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Umbrella payroll and PAYE are two different methods that businesses can use to pay their employees. While the two are often compared, it’s important to understand the differences between them. This will help you to understand the best option for your business, as well as the payroll software functionality you’ll need to manage employee payments.
In this article, we’ll cover what is umbrella pay and how it compares to PAYE, including outlining the benefits and implications for employees and employers.
What is Umbrella Pay?
Umbrella pay is when temporary workers are employed by a third party or employment agency, known as an umbrella company, instead of directly by the organisation they’re working for. It's commonly used by contractors and freelancers for short-term projects, allowing them to focus on work while the umbrella company handles administrative tasks like invoicing and accounting.
The umbrella company processes the worker’s salary payments, making the necessary deductions for tax and National Insurance and producing payslips. In most cases, they also deduct a fee for their service from each payment.
Umbrella Pay vs PAYE
The key differences between PAYE and umbrella payroll is that PAYE is a direct employment model, while umbrella pay is managed through a third party. However, in both options, the employee receives their net pay with all necessary deductions already removed.
Employers operating a PAYE model are responsible for calculating and deducting taxes and National Insurance and sending them to HMRC. When an umbrella company is used, the employer sends the employee’s gross salary to the umbrella company, whose responsibility it is to calculate and deduct tax, NI and other fees. They then disperse the deductions to HMRC, and net pay to the employee.
Some recruitment agencies also operate as PAYE agencies. This means that, although candidates are placed into a role at a separate company, they are technically employed and paid by the agency via standard PAYE methods. Unlike contractors working through an umbrella company, PAYE agency workers are entitled to standard workers’ rights after 12 weeks of employment.
Benefits of Umbrella Payroll for workers
Umbrella payroll provides a range of advantages that enhance workers’ financial security and simplifies administrative tasks. This makes it an attractive option for those engaged in temporary or contract work.
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Simplified tax
Umbrella payroll offers a straightforward approach to tax for employees, which makes it a good option for freelancers and contractors. Instead of calculating and paying taxes themselves, the umbrella company takes care of tax deductions. This simplifies the process, ensuring that workers comply with tax regulations without the hassle of managing it themselves.
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Holiday pay and statutory entitlements
Workers under umbrella pay are entitled to holiday pay and statutory benefits such as sick pay, parental leave, and pension contributions. While self-employed contractors typically don’t receive these benefits, workers appointed through an umbrella company are treated as employees. This ensures that they have access to the same entitlements as regular employees.
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Additional employee benefits and perks
Umbrella payroll may also grant workers access to additional employee benefits that they wouldn’t receive as contractors. This could include benefits such as private health insurance, or access to perks like employee discount schemes. This gives workers a little something extra beyond their basic pay, and allows them to feel more like part of the team. Staying with the same umbrella company through different contracts also counts as continuous employment, which could benefit workers applying for a mortgage or other financial products.
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Legal compliance and protection
Umbrella companies ensure that workers comply with employment laws and regulations, providing legal protection and peace of mind. They handle administrative tasks such as contracts, invoices and compliance checks, reducing the risk of legal disputes or penalties. Additionally, umbrella companies may offer professional indemnity insurance and legal support, safeguarding workers from potential legal issues related to their employment.
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Professional development and support
Many umbrella companies offer professional development opportunities and support services to their workers. This can include training programs, career development resources and networking events. This helps workers to enhance their skills and knowledge, boosting their career prospects and contributing to their long-term professional advancement.
From streamlining administrative processes to improving employee satisfaction, umbrella pay can provide numerous advantages for companies looking to hire staff on a temporary basis.
Benefits of Umbrella Payroll for companies
From streamlining administrative processes to improving employee satisfaction, umbrella pay can provide numerous advantages for companies looking to hire staff on a temporary basis.
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Reduced administrative burden
Outsourcing payroll responsibilities to an umbrella company significantly reduces the administrative burden for businesses. With the umbrella company handling tasks such as payroll processing, tax deductions and employee onboarding, employers can save time and resources, allowing them to focus on core business activities.
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Flexibility and scalability
Umbrella payroll services allow companies to adapt to changing workforce demands with ease. Whether scaling up to support a short-term project or downsizing during quiet periods, companies can quickly add or release temporary workers without the administrative hassle associated with traditional employment arrangements, offering greater flexibility.
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Cost savings
By leveraging umbrella payroll services, companies can avoid the overheads associated with maintaining an in-house payroll department, investing in payroll software, and managing payroll-related expenses. This enables businesses to allocate resources more efficiently, reinvest savings into core business activities, and improve their bottom line.
