How a compliant Umbrella Company should work…

The role of a compliant umbrella company has become that of employer. This means that the contractors who use their services are employed under a contract of employment and paid through PAYE.

The contractor will, typically, have sourced work through a recruitment agency or direct with a client. They then seek the services of a compliant umbrella company (the alternative to working through a Personal Service Company or PSC; what used to be known as a single person Limited Company). The umbrella company will liaise with the recruitment agency or client. They will forward documentation such as copies of insurances (public liability, employer’s liability and professional indemnity), copy of a VAT certificate and a copy of their Certificate of Incorporation. They will then request a business to business contract from the recruitment agency or client. This will contain schedule information for the assignment. At this point the contractor is engaged under a Contract of Employment with the umbrella company. They will then provide the contractor with details of the assignment.

Working through the chain…

The chain of client, recruitment agency, intermediary (compliant umbrella company) and contractor works as follows:

  1. Client engages Recruitment Agency to fill a contract position for an agreed sum (A)
  2. Recruitment Agency enters into a B2B contract with the intermediary for the sum agreed with the client less their retained margin (B)
  3. Intermediary engages the contractor under a Contract of Employment for a salary equal to the contract value (as entered into with the agency) less Employer’s NI contributions less their margin (C)

When the contractor has finished his/her week’s/month’s work they will ask the client to sign a timesheet confirming the number of hours worked and the satisfaction that the work has been carried out to the required standard. The timesheet will then be sent to the recruitment agency who will raise an invoice to the client for the agreed contract rate (A). The client will then pay the recruitment agency for this invoice. The contractor will have also advised the umbrella company of his/her hours worked and they will raise an invoice to the recruitment agency for the contract rate (B). The agency will then pay this invoice. Upon receipt of funds from the agency the compliant umbrella company will put aside its margin as well as the amount payable to HMRC for Employer’s National Insurance contributions, they will then process the contractor’s salary (C) through PAYE.

All compliant umbrella companies operate what is referred to as an ‘over-arching’ Contract of Employment; this is to maintain continuity of employment. Without the over-arching contract the worker would be engaged on a series of fixed term appointments at permanent workplaces, as it is the worker is employed by the umbrella company and works for them on a series of temporary assignments. In order for a contract to be over-arching it has to contain certain provisions as required by HMRC, these are as follows:

1. A Contract of Employment must first be in place i.e. a contract of service rather than a contract for services. To make this determination HMRC uses case law – Ready Mixed Concrete Ltd v. Minister of Pensions and National Insurance. The Judge in this case, MacKenna J summed up what is meant by a Contract of Employment (contract of service) as follows: “A contract of service exists if these three conditions are fulfilled.

(i) The servant agrees that, in consideration of a wage or other remuneration, he will provide his own work and skill in the performance of some service for his master.

(ii) He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other’s control in a sufficient degree to make that other master.

(iii) The other provisions of the contract are consistent with its being a contract of service. As to (i). There must be a wage or other remuneration. Otherwise there will be no consideration, and without consideration no contract of any kind. The servant must be obliged to provide his own work and skill. Freedom to do a job by one’s own hands or by anothers is inconsistent with a contract of service, though a limited or occasional power of delegation may not be….” These considerations mark the contract as being ‘of service’ rather than ‘for service’ where there would be no direction and control, no obligation for personal service, financial risk and opportunity for profit. (As an aside, these are also the determining factors when deciding IR35 status).

2. As umbrella companies have the statutory obligations of any other employer the contract must also contain reference to paid holiday entitlement, sick pay, maternity and paternity pay.

3. An umbrella company has a contractual obligation to guarantee a minimum number of hours of work in any 12 month period which is akin to paying a retainer i.e. there would be a guarantee of earnings regardless of whether there is work to be done. The acceptable number of hours guaranteed in an over-arching contract to satisfy HMRC on this point is 336 hours.

4. HMRC also require mutuality of obligation between assignments in order for an over-arching contract to be in place and the mutual obligations during the gaps must be obligations which relate to the provision of payment for work personally performed by the worker. HMRC believe that the correct legal position is set out in the case Clark v Oxfordshire Health Authority [1998] IRLR 125 (see ESM7190). At paragraph 41 Sir Christopher Slade said:
“I would, for my part, accept that the mutual obligations required to found a global contract of employment need not necessarily and in every case consist of obligations to provide and perform work.

To take one obvious example, an obligation by the one party to accept and do work if offered and an obligation on the other party to pay a retainer during such periods as work was not offered would in my opinion, be likely to suffice. In my judgment, however, as I have already indicated, the authorities require us to hold that mutuality of obligation is required to found a global contract of employment. In the present case I can find no such mutuality subsisting during the periods when the applicant was not occupied in a ‘single engagement’. Any obligation of confidentiality binding her during such periods would have stemmed merely from previous single engagements. Apart from this, no continuing obligation whatever would have fallen on the authority during such periods.”

HMRC do not accept that payment of holiday pay between assignments satisfies the required minimum mutuality of obligation.

The over-arching contract will detail the contractor’s remuneration as being a combination of minimum wage and a profit related bonus. The umbrella company has a responsibility to pay the contractor’s salary once a month regardless of whether or not funds have been received from the recruitment agency or end client and this is paid at minimum wage (currently £6.19 per hour); the umbrella company will pay the Employers NI contributions due on this amount. When funds are received from the agency/client, the contractor will be paid the rest of their salary as a profit related bonus which equates to funds received less their margin less the Employer’s NI contributions.