What is an umbrella company and how does it work?
What is an umbrella company?
An umbrella company is a business that acts as your employer while you carry out temporary contract work for a client. Instead of setting up your own limited company, you become an employee of the umbrella company.
The umbrella company processes your earnings through PAYE (Pay As You Earn), deducts tax and National Insurance, and pays you a net salary — much like a traditional employer would.
This arrangement enables you to work on short-term assignments without running your own company or handling tax filings.
Why might you need to use an umbrella company? (IR35 explained)
IR35 is a UK tax law that was introduced by the government to prevent “disguised employment.” It aims to ensure that contractors who work in a similar way to employees pay broadly the same Income Tax and National Insurance.
If a contract is assessed as “inside IR35,” you must be paid through PAYE, with tax and National Insurance deducted before you receive your income.
Since 2021, medium and large private-sector clients are responsible for deciding whether a role falls inside or outside IR35 (small private-sector clients remain responsible for determining status themselves). Where a role is classed as inside IR35, agencies often require contractors to work through an umbrella company so that PAYE can be applied correctly.
For a more detailed overview, refer to our guide explaining what IR35 is and what it means for contract workers.
How do umbrella companies work?
Umbrella arrangements typically involve four parties: the client, the agency, the umbrella company, and you (the contractor).
Here’s how the process works:
You carry out work for the end client (found through an agency).
The agency pays your agreed assignment rate to the umbrella company.
The umbrella deducts employer costs and processes payroll under PAYE.
You receive your net pay directly into your bank account.
You usually submit timesheets to the umbrella (or agency), and the umbrella invoices the agency on your behalf. The umbrella handles payroll, tax deductions, and reporting — you don’t need to manage any of these aspects yourself.
What are the benefits of using an umbrella company?
The main advantage of working through an umbrella company is simplicity.
As a contractor, you don’t need to:
Register a limited company
File VAT returns
Submit corporation tax returns
Manage business accounts or bookkeeping
Because you’re employed by the umbrella company, you may also be entitled to statutory employment rights such as holiday pay, statutory sick pay, and auto-enrolment into a workplace pension.
For contractors working on inside IR35 roles, this hassle-free structure provides a fully compliant way to get paid without ongoing admin.
Understanding your umbrella company take-home pay
One of the biggest surprises for contractors new to umbrella companies is that their take-home pay looks lower than expected.
This usually comes down to one key misunderstanding: the rate quoted by your agency is not your gross salary.
So let’s break it down.
The assignment rate vs your gross pay
When an agency offers, for example, £500 per day, that figure is known as the assignment rate. It’s the amount paid to the umbrella company — not the amount you’ll receive as taxable salary.
That assignment rate must cover all employment-related costs associated with paying you through PAYE. So your gross pay is what’s left after employer costs and the umbrella’s margin are deducted. From there, standard employee deductions apply.
What gets deducted and why?
Deductions under an umbrella arrangement fall into two stages.
1. Employer-level costs (taken from the assignment rate before your gross pay is calculated):
Employer National Insurance contributions
Apprenticeship Levy (where applicable)
The umbrella company’s margin (often a fixed fee of £15–£30 per week or month)
These are employment costs that would normally be paid by an employer in a traditional job. Under an umbrella arrangement, they’re factored into the assignment rate.
2. Employee deductions (taken from your gross pay):
Income Tax
Employee National Insurance
Pension contributions (if you’re auto-enrolled)
Once these deductions are applied, what remains is your net take-home pay.
Holiday pay: rolled-up vs accrued
Umbrella companies are required to provide holiday pay, but how it appears can vary.
Rolled-up holiday pay means your holiday entitlement is included within each payslip, slightly increasing your regular net pay.
Accrued holiday pay means a portion of your earnings is set aside and paid when you take leave.
If you’re unsure which model applies, check your contract or ask the umbrella directly.
Umbrella company take-home pay calculation example
Let’s say your agency offers £500 per day for a five-day week. That’s an assignment rate of £2,500 per week paid to the umbrella company.
From that £2,500, employer-level costs are deducted first. Here’s how that might play out (using hypothetical figures):
Employer National Insurance (approx.): £276
Apprenticeship Levy (0.5%): £12.50
Umbrella margin (weekly fee): £25
After these deductions (totalling £313.50), you’re left with a gross taxable pay of £2,186.50.
From this gross pay, standard employee deductions apply. For example:
Income Tax (approx.): £437
Employee National Insurance (approx.): £175
Pension contribution (5%, if enrolled): £109
That amounts to £721 in employee deductions, leaving an estimated net take-home pay of around £1,465 per week.
Bear in mind that these figures are purely illustrative, and the exact amounts will depend on your tax code, pension status, and personal circumstances. However, this example shows why your actual umbrella income is typically lower than the headline day rate.