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Legal compliance
Engaging workers through an umbrella payroll service helps companies to navigate complex employment laws and regulations, reducing the risk of non-compliance and associated penalties. Umbrella companies ensure that workers are correctly classified and that all payroll-related obligations, such as tax deductions and National Insurance contributions, are met in accordance with HMRC guidelines.
Potential problems for companies using umbrella payroll
Like any business decision, there are important considerations to bear in mind when deciding whether to partner with an umbrella company. Here are some of the reasons that umbrella payroll might be less suitable for your business than opting for PAYE.
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Cost Considerations:
While using an umbrella company can save you money with regards to managing an internal payroll team, there are additional costs that you’ll need to weigh up. First of all, umbrella companies tend to charge for their services. This could be a regular fixed fee or a percentage of the wages they’re processing for you.
It’s also worth understanding that contracting rates for umbrella workers tend to be higher than their PAYE equivalents, as they take additional costs into account. While the worker should end up receiving roughly the same amount after deductions, your company will pay out a higher gross amount than if they were a regular PAYE employee.
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Administrative Complexity:
Outsourcing payroll to an umbrella company helps to alleviate the administrative burden for employers when it comes to paying employees. However, managing the relationship with an umbrella company poses its own complexities, particularly if you work with multiple providers. Ensuring that you choose a trustworthy partner is essential to ensure a smooth ongoing relationship, as well as providing a great experience for workers engaged through the umbrella company.
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Risk of Non-Compliance:
Working with an umbrella company should help your business to ensure compliance with all relevant payroll and compliance responsibilities. However, there is a risk of non-compliance if the umbrella company fails to fulfil its obligations accurately. It’s important to do plenty of research before deciding which, if any, umbrella company to engage, to ensure that your choice is in the best interests of your business and its employees. Building a relationship with a trusted umbrella company is often much more beneficial than working with a wider network of suppliers.
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Limited Control over Employment Arrangements:
When using umbrella payroll services, your company will likely have less control over the terms and conditions of employment for the workers you engage. This is because the contractual relationship is primarily between the worker and the umbrella company, rather than a traditional employment contract, which would be between the worker and your organisation. This limited flexibility could pose challenges in managing dynamics and ensuring alignment with organisational goals.
Umbrella Pay and IR35
IR35 is the UK legislation governing off-payroll working rules. It requires companies to check whether contractors working for them should be taxed like regular employees. It’s important for businesses working with, or considering working with, umbrella companies to understand IR35, and when it applies. This is particularly relevant at the moment, as recent changes to the legislation require public sector employers to take responsibility for determining IR35 status, rather than this being the responsibility of the contractor themselves.
Employers who engage umbrella companies must ensure compliance with IR35 regulations by accurately classifying the employment status of workers, and ensuring that appropriate tax deductions and National Insurance contributions are made. Failure to comply with IR35 can result in financial penalties, backdated tax liabilities, and reputational damage for both umbrella companies and their employers.
FAQS
As we wrap up this guide to the difference between PAYE and umbrella payroll, let’s take a look at some commonly asked questions.
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What’s the difference between hiring an employee through PAYE and an umbrella company?
The main differences when considering umbrella vs PAYE are the employment structure and tax arrangements. With PAYE, employees are directly employed by the company, and their taxes and National Insurance contributions are deducted directly from their salary by the employer. With an umbrella company, employees are technically employed by the umbrella company, which is responsible for managing payroll and tax deductions.
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What factors should employers consider when deciding between PAYE and an umbrella company?
There are various important factors for employers to consider, including their budget, administrative capacity, and the nature of the workforce. Choosing PAYE may be more suitable for companies with the resources and expertise to manage payroll and compliance internally. On the other hand, using an umbrella company provides convenience and flexibility, particularly for businesses with fluctuating staffing needs or limited administrative capabilities.
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Why is umbrella pay higher than PAYE?
When engaging contractors through an umbrella company, the agreed daily or hourly rate is often higher than it would be for a standard PAYE. This is to accommodate a margin for the umbrella company’s fees, ensuring that the worker receives roughly the same net pay as they would if they were employed and paid through PAYE. This makes it more expensive for the employer, although this is a cost that should be weighed up against the benefits of working with an umbrella company.
Umbrella Pay: Is it worth it?
Understanding the differences between umbrella pay and PAYE will help you to find the right solution for your business. As we’ve seen above, each option offers its own benefits and drawbacks, making them more or less suitable for different applications. Some businesses opt for PAYE for the majority of their employees, while engaging temporary or contract workers through an umbrella company, providing the best of both worlds.
Whichever option you choose, comprehensive HR and payroll solutions, such as those provided by PeopleHR, can help you to navigate the complexities of modern payroll management effectively. If you’ve got questions about the suitability of working with an umbrella company for your business, or any other payroll enquiries, get in touch and our experts will be happy to advise you.
