If you are a contractor working on temporary assignments, there are two common ways to be paid: via agency PAYE or through an umbrella company.
Please keep reading. We’ll explain agency PAYE and umbrella company payroll and the differences between each type of business structure.
What is agency PAYE?
Using agency PAYE is the easiest way to get paid when working on temporary assignments.
“Agency PAYE” is the process of employing a contractor or freelancer directly by a recruitment agency for the duration of a contract.
When employed by the recruitment agency, the employee has employee benefits (statutory) and is paid a salary like a worker in a permanent role.
However, the worker must work for the agency for a minimum of 12 weeks to get access to the employee benefits (Agency Worker Regulations, 2010).
The agency PAYE rate is usually slightly lower than through an umbrella company because the worker doesn’t need to worry about the umbrella company’s margin and employment costs.
Once the assignment is complete, the temporary worker’s employment will be terminated, and they’re free to become employees of another agency in a different role.
What is an umbrella company?
An umbrella company is an intermediary that provides payroll services to contractors and freelancers.
Umbrella companies fall between the end-hirer and the recruitment agency in the supply chain and become the employers of temporary workers for payroll purposes.
Initially, the concept of an ‘umbrella company’ may sound confusing, but the process is straightforward.
Let us explain how they work.
A contractor or freelancer works for their end-hirer – a role secured through a recruitment agency.
After completing a week of work, they fill out a timesheet and send a signed copy to their agency and the umbrella.
In the background, the umbrella company has signed an overarching contract with the recruitment agency – so the workers’ funds can be passed down the chain.
The end-hirer will then pay the agency the agreed amount for the contractor’s work. The agency will then pass this down the chain to the umbrella. At this point, no income tax or National Insurance Contributions (NIC) deductions have been made.
As the employer, the umbrella company will then process the temporary worker’s payroll under Pay As You Earn (PAYE), HMRC’s tax system for employees.
Before any deductions are made, the umbrella will deduct its margin (from gross)—a small amount that is the only income the umbrella generates for itself.
The rest of the deductions are sent to HMRC directly and include income tax, employees’ NIC, and employers’ NIC.
Additional deductions, including pension contributions and student loan repayments, may also be made depending on the worker’s circumstances.
The differences between agency PAYE and umbrella company payroll
There are many differences between agency PAYE and umbrella company payroll; we’ll explain the main ones below.
Rate of pay
If an agency operates its own PAYE payroll services, it will commonly offer two pay rates for workers. The first pay rate will be to go through the agency’s payroll. The second rate of pay involves payroll through an umbrella company. Why is this?
Because umbrella companies retain a margin for their service and the employment costs are passed down, agencies often offer an inflated rate of pay for workers being paid through an umbrella company to consider these and ensure that workers are not out of pocket.
Cost to the worker
Being paid through a recruitment agency’s PAYE payroll will not cost the contractor or freelancer anything. There will be no fees or charges for using this method of payroll. However, consider a contractor working via an umbrella company:
In that case, they will be responsible for paying the umbrella company’s margin – a deduction made to the worker’s gross pay for each payment frequency (roughly £20 per week).
As mentioned above, recruitment agencies usually offer an inflated pay rate for those paid through an umbrella to cover these costs.
Employee benefits
Whether a worker is paid PAYE by their agency or uses an umbrella company, they have instant access to several statutory employee benefits, including sick pay, maternity pay, paternity pay, and holiday pay.
However, according to the Agency Worker Regulations 2010, you must work 12 weeks for an employer to qualify for full employment benefits. This applies to both umbrella company and agency PAYE employees.
Continuity of employment
One of the main differences between an agency PAYE and an umbrella company is continuity of employment.
If a worker uses an agency’s PAYE payroll service, they will probably only use it for a short period because they will undoubtedly take another role elsewhere soon.
However, if workers use an umbrella company for their payroll, they can use the same umbrella for all their working assignments – giving them continuity of employment.
Continuity of employment is a big deal because it can seriously help contractors and freelancers access attractive finance and credit, such as mortgages and bank loans.
However, if you use an umbrella company or an agency’s PAYE payroll service, you don’t have to worry about it because you’ll be paid as if you’re inside IR35. All of your income is subject to standard employment tax.
The most tax-efficient way to operate as a contractor or freelancer is outside IR35 via your own limited company.
By doing this, you can pay yourself a combination of salary and dividends—the best way to legally maximise your pay retention.
However, if you’re inside IR35, you are deemed to work as a permanent employee, and therefore, you’ll be required to pay tax like an employee (PAYE).
Insurance cover
Many umbrella companies and recruitment agencies include insurance cover for free.
The most common policies are Employers Liability Insurance, Public Liability Insurance and Professional Indemnity Insurance.
Always check before committing to an agency or umbrella company because many contracts stipulate that you must hold a minimum level of business insurance (particularly PI cover).
Claiming expenses
Before 2016, many umbrella company employees could claim tax relief for travel and subsistence expenses. However, the introduction of legislation called Supervision, Direction, and Control (SDC) ended this—well, not entirely.
Nowadays, if you are eligible to claim expenses via an umbrella company, you must be able to prove you’re not subject to supervision, direction or control in the workplace.
The chances are you are subjected to at least one of these, and therefore, you won’t be eligible to claim expenses.
Most umbrella companies don’t offer an expense service because they found that almost every worker who enquired wasn’t eligible to claim (as they were subjected to SDC).
You can still qualify for reimbursed expenses – the same type of expenses that full-time employees can apply for.
For example, if you must travel to an off-site destination as part of your assignment, you can probably claim the travel cost back. Make sure you speak with your recruitment agency or umbrella company before committing to a payroll service.
Which option is best for you – agency PAYE or an umbrella company?
Your choice of payroll service is entirely up to you. However, agency PAYE and umbrella payroll may not be available for specific assignments. For example, many agencies no longer offer PAYE, and we explain why in the section below.
Therefore, if you accept the role, you may be presented with a list of umbrella companies to choose from.
Generally speaking, agency PAYE may be the best solution for you if:
You think umbrella company payroll is too much hassle.
You are going to be a contractor/freelancer for a short period.
Employee rights are unimportant to you (because you need to work with agency PAYE for 12 weeks to qualify).
You want to be paid by the agency that has sourced the role for you (keeping everything together and excluding the requirements of a third party).
Using an umbrella company for your payroll may be the best option for you if:
You work on multiple assignments at once.
You want continuity of employment.
You plan on contacting for a long time and like the idea of having one employer for multiple assignments.
You think there is a possibility you could be eligible for travel and subsistence expenses.
Why do most recruitment agencies no longer offer agency PAYE?
Generally speaking, providing payroll to employees is a costly and time-consuming task. There is also a lot of legislation to abide by to process payroll compliantly with HMRC’s rules and regulations.
Recruitment agencies specialising in placing temporary workers may have tens of thousands of workers on their books simultaneously.
With many of these workers quickly changing assignments and working for different end-hirers, there is a considerable amount of associated administration.
Therefore, many recruitment agencies prefer to incorporate the services of umbrella companies, specialist payroll intermediaries that manage the payroll of temporary employees.
