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With the rise of “the gig economy,” many workers are contracting themselves out as freelancers rather than becoming employees of a single company. This model comes with a few vulnerabilities and inconveniences, which is why some contractors choose to partner with an umbrella company. These workers still complete temporary work, often through a recruitment agency, but they are technically classified as employees of the umbrella company.
This model is preferable to some contractors and the companies they work with, but it isn’t without its disadvantages. Let’s explore this employment arrangement in more depth and consider the pros and cons for both workers and the companies they serve.
What is an umbrella company?
An umbrella company is an intermediary company that employs workers who would otherwise be independent contractors or temp agency workers. The umbrella company manages how these freelance workers get paid by their recruitment agencies or by end clients. An umbrella company bills an agency or individual clients for an employee’s work and pays the employee through Pay As You Earn (PAYE), deducting tax and social contributions.
To understand the role umbrella companies play, you might find it helpful to consider the alternative. Without an umbrella company, contractors may operate independently either as self-employed or as their own limited company. Contractors offer their services temporarily to various clients. They are not employees of the companies they work for, so they are not placed on companies’ payrolls and do not receive benefits. Instead, they are paid in installments or lump sums for their work, and it is typically up to them to set aside income taxes and other mandatory contributions.
By becoming an employee of an umbrella company, workers can forgo the responsibility of handling their own wages and government contributions and can receive benefits like paid leave. However, they give up some of the freedom they would have if they were functioning independently and are wholly reliant on the umbrella company to ensure they comply with the country’s employment and tax laws.
While some contractors find their own work and manage their own contracts, many contractors use recruitment agencies to help them with this. In these cases, agencies can be the ones to partner with umbrella companies. Using an umbrella company can reduce the recruitment agency’s administrative duties and their liability.
Umbrella companies have become especially popular in the UK, though they can be found in other countries, as well. Some umbrella companies market themselves as international umbrella companies designed to help contractors take on contracts from clients in various countries and get paid in legally compliant ways.
Advantages of working with an umbrella company
Umbrella companies offer some notable advantages to both workers and companies that want to employ these workers.
1. Benefits for workers
Compared to working independently as a contractor, there are some advantages to becoming an employee of an umbrella company. The main reasons workers choose this option is because it can:
- Simplify taxes: One of the primary reasons to choose this option is because being paid as an employee through PAYE is much simpler than figuring out your own taxes and paying on your own. It also saves workers from possible cases of disguised employment if they take advantage of self-employment tax breaks. In the UK, contractors must contend with IR35, which targets tax avoidance through disguised employment. In other words, if the government determines workers are actually functioning as employees for another company, they could suddenly owe back taxes, plus interest.
- Provide benefits: By becoming an employee of an umbrella company, workers can also receive benefits they wouldn’t receive as a contractor. In a survey by the Freelancer and Contractor Services Association (FSCA) in the UK, 76 percent of the hundreds of freelancers and contractors who responded reported having no access to paid leave of any kind. In some countries, benefits packages may also include health insurance policies and pension schemes.
2. Benefits for companies
There are also some advantages to businesses that engage workers through an umbrella company. Some companies may prefer to work with employees of umbrella companies rather than taking on self-employed contractors or hiring employees directly because this arrangement can help them:
- Avoid worker misclassification: Countries have their own laws about what legally constitutes a contractor-client relationship versus an employee-employer relationship. If you hire someone as a contractor, but the government determines this contractor should actually be an employee — perhaps because the individual ends up working for you exclusively — you could incur fines or legal action. With recent updates to IR35, employers bear more responsibility for ensuring contractors are not misclassified. When you hire workers with an umbrella company, these workers are already classified as employees, so you don’t have to worry about potentially misclassifying them.
- Facilitate international employment relationships: Companies that want to start hiring internationally may also want to partner with an umbrella company in the country they’re interested in. The umbrella company can help you legally hire contractors in another country. However, this arrangement is only designed to be temporary. That can be helpful if you’re only looking to hire someone for a particular project or consulting services but don’t plan to work with them long term. In these cases, you may be able to hire workers as contractors directly.
Disadvantages of umbrella companies
There are also some notable disadvantages that both workers and companies should consider before partnering with an umbrella company.
1. Disadvantages for workers
Workers need to consider some important disadvantages before deciding between using an umbrella company, freelancing as an independent contractor, or becoming an employee of their end client or of an Employer of Record (EOR). Some downsides to working with umbrella companies include the following:
- Limits workers to temporary jobs: Compared to being self-employed as an independent contractor, working under an umbrella company may feel like a step up for workers. However, this option is limited to contract work. In other words, while workers are technically employees of the umbrella company, they will conduct work temporarily for various clients. If this type of work is less appealing than working long term for one company, they should seek a more traditional employment relationship.
