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Umbrella Companies and Employers NI
If you work as a freelance contractor you are required to pay Class 1 Employers National Insurance, Class 1 Employees National Insurance and Income Tax on PAYE income.The level of National Insurance you pay depends upon your IR35 status and contracting structure. If you work on contracts Inside IR35, whatever structure you use, all contract income must be paid through the PAYE scheme meaning you pay more Class 1 National Insurance. If you work on contracts outside IR35 you can use your own limited company to set a low annual salary (normally around £12-24k pa) and take remaining contract billing in dividends, therefore paying less Class 1 National Insurance.
To find out more about umbrella companies and limited companies call Commonwealth Contractors now on 0800 294 4388 or Submit your details and we will get right back to you
Why do I pay Employers National Insurance when using an Umbrella Company?
If you’re a first time contractor you might be wondering why you have to pay Employers National Insurance when using an Umbrella Company. To answer this it’s probably best to look at an example.Let’s say you were the permanent employee of a consultancy such as EDS and you worked on a project at a client site. EDS would bill the client £7,500 per month and you received a gross salary of £2,500, meaning you were paid 1/3 of contract billings generated. Each month your payslip showed you had paid Income Tax and Employee’s National Insurance on the salary. Of course what the payslip doesn’t show you is that the Employer has also paid a Class 1 National Insurance Contribution as well. This contribution is considered a cost by the employer and is paid by EDS from the 2/3 of the contract income generated that is not your salary.
Now let’s look at a situation where you use an Umbrella Company. When the umbrella company receives contract billings it takes a margin, say 5%. For the sake of this example we will use a margin exclusive of employer’s national insurance. That means that 95% of contract income is dedicated to your remuneration as opposed to the 1/3 in the EDS example. Of course Employers National Insurance (12.8%) still needs to be paid but the umbrella company is not willing to deduct it from its 5% Margin (if it did, it would rapidly go bankrupt). Therefore the gross salary is lowered to take into count Employer’s NI and the contractor receives a gross salary on which Employee’s NI and Income Tax is paid.
Inclusive of National Insurance Margins
Not all umbrella companies make life this complicated; some take a margin inclusive of the 12.8% Employer’s National Insurance. This ‘inclusive of Employer’s National Insurance’ structure makes it clearer to understand, especially when it comes to payslips.Do not be fooled by umbrella companies that take a margin exclusive of NI and try to give the impression of lower rates, you still have to pay National Insurance.
The situation is summarised below:
| Type of company | Salary & bonus package for the fee earner | ‘Margin’ retained by the company | Employer’s NI costs (12.8%) |
|---|---|---|---|
| Traditional global consultancy | 25-33% of billings | 67-75% of billings | Covered by the company’s 67-75% margin |
| Traditional umbrella company | 95% of billings | 5% of billings | Deducted from the 95% allocated to the individual’s pay package |
| Umbrella company with inclusive margin | 75-87% of billings | 13-25% of billings | Covered by the company’s 13-25% margin |
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