Increasingly, many of these 'independent workers' are opting to make use of service companies rather than take the more traditional approach of forming their own sole tradership, partnership or limited company, and with good reason: Unfortunately setting up a legal entity to act as a vehicle for your freelance aspirations can be dauntingly complex, time-consuming and expensive, while running such an entity, keeping up with the mountain of paperwork it often generates, remaining compliant with ever-changing regulations and performing all the necessary fiduciary duties can seem like a full-time occupation.

Service companies provide a managed limited company through which many freelancers simultaneously operate their contracts, thus benefiting from centralised expertise as well as economies of scale. The company carries out all the administration normally associated with running a limited company, e.g. executing legal contracts, processing timesheets and expense claims, raising invoices, collecting payments from clients and agencies, calculating Tax, N.I. contributions and Net Pay as well as dealing with statutory filing and regulatory compliance. By becoming a client of a service company, a freelancer becomes a de facto employee of that company, albeit with a lot more freedom than an employee would normally have - retaining the flexibility to choose clients, assignments, terms & conditions, rates and locations. Obviously, all this administration costs money and the service company charges a fee.

Commonly lumped together under the term 'umbrella company', there is a somewhat bewildering array of service companies vying for the business of the unwary freelancer. At the risk of over-simplifying, these companies fall into one of three distinct categories: Managed Services companies, Composite Services companies and Combined Managed/Composite Services companies.

Managed Companies purely act as invoice vehicle and employer to freelancers, sometimes offering additional benefits (at a price) such as holiday and sick pay. Composite Companies offer these same services but also allow the freelancer to become a shareholder of the Composite Company, making it possible to reduce Tax and NI liability by dividend payments or revenue-share schemes. Combined Companies provide all the features of both Managed and Composite companies, but tailor the service to the needs of the freelancer, acting either as a Managed or Composite Company depending on circumstances like the contractor's of working practices, contract stipulations and industry sectors.

For the remainder of this article, we will use the term 'umbrella company' to mean (as in the vernacular) either a Managed or a Composite or a Combined Managed/Composite services company.

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There are three elements that warrant careful consideration when choosing an umbrella company to entrust your freelance future to: the Services/Benefits on offer, the Cost involved and the Legality/Regulatory Compliance of the solution the company provides.

A. Services/Benefits
In order to make a like-for-like comparison between umbrella companies, you will need to evaluate their offerings dispassionately:

1. Administration, Billing & Collection, Payroll and Expenses processing
To be worthy of the name, an umbrella company has to offer at least these basic services. Anything less and you will have to take care of most if not all of the hassle and paperwork yourself, or pay someone else to do it. If this set of basic services is all they have to offer, you will probably outgrow that particular umbrella very quickly, or end up paying more tax than you need to.

2. Tax Mitigation
A properly structured umbrella company operating within Inland Revenue guidelines should provide all the tax benefits of your own limited company, including a special dispensation for expenses and a mechanism for dealing with thorny issues like IR35 and Section 660. Unfortunately most umbrella companies seem to avoid the issues (by not allowing shareholding or dividends) rather than helping freelancers to avoid the additional tax liability through careful planning.

Unless you operate solely inside IR35 and your tax planning requirements are extremely simple and not likely to grow in future, your interest will be best served by a Combined Company that can deal with your specific situation on a contract-by-contract basis.

3. Insurance
By law, every employer (and therefore every umbrella company) has to have at least Employer's Liability (EL) and Public Liability (PL) insurance cover, protecting the employer in case of claims arising from employees or members of the public in connection with the company's trade, premises and so forth.

Whether we like it or not, we live in an increasingly litigious society where individual freelancers are being held liable for negligence, incompetence, improper conduct or even simple misfortune in relation to the services they provide to clients. Comprehensive Professional Indemnity (PI) insurance is therefore indispensable, although not yet a legal requirement. Many agencies and intermediaries will no longer offer contracts without the contractor being covered by (substantial) PI insurance, so make sure you choose an umbrella that provides the necessary coverage.

4. Funds Management
As a freelancer, you do not generally have the luxury of getting paid when you are not working. Periods of inactivity therefore (e.g. holidays, sickness, idle time between assignments) can cause cashflow to dry up unless you make provisions for setting aside some funds to cover these lean times. Many umbrella companies offer holiday- and sick pay schemes, retaining a fixed percentage of turnover (e.g. 1/12 or 8%) in order to pay freelancers while they are not actively working. Most of these schemes lack flexibility and are of limited use.

