Umbrella Companies compared to Employee Benefit Trusts
Many freelance contractors in the UK are currently opting for alternative tax solutions to the traditional and somewhat outdated structures of Umbrella Companies and Managed Service Companies. These days, many self-employed contractors are now joining a new kind of tax solution known as an Employee Benefit Trust. And although the many advantages of Umbrella Companies are well known (when compared with Managed Service Companies) it is worth examining which option nowadays is more advantageous for contractors - the Umbrella Company or the Employee Benefit Trust (EBT)?
Pre-2007 most freelance contractors used Managed Service Companies (composite service company structures designed to manage accounts, invoices and any other kind of general admin). These contractors would become shareholders in the Managed Company but would not have to deal with any of the management or general admin traditionally taken on by directors. With an MSC such tasks would be handled by a service-provider, allowing the independent contractors to concentrate on contracting and collecting their salary in a more efficient contracting environment.
Ever since the arrival in 2007 of legislation dealing with the formation of Managed Service Companies’ in order to avoid paying National Insurance and income tax, Umbrella Companies and thereafter Employee Benefit Trusts (neither of which are affected by the MSC legislation) became the de facto choice for the smart independent contractor.
Umbrella Companies are essentially companies that act as employers to self-employed contractors who work on fixed term contracts and which remove the irritation of organizing invoices, payment collection from clients and agencies, calculating tax and deducting national insurance. The individual self-employed contractors will go about their contracted employment as usual, but at the end of the month they have only to submit expenses and timesheets to their chosen umbrella company. Thereafter their umbrella company handles all the paperwork.
A great many self-employed or portfolio contractors have in recent years moved once again, this time from Umbrella Companies to Employee Benefit Trusts which also offer many further advantages.
Employee Benefit Trusts could best be described as discretionary trusts set up by some employers for the benefit of all their employees. An Employee Benefit Trust for freelance contractors is therefore such a discretionary trust established specifically with freelance contractors in mind, who will become ’skilled employees’ of their company providing the EBT and who are then in a position to take advantage of their EBT’s tax solution. The company running the trust will pay the contractor a minimum wage, from which PAYE and NIC are deducted. Thereafter, the rest of the contractor’s wages will be paid into the Employee Benefit Trust. After this, the Trust makes a loan to the contractor for the balance of the pay owed.
Which then is the smarter option? Clearly Employee Benefit Trusts offer all of the advantages of umbrella companies from the delegation of invoices and paperwork and director’s responsibilities to not being subject to the MSC legislation; with none of the problems. Moreover an Employee Benefit Trust, unlike an umbrella company, requires no expenses or timesheet submissions. Moreover, they also provide job-security for their contractors who are given full employment rights and benefits.
Lastly, an EBT also offers a far better gross to net earnings ratio than an umbrella company. An umbrella company will generally offer around 65% gross to net whereas an EBT can give a massive return on contract earnings of up to 85%.