How should a Compliant Umbrella Company work?

ContractorUmbrella look at the processes that a compliant umbrella company should work to following the guidance provided by HMR&C.

An umbrella company’s role is that of employer subsequently any contractors who use their services are employed under a contract of employment and paid through PAYE.

A contractor will normally source their work via a recruitment agency or direct with the client before looking for an umbrella company (another alternative is to work through a Personal Service Company; previously known as a single person Limited Company).

The umbrella company should then liaise with the recruitment agency or client, forwarding documentation such as insurance details (public liability, employer’s liability and professional indemnity), a VAT certificate and a copy of their Certificate of Incorporation. A business-to-business contract is then requested from the recruitment agency or client, which contains schedule information for the assignment. Once agreed, the contractor is engaged under a Contract of Employment with the umbrella company and provided with details of the assignment.

When the contractor has finished the week’s/month’s work they client should be asked to sign a timesheet confirming hours worked and confirmation that the work has been carried out to the required standard. The timesheet is then sent to the agency who in turn raises an invoice to the client for the agreed contract rate. The client then pays the agency for the invoice. At the same time the contractor should also have submitted a timesheet for the hours worked and the umbrella company will then raise an invoice to the agency for the contract rate. At this point the agency should pay this invoice, when the umbrella company receives funds from the agency they will put aside their margin and the amount payable to HMRC for Employer’s National Insurance contributions, before they process the contractor’s salary via PAYE.

All compliant umbrella companies operate with an ‘over-arching’ Contract of Employment to maintain continuity of employment. Without this type of contract, the worker would be engaged on a series of fixed term appointments at so called permanent workplaces. However under an over-arching contract 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 HMRC guidelines say that it has to contain certain provisions 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 another’s 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.

All the requirements listed above put a financial burden on an umbrella company as all the potential costs must be taken from their margin.

An over-arching contract should detail the contractor’s remuneration as being a combination of minimum wage and a profit related bonus. Every 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; 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.