Umbrella company compliance: how to spot a dodgy umbrella scheme
Most umbrella companies operate legitimately. However, the market has also seen non-compliant schemes that promise unusually high take-home pay. Here’s how to spot a dodgy umbrella scheme, and what it means from a legal perspective.
Warning signs to look out for
Be cautious if an umbrella company advertises:
80–90% take-home pay
Payments described as “loans,” “advances,” or “credit facilities”
Offshore arrangements or complex payment structures
Payslips that lack a clear breakdown of deductions
Unclear or unusually low margins paired with high net pay
These arrangements are often tax avoidance schemes designed to reduce PAYE deductions artificially. While they may increase short-term take-home pay, they can create serious long-term risk.
Can an umbrella company legitimately offer 80–90% take-home pay? In most cases, this is unlikely. Very high take-home percentages often rely on part of the income being paid in a way that isn’t taxed as normal salary. If you see these claims, ask for a clear written breakdown before proceeding.
The consequences of non-compliance
It’s important to note that HMRC can pursue unpaid tax from the individual worker, even if the scheme was promoted by an umbrella company or agency.
A well-known example of this is the government’s Loan Charge legislation. It was introduced to tackle so-called “disguised remuneration” schemes, where contractors were paid partly through loans rather than salary in order to reduce Income Tax and National Insurance.
These arrangements were often promoted as compliant at the time. However, HMRC considers them to be tax avoidance schemes, and the Loan Charge was introduced to recover the unpaid tax. As a result, many contractors were required to repay significant amounts.
In other words, responsibility ultimately sits with you. Choosing a compliant umbrella company is crucial for avoiding unexpected tax bills and financial uncertainty.
A simple compliance checklist
Before signing up with an umbrella company, check:
Is the company accredited by the Freelancer & Contractor Services Association (FCSA) or Professional Passport? You can usually verify accreditation directly on the accrediting body’s website, or ask the umbrella to confirm their current membership status.
Do they provide transparent payslips with clear employer and employee deductions? You should be able to see the assignment rate, employer costs, your gross pay, and your net pay clearly itemised.
Is the margin clearly stated as a fixed fee? Most compliant umbrellas charge a fixed weekly or monthly amount (for example, £15–£30).
Are you paid entirely through PAYE? All of your income should be taxed at source. If part of your pay is described as a “loan,” “advance,” or similar arrangement, treat that as a warning sign.
If the answer to any of these is unclear, ask questions before proceeding.
Umbrella vs. limited company: which is right for you?
Whether an umbrella company or a limited company is right for you depends on your contract, your day rate, and how much admin you’re willing to take on.
If your role is inside IR35, your income must be taxed as employment income through PAYE. In practice, the overall tax outcome is often similar whether you use an umbrella company or your own limited company, as most of the income is subject to income tax and National Insurance. For this reason, many contractors choose an umbrella for simplicity and compliance.
If your role is outside IR35 and you want full control over how you extract income, operating through a limited company can offer greater flexibility. However, this comes with additional admin and compliance responsibilities.
Here’s a quick comparison:
Umbrella Company | Limited Company |
|---|
Best for inside IR35 roles | Best for outside IR35 roles |
Suitable for short-term or lower-rate contracts | Often more tax-efficient for higher day rates and longer-term contracts (particularly where outside IR35 applies) |
| Requires company setup and ongoing filings |
| You’re responsible for managing tax, accounts, and compliance |
Includes statutory employment rights | No employment rights as a company director |
Simple, low-maintenance structure for easy compliance | Greater control and flexibility |
For more help deciding if the limited company route is for you, check out our full guide explaining what a private limited company is (plus the pros and cons).
How Tide helps you manage your contracting income
Your employment setup also impacts how you manage your finances.
If you’re working through an umbrella company, you’re paid via PAYE directly into your personal bank account, just like a standard employee. However, if you take on outside IR35 contracts and decide to set up a limited company or operate as a sole trader, you’ll need a dedicated business bank account to keep company income and expenses separate from your personal finances.
With Tide, you can open a business account online in minutes, track income and expenses in one place, and access tools designed to simplify bookkeeping and tax management.
Whether you’re planning your next step or already running a company, having clear financial separation makes compliance easier and gives you better visibility over your cash flow.
Wrapping up
Umbrella companies offer a compliant, low-maintenance way to get paid for inside IR35 or other temporary contract roles. While they may not maximise your take-home pay, they avoid the complexity of running your own company and keep your taxes simple.
Once you understand how the assignment rate works and what deductions to expect, you can make an informed decision about how to structure your contracting work.
If simplicity and certainty matter more than squeezing every last pound from your day rate, an umbrella company can be a practical and straightforward solution. But if flexibility and control are your top priority, operating through your own limited company may be the better fit.
Thinking about setting up your own limited company? Tide has everything you need to manage your business — from company registration to effortless online banking, smart accounting tools and beyond. Learn more about Tide.
