What is umbrella payroll? Everything you need to know

Here is everything you need to know to decide whether you should use an umbrella payroll provider if you work as a contractor. 

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Umbrella payroll is when an external company processes the pay and benefits from a client to a contractor.

Umbrella payroll providers are often used by contractors or temporary workers. The worker is employed via the umbrella payroll company to work for one of their clients. The umbrella payroll company pays the contractors wages and processes any other employment benefits such as holiday and sick pay.

Umbrella payroll exists to provide an option for contractors working short-term assignments to do so under a PAYE framework, whilst retaining the flexibility that a self-employed person has.

Below, we outline what umbrella payroll is, how it works and when it is appropriate to use.

What is umbrella payroll?

An umbrella company processes payroll from a client to a contractor, managing payroll for individuals who don’t work for one company on a permanent basis, but work flexibly, completing short-term contracts.

It acts as an employer for its contractor employees, operating PAYE on their behalf and paying income tax and national insurance contributions the contractor is liable for. The umbrella company acts as a link between the contractor and the agency they work for,  As well as managing pay, it will look after the benefits and employment rights of a contractor, irrespective of who they work for and how often they switch employment providers.

When an individual joins an umbrella company, IR35 rules don’t usually apply because they become an employee of the umbrella company rather than working via their own limited company.

The difference between umbrella payroll and PAYE

PAYE is the mechanism HMRC operates to collect tax from employees. Self-Assessment is the system for collecting tax from self-employed workers. The check employment status for tax (CEST) tool on Gov.uk can help people decide what status applies for them.

Some contractors join a PAYE agency to manage their affairs. An umbrella company is different because it manages all employment booking and contracts. It becomes the contractor’s employer, even for multiple contracts and gaps in working, whereas a PAYE agency must be appointed for each individual contract.

Umbrella companies can offer a wider range of services for contractors, including processing expenses and offer statutory benefits like holiday, maternity and sick pay. They do not pay employer taxes and National Insurance, unlike a PAYE agency. Lower costs mean umbrella companies can pay a higher rate of pay.

A contractor working via an umbrella company does not complete a Self-Assessment tax return as they are not classified as self-employed.

When is an umbrella payroll appropriate to use?

If you are a contractor working consecutive short-term contracts you could register as a limited company or work under an umbrella company using their payroll.

Another option is to use an umbrella company initially while you decide which is best; setting up a limited company or continuing to work under umbrella payroll.

Setting up a limited company means the worker is not personally liable for debts incurred from business operations, because a company is a separate legal entity from an individual. They will not have to pay fees to an umbrella company. Limited company owners can be paid via a combination of salary and dividends which can reduce tax.

If a worker decides to set up a limited company, they must manage their own tax affairs, submit annual accounts and pay any tax and NI due.

Some employers that use contractors may want them to work under a company structure so the employer complies with IR35 legislation.

Overview of the pros and cons of using an umbrella payroll arrangement


  • A worker receives benefits such as holiday and sick pay as a PAYE employee would
  • Retain some of the flexibility of being self-employed
  • Tax and NI taken care of by umbrella company
  • No need to complete a tax return
  • IR35 status is usually irrelevant


  • Umbrella company’s charge a fee or ‘margin’
  • Some umbrella companies are not compliant with all employment and tax rules
  • Not as tax efficient as being paid by a combination of salary and dividends as a limited company
  • In most cases umbrella employees are not allowed to claim expenses

Consider your specific circumstances when making a decision or get financial advice.

How does umbrella payroll link to IR35?

IR35 or off-payroll rules ensure workers’ pay the same tax and NI as employees when they operate through an intermediary. It means they can’t avoid tax by operating as a limited company. 

These rules apply if the worker that provides services to a client through an intermediary would have been classed as an employee if they were providing services directly to the client.

Contractors that work through an umbrella company are exempt from IR35 rules because the umbrella payroll provider will pay their tax and NI payments. 

IR35 applies when a contractor supplies services through their own intermediary, usually a  limited company. The responsibility for deciding if a contractor should follow IR35 is usually the employers. 

In April 2021, IR35 rules were amended so private companies, as well as public companies, need to make this decision when employing contractors. 

What is an umbrella company’s ‘margin’?

Umbrella payroll companies do not charge contractors a fee. They earn revenue by deducting a ‘margin’ from employees’ gross pay, before tax, NI and other deductions. 

This margin is the only revenue an umbrella company receives. It is effectively the charge an umbrella company makes for payroll services they provide for temporary workers.