Always remember that it is your money - an umbrella company should help you keep as much of it as is legally possible, not dictate how it should be paid to you. Look for a company that provides a flexible funds management solution, allowing you to choose how much, when and even where the turnover you generate is remunerated.

5. Benefits
Unlike regular employees, most freelancers do not have much in the way of fringe benefits. Umbrella companies try to level the playing field somewhat by giving access, amongst others, to pension schemes, private healthcare, life and critical illness insurance and other benefit schemes like childcare vouchers.

Keep in mind that having a link to a provider's website or introducing you to a broker that can sell you an insurance policy is not enough - look for the capability to make employer contributions, deductions or salary sacrifices through payroll and insist on preferential corporate rates.

B. Cost
As with most things in life, where umbrella companies are concerned, you tend to get what you pay for. Service charges vary widely from company to company and are normally calculated either as a percentage of gross turnover (e.g. 3% of the gross value of each invoice raised on your behalf) or as a fixed amount per period (e.g. £50.00 per week). Different pricing structures and additional costs that are sometimes hidden in the fine print make it difficult to compare service charges between different companies, but be aware that cheaper is not always better. If the service is not comprehensive, you will have to incur additional costs to gain access to certain features or benefits elsewhere, which means that the eventual total cost to you might be higher than a comparable (but more feature-rich) package offered by another company.

For instance, many companies offering a fixed weekly/monthly charge can seem cheap when compared to those charging a percentage of turnover (especially if you expect to earn a fairly good rate), until you realise that most of these fixed fee companies do not offer any Professional Indemnity insurance, or do so at a hefty additional cost not included in the fixed fee.

C. Legality and Regulatory Compliance
Unfortunately, there is no shortage of unscrupulous umbrella companies offering quasi-legal or even downright illegal schemes amounting to tax evasion. Most of these schemes are highly complex, depend on some (mythical) tax loophole that is being exploited and often revolve around an 'offshore' company or trust. The Inland Revenue has investigated and stamped out many of these schemes over the last few years and are actively targeting others. You would be well advised to steer clear of any scheme that might make you fall foul of Her Majesty's Revenue and Customs.

As a general rule, unless special circumstances apply (e.g. you are not tax domiciled in UK), British taxpayers are legally required to declare and pay tax on income arising anywhere in the world, so most 'offshore solutions' are useless unless you want to risk breaking the law.

REMEMBER: if it sounds too good to be true, it usually is!

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At PMMC, the suite of services we offer is second to none, as is our understanding of the freelance marketplace. As a Combined Managed / Composite Services Company run by a team with more than 10 years’ experience, we provide the only viable alternative to a freelancer having their own limited company, at a very competitive cost.

We cater for short- or long-term contracts, falling inside or outside of IR35. Our service is tailored not only to the individual and the sector in which they operate, but also on a contract-by-contract basis, leading to the highest possible rate of retention of income under all circumstances.

We are committed to ensuring that our portfolio of services remains fully comprehensive and we give all our employees this promise – if they come across a service or benefit (offered by another service company) for which we have no equivalent, we will strive to add it to our repertoire, as long as it is legal, compliant with current regulations and commercially viable.

Our Service Charges (which include access to ALL services) are set at a maximum of 2.5% of turnover and are tiered, hence the more you earn, the lower the rate will be in relation to your income. There are no setup charges, joining fees or termination penalties. No additional costs are incurred by working directly with a client and not via an agency or intermediary, nor would there be any fees to pay when you are not working on an assignment.

At PMMC, you will find no quasi-legal offshore arrangements, outlawed foreign exchange loans or defunct Employee Benefit Trusts, just a plain and simple vision to help each freelancer to focus on what they do best while retaining as much of their generated income as is legally possible, operating either inside or outside IR35.

Whether looking to become a freelance professional for the first time, mid-way through an assignment or currently between contracts, there has never been a better time to join the ranks of PMMC’s many partners in all sectors of the contracting market: Education & Training, Engineering & Manufacturing, Finance & Banking, Hospitality & Catering, IT & Telecoms, Medical & Pharmaceutical and Sales & Marketing.

About the Author: Johan Steyn has been working as a freelance Enterprise Resource Planning & Management Consultant for 10 years and he is the founder and Managing Director of PMMC (UK) Limited.

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Published: 28/07/2005 (ART001) ©2004-2006