many other types of web-based roles.

It is common that freelance jobs unlike contractor jobs are completed on the freelance workers’ location whether it is in an office or from their homes. It is not common for freelance workers to work full time, rather they may work part time on the clients’ locations but a major chunk of the work is completed on their own premises.

Most freelance work is won through bidding as many freelancers offer the lowest quote to get a certain job done and the client chooses one which is the most economic option, or most appropriate for them as per their requirements.

Freelancers mostly find work through existing clients, online job portals, recommendations, etc. but rarely do they use recruitment agencies like contractors do.

As a result, they rarely or never use a contractor umbrella company or any type of umbrella companies.

Freelancers work as both “sole traders” and also as “limited companies”, although the former is more common. There are no obligations in place for hirers or clients as is the case with contractors.

However, just like contractors, freelancers also do not have any types of employment perks from clients or anyone they work for. They almost always get direct payments from their clients.

Freelancers who are classed as sole traders have the following taxing guideline:

Those freelancers who work as a limited company, they are similar to contractors and have similar tax guidelines such as the following:

  • pay Class 1 National Insurance
  • PAYE tax on income
  • use the annual self-assessment process for any further salaried income taxes

Given what we have discussed about the differences between contractors and freelancers, one thing that will have caught your attention is the differentiation in being a sole trader.

Let’s learn a little bit more about this now.

What is a Sole Trader?

We slightly mentioned what a sole trader was when comparing it to a limited company above.

In the United Kingdom, becoming a sole trader is the easiest way of setting up a business. After you inform the taxman or HMRC that you are operating as a self-employed individual in the sole trader model, you are ready to go unlike a limited company which has many prerequisites.

But the biggest area of concern is that, as a sole trader, the liabilities involved are unlimited in the scope of things. So, when you are in trouble your personal and business finances will all be treated as the same to settle disputes, etc.

But in terms of a limited company, you actually have the safety of your personal finances separate from you as a limited company entity.

It is so popular that there almost twice as many sole traderships formed each year compared to limited companies. However, the risk is big!

Why Recruitment Agencies & Clients Are Not Eager To Work With Sole Traders?

As a sole trader, it is extremely difficult to find recruitment agencies who are willing to work with you to find a client or do any sort of business with you. this is because there are significant risks involved.

The best option for you as a sole trader, is to become a PAYE employee of the agency. Also, you can choose to do it by setting up your own limited company, or under a contractor umbrella company.

As a result, while you may be legally allowed to work as a sole trader, most find themselves working directly with clients and rely on their satisfaction and recommendation for income.

These Are The Key Reasons Why Sole Traders Are Risky:

  1. According to the Income Tax (Earnings and Pensions) Act 2003and other associated legislative documents, they don’t entirely fall under the category of “self employment”. The recruitment agency, or the client would have to treat the sole trader as an employee in terms of taxation.


Chapter 7, Section 44 of the Act:

“all remuneration receivable under or in consequence of the agency contract (including remuneration which the client pays or provides in relation to the services) is to be treated for income tax purposes as earnings from that employment.”

Taxes On Calculator Showing HMRC Return Due
  1. This of course means that if a sole trader were to make errors or make mistakes on their tax obligations to HMRC, the hiring party can and will be held legally liable.

 

  1. The third point is something that could really hamper the sole trader’s personal life. If the finances do not add up, or if defaults occur, then there is financial protection for his or her personal finance or properties as they are all treated the same as the business. Which of course is not the case for limited company contractors who have separate personal and business finances.

Final Thoughts

This brings an end to this blog about the differences between contractors and freelancers. Not just this, the main objective being whether or not you should be using a contractor umbrella company for your contracting work in the UK.

As a bonus, we covered how sole traderships are the easiest way to setup a business in the UK. But we also advised on why it may not be the best route to take for everyone, considering the risks involved.

Working as a contractor in the United Kingdom as an employee of a PAYE contractor umbrella company is a great option, but you must be fully aware of all things associated with contractor umbrella companies.

Let us know if you need to learn more about the what a contractor umbrella company is, how it works or whatever you want to learn more about. We will make sure to cover it in a blog in the future.

Keep your eyes wide open for the follow up blogs of this series where we cover all about contractor umbrella companies in the United Kingdom.

See you in the next one!

Update:

In this first blog of the contractor umbrella companies series, we explained the differences between freelancers, contractors and even sole traders in the UK. All in an effort to make it clear for you whether or not you should be using Contractor Umbrella companies.

In the second blog, we covered the legal aspects of things. These are essential steps that you must take to fulfil all the UK legal requirements as a self-employed individual. Things like setting yourself up as a limited company and how to do it done.

Read it now as a follow up to this blog so that you too can set yourself up as a limited company and start working with contractor umbrella companies.

In the third blog of all about contractor umbrella companies series, we covered how a PAYE umbrella company works. So, we covered the contractor umbrella company fee structure, how to invoice contractor umbrella companies, and the importance of choosing the most suitable, reputed and trustworthy Contractor Umbrella companies.

In the final blog of the series, we covered all the essential tips when choosing contractor umbrella companies such as how to get online reviews for contractor umbrella companies. How to determine whether or not the online reviews are trustworthy.

We also inform you all about the most important questions you should be asking contractor umbrella companies before signing an agreement with them. As a bonus, we covered the details of maternity rights as a contractor umbrella company employee. Read all about it here.