The margin amount varies between providers and is usually quoted as a weekly or monthly amount to match how employees are paid. Typically, a weekly margin will be between £15 and £25 per week or £60 and £100 per month.

What is the relationship between the worker, agency and umbrella company?

If a worker finds contract work as a contractor with a recruitment agency client, they may decide to join an umbrella company to be treated as an employee for payroll purposes for each temporary role they take on. When working through an umbrella company, a worker, contractor and employee are interchangeable terms. They are all treated the same and have the same employment rights.  

The client receives the employee application from the recruitment company. If the client decides to hire the employee, they may consider if off-payroll (IR35) rules apply. If it does, they may suggest the worker is employed through an umbrella company. 

If the agency wants the worker to work through an umbrella company, it should give the worker details of the umbrella company to be used for temporary work from the agency, the terms between the recruitment agency and umbrella company, the minimum rate paid to the umbrella company, the employee’s minimum gross pay and the umbrella company’s margin.

The agency will then create a contract for the umbrella company that shows who is responsible for employing the worker and paying their wages and who invoices the recruitment agency for the work completed. 

For each new role the agency must give the employee new information that shows who they are working for, job title, details of the role, notice period, location of the work and any other relevant information.

How to understand payslips through umbrella payroll

A worker under an umbrella payroll arrangement is entitled to a payslip that shows their pay and how the umbrella company deducts its margin.

The worker sends their timesheet to the recruitment agency who then charges the client. The recruitment agency pays the umbrella company. The umbrella company then pays the worker through its payroll software as the employer.

Payments usually follow normal PAYE procedure with gross pay linked to the rate of pay and hours worked, employers pension contribution and holiday pay. The main difference comes when the umbrella company’s margin is deducted before tax and NI due is calculated. This is based on the worker’s tax code and deductions such as pension contributions or student loan repayments. 

Umbrella payroll and holiday, maternity, and sick pay?

All full-time workers are entitled to 5.6 weeks of annual leave each year, including bank holidays. The pro rata equivalent is due for part-time workers. 

Umbrella companies deduct holiday pay from the assignment rate of the job and repay it when annual leave is taken or when the contract ends if some holiday pay is still due. 

Statutory sick pay (SSP) is paid at the current rate for 2024/25 of £116.75 per week for illness for up to 28 weeks.

Depending on the individual contract, workers may qualify for maternity or paternity leave as an umbrella employee. The worker must have worked for the same employer or umbrella company for 26 weeks and provide proof the worker or their partner is pregnant.

Employment rights for umbrella payroll

A worker should discuss what employment rights they have with any potential umbrella payroll provider they decide to join.

Under an umbrella payroll arrangement, workers have the same employment rights as other employees. They must be given a written employment contract. They should be paid at or above the national minimum wage or national living wage, at the correct rate dependent on the worker’s age, be paid on time and in full at the agreed rate and agreed regular intervals.

Unless a worker has opted out or is ineligible, they must be auto-enrolled in the employers’ pension scheme and the pension deductions should be shown on their payslip.

The benefits and disadvantages of using an umbrella payroll system

There are pros and cons to having payroll managed by an umbrella company. The merit depends on individual circumstances.

If you choose a reputable and compliant umbrella company you could receive all the benefits an employee is entitled to, company pension, holiday, sick and maternity pay whilst still retaining some flexibility over who you work for, length of contract and how you work.

All income tax and NI payments are handled by the umbrella company, so workers don’t need to complete a tax return or budget for tax payments. The main disadvantage is the worker pays the umbrella company’s margin charge. In some circumstances it could be more beneficial to register as a limited company. 

It is important to select a reputable umbrella company because some can act incorrectly, which means the worker risks not paying the correct tax and be penalised or investigated by HMRC.


Deciding whether to work consecutive roles under an umbrella company depends on the worker’s individual circumstances.

It can provide a beneficial balance between receiving the benefits of working as an employee alongside the flexibility of being self-employed. It can also simplify tax arrangements.

When choosing an umbrella company, make sure it has an established, good reputation and is compliant with UK tax rules. Check to see if they are accredited with the Freelancer and Contractor Services Association (FCSA). HMRC also has useful information on reducing risks when using an umbrella payroll company on Gov.uk here.

Find out more about IR35 and how it works here and what tax self-employed sole traders pay here.

Benjamin Salisbury - business journalist

Benjamin Salisbury is an experienced writer, editor and journalist who has worked for national newspapers, leading consumer websites like This Is Money and MoneySavingExpert.com, business analysts including Environment Analyst, AIM Group and written articles for professional bodies and financial companies. He covers news, personal finance, business, startups and property.

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