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How to Pay VAT in a Umbrella Company

Who could benefit from this?

Those who want to work as contractors as a sole trader and have profits inside an umbrella company.

Introduction

There are many myths and misconceptions about how umbrella companies work and many people think that they are not transparent. As a result many companies do not use umbrella companies to their benefit and hence miss out on substantial tax savings. Umbrella companies are now very transparent because of Googles listing of umbrella companies on their search page. There are many benefits for the contractors who use them, because you can separate your profits from your working costs and your tax savings will be kept totally separate from the umbrella company.

Everything you need to know about VAT and the Umbrella Company

The current structure of VAT is that you can reclaim VAT on expenses that are directly related to your business. However, your tax and insurance costs cannot be reclaimed. What does this mean? Well, lets say that you pay £2000 in tax for an year. This is a direct cost to you from your business but you will not be able to claim this against your taxes. However, if you pay the same in insurance for example, you can claim all of it back. This is because you are not working on your own capital. You are working on someone else’s capital. This is the reason why you are usually able to recover the VAT on the services you buy from the umbrella company, but not the tax.

This is one of the reasons that some people think that you are not able to reclaim VAT on the services you get from the umbrella company. Out of principal, they will not be willing to claim it or will ask for money in return for a service. These type of people are unlikely to be found in these circles. Some people in this circle may even be willing to help you get the VAT back but they will demand something in return for the service. This service will usually be that someone else will be benefiting from the service.

When you use an umbrella company you do not pay tax on the profits as you would if you were working as an individual. You also do not use your own capital when you have the services provided to you by the umbrella. You are using the umbrella’s capital and you are paying the umbrella company its corporate tax rate. You do not have to pay corporation tax on the provisional tax that is deducted from your earnings. In fact you will not be liable for this until you have withdrawn the money as a dividend. At the moment there is no capital gains tax at all for umbrella companies. As a result the effective corporation tax rate is very low at the moment as you only pay the VAT on the services you receive. The services that you receive are treated as entirely separate from your main business. This means that you can be very profitable and still not have to pay a great deal of tax.

Now that we have looked at the benefits and the tax rates lets dive into how you can pay VAT in the umbrella company.

How to pay VAT in the Umbrella Company

The process of paying VAT in the umbrella company is operationally simple. As an example we have taken the same type of service that most people do when they work for the umbrella company. The service is that you will provide a service and the umbrella company invoices for that service. Theoretically they will pay you up to the set limit and keep aside any recompense or insurance etc. or whatever they are paying you for. You will then use the money for your own expense. In this example you will be paying insurance, tax and living costs in addition to the costs related to your work. If you are keeping the profit the service could be that you are paying tax and insurance on the profits and keeping the rest as profit yourself. If you are not keeping the profit the service could be that you are paying tax and living costs out of the service. The tax would be on your own income and you would pay the rest on your own expenses. If you are doing this without the profits the service could be that you are getting your tax and insurance paid for by the umbrella company on your earnings.

There are some common services that an umbrella company would pay for (if they weren’t keeping the profits or paying you for the service in full), though it depends on what you are working for and how you are being paid. Common services would be car insurance, tax and even mortgage repayments. If you are using rent-a-room for your living costs you will not need an umbrella company if you are working for the umbrella company but you will definitely want to have an umbrella company if you are not working for them. Some umbrellas pay for tax and insurance on the whole, including your personal costs. To explain the different types of service, we have taken a sample service where you will be keeping the profits or the umbrella is paying tax and insurance on your profits. The most common one is where you are paying insurance and tax out of your service.

Example services

Service One – Profit service

The umbrella company pays tax and insurance on your service and you keep the profits.

Service One – Profit service with tax and insurances

The umbrella company sends you a monthly report and asks for bills from you for any tax or insurance etc. that you have incurred. They send you the service into this report.

Service Two – Service with tax, insurance and profit

The umbrella company pays your tax and insurance out of the service and they ask for bills from you for any tax or insurance etc. you have incurred. They also send you a monthly report and will ask that you pay them a set amount into the report if you have any left over. This will be anything above the tax and insurance that they have paid on your behalf.

Service Three – Service with tax and insurance ONLY

The umbrella company doesn’t pay you anything and they ask you for a bill of the tax and insurance they have deducted from your service.

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