- Offers fewer tax benefits: Since workers are considered employees under this model, they cannot claim as many expenses in their tax filings as they would if they were self-employed. If they’re used to writing off items for their work, they may lose that ability by becoming employees. Some umbrella companies claim they can help workers maximize their take-home pay with “tax-efficient” strategies, but these companies may be guilty of tax avoidance schemes. Workers could end up owing back taxes, interest, and possible penalties.
- Involves fees: Many contractors have chosen to forgo using umbrella companies because they take a margin from workers’ paychecks in exchange for the service they offer. Some umbrella companies use a flat rate, while others use a percentage to determine fees. Most workers in the UK can expect to pay their umbrella companies aboutGBP£20-30 per week. Contractors should look into umbrella company fee comparisons before partnering with a certain company to ensure they’re getting a competitive rate.
2. Disadvantages for companies
There are also some downsides companies should be aware of if they hire freelance employees through an umbrella company rather than hiring them directly as their own employees. Here are some of the disadvantages of the umbrella company model in this context:
- Incompatible with traditional employment relationships: If you want to hire top talent to work exclusively for your company for an indefinite period, then you shouldn’t try to do so through an umbrella company. These workers are freelancers who can sign a contract to work for a specified time, but they are under no obligation to work for your company indefinitely. Along those same lines, these workers are free to exercise autonomy in the way they complete work. You cannot manage them in the same ways you may be used to with your employees.
- Often tied to recruitment firms: In most cases, working with an umbrella company also means working with a recruitment firm. Essentially, this means you will partner with a recruitment agency that will help provide you with workers and use the umbrella company to pay those workers. This arrangement can feel convoluted compared to hiring workers directly and also limits the control you have over choosing your employees. If you want more control over your own recruitment, umbrella companies are not a good choice.
- Limited to the most basic HR functions: Especially if you’re planning to hire internationally, note that an umbrella company tends to be limited in the services it offers. They can pay your workers, keep some basic records, and offer legally required benefits. However, they are not a resource to assist with international growth as you would experience with an Employer of Record.
Employer of Record vs. umbrella company
Companies looking to hire internationally without establishing a subsidiary in another country — especially if that country is the UK — may find themselves choosing between an Employer of Record or an umbrella company. Note that an EOR is also sometimes called a professional employer organization (PEO) in certain contexts. The umbrella company and EOR/PEO options share some similarities, but they are not the same. These two options differ in:
- Purpose: The main distinction between an umbrella company and an Employer of Record is in the type of employment relationship they facilitate. Umbrella companies are only designed to facilitate temporary work, while an EOR can allow you to employ long-term workers. If you want to hire an expert to consult on a particular project, for example, you may be able to hire him or her through an umbrella company. However, if you want that expert to work exclusively for your company indefinitely, just as an employee would, then you need to hire the individual through an Employer of Record.
- Scope: An EOR can also serve a more comprehensive role for your company than an umbrella company could. An Employer of Record handles the full range of HR tasks needed to provide your employees with employment contracts and competitive pay and benefits packages. In contrast, when it comes to HR, an umbrella company will only handle the most basic functions and is only likely to offer the legally required minimum when it comes to benefits.
- Flexibility: You may also have more freedom when you work with an Employer of Record to choose your own employees in many cases and to manage them as true members of your company. The Employer of Record will work in the background as the bridge connecting you to your employees. Working with a recruitment agency and umbrella company, on the other hand, can limit your access to talented workers and can create a more distanced relationship between your workers and your company.
Why work with an EOR for global growth?
All the distinctions above are important to consider when you’re planning to grow globally. In these instances, there are even more reasons to choose an Employer of Record over an umbrella company. An EOR can help you scale your company internationally and can provide a long-term solution.
A payroll agency or umbrella company is likely to be quite small compared to an international Employer of Record — especially compared to the scale of Globalization Partners, which has a presence in 187 countries. Umbrella companies are not designed to help you enter new markets across the world and get the legal, tax, and HR guidance you need to successfully hire employees in various countries. When you’re building an international team, you need an EOR — not an umbrella company.
An Employer of Record is also the only long-term solution for employing international workers without establishing your own international branch or subsidiary. While you can use an umbrella company to hire temp workers for short-term projects, when you want to enjoy more meaningful, long-term employment relationships, you need an Employer of Record. Many workers prefer this model, as well, as they can become part of a team rather than working independently for countless companies on many projects.
Hire internationally with Globalization Partners
By working with an Employer of Record, you can enjoy the same benefits you would get with an umbrella company, plus many more benefits. If you want to hire internationally without establishing a subsidiary, consider working with Globalization Partners.
As a global employment platform, we offer full stack AI-driven technology paired with in-house expertise and resources to help you make your international growth a success. We can offer your international employees competitive and legally compliant contracts and handle payroll, taxes, and benefits so you can focus on fostering positive relationships with your employees. To learn more about hiring workers in the top 20 countries for global growth, download our Global Hiring Handbook.