What does Pay As You Earn (PAYE) mean?

By joining a compliant UK-based umbrella company, you become an employee of theirs. As your employer, the umbrella company is legally required to process your payroll with Pay As You Earn (PAYE) – HMRC’s tax system for employees. PAYE ensures that HMRC collects the right amount of income tax and National Insurance Contributions (NIC).

Before joining an umbrella company, you will have agreed to an assignment rate. You will be paid this amount to complete your work for your end-client. The assignment rate is passed from your end client to the agency and then to the umbrella company. The umbrella company, your employer (the entity that pays you) will make the deductions to your pay before transferring your net salary to your personal bank account.

The deductions you should expect to see to your assignment rate when using a compliant umbrella company operating PAYE are:

• Umbrella company margin – Umbrella companies will deduct a margin from your assignment rate before processing PAYE deductions (saving you on tax). The margin is essentially the administrative fee that umbrella companies charge for processing payroll, and this will be discussed and agreed with you before you join an umbrella.
• Income tax
• National Insurance Contributions (NIC) – Employee’s National Insurance Contributions.
• Pension contributions – Your umbrella must automatically enrol you into a pension when you register with them, because as an employer, it’s a legal requirement. However, you can choose to opt out later if you would prefer.
• Student loan repayments – If you are paying back a student loan, your umbrella will process these deductions for you, each time you’re paid.
• Holiday pay – Holiday pay is included in your assignment rate. Most umbrella companies will process holiday pay each time you’re paid. Others will give you the option to have holiday pay accrued and paid to you in a lump sum at a later date.
• Employment costs – Umbrella companies will also deduct the employment costs from your assignment rate. These are not part of PAYE. The employment costs include the Employer’s National Insurance Contributions and the Apprenticeship Levy. When you use an umbrella for payroll, your rate of pay (assignment rate) should account for the employment costs, to ensure that you are no worse off using an umbrella. If you are unsure, please check with your recruitment agency/end-hirer.

Before registering with an umbrella, have your P45 ready, as it will help ensure you are put on the correct tax code. Your umbrella will request a P45; if you cannot provide one, you will need to complete a short online form (New Starter for PAYE).

Compliant umbrella companies will process your payroll in the same way. Therefore, the only deduction that should impact your pay retention between providers is the umbrella company’s margin. For example, suppose you register with an umbrella company with a weekly margin of £20. In that case, you should retain a little bit extra compared to if you registered with an umbrella company with a £30 weekly margin.

Never register with an umbrella company that does not operate Pay As You Earn (PAYE) because they will not comply with UK tax law. Engaging with such an organisation could land you in serious trouble with HMRC because you risk paying the wrong taxes.

Please visit the government’s website for more information about Pay As You Earn (PAYE) tax system.