Counting the true cost of a contractor umbrella company – contractor checklist

It can be tough for contractors to know exactly what they’re buying when they compare the advertised prices of contractor umbrella companies. But Contractor Calculator’s exclusive umbrella checklist now brings clarity to this complex sector.

Contractors seeking an umbrella company solution have well over 100 suppliers with a UK presence to choose from, and that number is growing. However, many contractors find the advertised fees do not necessarily include everything they thought they were buying. Unexpected costs are a typical contractor complaint.

And, according to Rob Crossland – who himself runs a contractor umbrella company, Parasol – there are companies purportedly selling umbrella solutions that may not be umbrellas at all. “Some are in fact masking any number of different structures and tax solutions that may fall well short of fulfilling the contractor’s actual requirements,” he warns.

Make sure you’re the umbrella’s employee

“Contractors joining a ‘real’ umbrella company become legitimate permanent employees of that business,” says Crossland. “So before joining any company claiming to be an umbrella, check the small print to see that they are offering employment contracts.”

That is one of many checks contractors should make, and Crossland advises contractors to use Contractor Calculator’s umbrella checklist to make sure they have all the facts before joining an umbrella company. The checklist is available to download here.

The first umbrella companies were launched in the 1990s, but the major stages of growth in the sector have been post-2000. That was when the implications of IR35 began to sink in, leading to a mushrooming of ‘new’ firms in 2007, particularly after the introduction of the Managed Services Companies (MSC) legislation.

Dig deep into an umbrella company’s background

Whilst most umbrella companies are UK based and have good trading histories, Crossland urges contractors not to take this for granted. He advises: “Find out things like how long the firm has been trading, what other services it offers, if it moves money offshore, and is it a tax solution, rather than an employer.”

Some contractors’ attitude to risk suits a solution provider that operates a tax mitigation service based on some form of trust or offshore tax treaty, but such firms are not umbrella companies and won’t suit many contractors. Contractors who choose this route should ensure they are fully aware of the risks of such schemes, as well as the potential rewards, advises Crossland.

Fees – how much and for what?

Find out things like how long the firm has been trading, what other services it offers, if it moves money offshore, and is it a tax solution, rather than an employer

Rob Crossland, Parasol

“Umbrella companies generally charge on a weekly or monthly basis,” he says. “It is important to check that the fees quoted are gross and exactly what they do and don’t cover. For example, some umbrella companies charge extra for things like expenses processing, P11Ds and other tax forms, and insurance.” Crossland also warns that some calculations of net pay used in umbrella marketing assume high expenses levels, so contractors should check the sums actually apply to their personal situation and contract.

If the umbrella is advertising its services as free, then contractors should ask how the umbrella can do this. Crossland says: “Free umbrellas operate a range of models, from simply being well funded and looking to gain market share, to cross-subsidising and switching contractors between free and paid for services, to using the flat-rate VAT scheme to claw back margins. If it’s free, contractors should ask how and why, and if it sounds too good to be true then the old adage applies – it probably is!”

An increasing trend is for umbrellas to offer incentives to agencies that send contractors their way, or for agencies to insist on a ‘timesheet levy’, where the umbrella company pays the agency for every contractor timesheet processed. Finders’ fees and commissions for negotiating new business are normal business practice and not illegal, but it is ultimately the contractor who will cover the cost of such incentives to agencies, and asking the umbrella if they pay commissions, and how much, at least gives the contractor the choice.

A full contract of employment on joining

On joining an umbrella company service provider, contractors will usually receive a letter of engagement. This ‘sets the scene’ and is swiftly followed up with a full contract of employment. Crossland explains the importance of this: “A legitimate umbrella company employs its contractors and provides a full overarching employment contract, with all the rights and responsibilities this entails. Less reputable umbrellas will only send the letter of engagement, with no employment contract, believing that no contract gives them a ‘get out of jail free card’ when it comes to employment rights.’”

A legitimate umbrella company employs its contractors and provides a full overarching employment contract, with all the rights and responsibilities this entails.

Rob Crossland, Parasol

The contract should have a minimum of 336 hours per year paid at the legal minimum wage. If it does not, then, from a tax perspective, expenses, benefits and employment rights may be called into question. And the contract should confirm that the umbrella company will still pay the contractor (its employee) if the end-user client or agency does not.

“A common trick of some less scrupulous employers, and a minority of umbrella companies, is to bring their employees up to the legal minimum wage by adding in expenses,” warns Crossland. “Contractors should check their preferred service provider does not try this, as it is illegal and should instantly set alarm bells ringing – if the service provider is prepared to break this law, what others might they be breaking?”

HR support and expenses

With umbrella companies being legitimate employers, and not ‘payroll processors’, contractors should expect the support of a qualified human resources department. In the event there are issues in the client’s workplace, the umbrella sometimes has to step in to fight the contractor’s case.

Crossland explains that tax compliance should be embedded within the umbrella’s organisation. He says: “A common myth is that a dispensation means contractors don’t have to keep their receipts and records. This is not true; it simply means the umbrella does not have to complete a P11D for every contractor. Contractors should always keep receipts, and if the umbrella company says they don’t have to, then the contractor should be suspicious about compliance in general.”

Leaving an umbrella – check for penalties

As contractors are employees of the umbrella company, when they want to leave they are technically tendering their resignation and terminating their employment. They are not simply moving on from a service provider, like limited company contractors will do when changing accountants. This has implications contractors should be aware of.

“Contractors should check the notice period in their contract of employment and any penalties it contains for leaving before working out a notice period,” says Crossland. “In addition, the contractor should bear in mind that if they want to leave the employment of the umbrella company mid-contract, there could be contractual implications for the umbrella company that could end up with it being in breach of contract with the agency or client. So, if a contractor leaves a contract early, this could be construed as gross misconduct by their umbrella employer.

“New contractors seeking a convenient trading solution whilst they decide if contracting is a lifestyle choice for them, or those considering a switch, should use the checklist to request information for the umbrella companies they are considering,” advises Crossland. “That way there won’t be any unpleasant surprises or unexpected costs and the contractor can focus on what they do best, leaving the umbrella company to manage their employment.”

To download the checklist choose right click on your mouse and select 'Save Target As...'.

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Published: Monday, March 22, 2010

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