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Umbrella Company explained
Employer of Record vs Umbrella Company: Which Is Right for UK Hiring?
If you are hiring contractors in the UK, you have probably come across umbrella companies. They are a common way for agencies and end clients to pay contractors without taking on the compliance risk of employment. But since the off-payroll rules (IR35) changed, the landscape has shifted significantly.
An Employer of Record (EOR) in the UK is a different model entirely. It employs people as full UK employees, handling payroll, tax, and compliance. It is not a way to pay contractors. It is a way to employ people.
This guide explains how umbrella companies and EORs differ, what IR35 means for both, and when to use each one.
What is the difference between an EOR and an umbrella company?
An Employer of Record (EOR) is the sole legal employer of your workers in the UK. It issues employment contracts, operates PAYE and National Insurance, manages pension auto-enrolment, and ensures compliance with UK employment law. The worker is a full employee with all the statutory rights that come with it.
An umbrella company is an intermediary that employs contractors on behalf of recruitment agencies or end clients. The contractor is technically an employee of the umbrella company, but the arrangement is designed for temporary or project-based work. The umbrella company processes payments through PAYE, deducts tax and National Insurance, and handles invoicing.
The key difference is intent and structure. An EOR is designed for genuine, ongoing employment. An umbrella company is designed to facilitate contractor payments while complying with tax rules.
What is an Employer of Record?
An Employer of Record is a third-party organisation that becomes the legal employer of your UK-based workers. The EOR issues a UK-compliant employment contract, operates PAYE and National Insurance, manages pension auto-enrolment, and ensures compliance with UK employment law.
Your company retains full control over the employee's day-to-day work. You decide what they do, how their performance is measured, and what projects they work on. The EOR handles the legal and administrative side.
The EOR model is designed for genuine employment relationships. The worker receives a proper employment contract, is enrolled in a pension scheme, and gets all the statutory entitlements that UK employees are entitled to: annual leave, sick pay, maternity/paternity pay, and protection from unfair dismissal. You can learn more about how EOR works in the United Kingdom.
What is an umbrella company?
An umbrella company is an intermediary that sits between a recruitment agency and a contractor. The umbrella company employs the contractor, processes their payments through PAYE, and handles tax and National Insurance deductions.
Here is how it works in practice:
- The end client engages a recruitment agency to find a contractor.
- The agency places the contractor with the end client.
- The umbrella company employs the contractor and processes their payments.
- The contractor submits timesheets to the umbrella company.
- The umbrella company invoices the agency, deducts tax and NI, and pays the contractor.
The contractor is technically an employee of the umbrella company, but the arrangement is designed for temporary work. The contractor does not get the same level of protection as a permanent employee, and the relationship is typically short-term.
How umbrella companies work in the UK
Umbrella companies have been a fixture of the UK contracting market for decades. They are particularly common in industries like IT, construction, engineering, and healthcare, where contractors are frequently engaged through recruitment agencies.
The umbrella company handles the PAYE deductions, issues payslips, and makes employer National Insurance contributions. The contractor receives their pay after tax and NI deductions, minus the umbrella company's fee (typically £15 to £30 per week).
Umbrella company regulations
Umbrella companies operate under several UK regulations:
Managed Service Companies (MSC) legislation: Introduced in 2007, the MSC rules target companies that provide services to contractors in a way that reduces their tax liability. If HMRC determines that an umbrella company is a managed service company, the contractor and the company's directors can be held liable for unpaid tax.
Agency Workers Regulations (AWR): The AWR, which implements the EU Temporary Agency Work Directive, gives agency workers the right to equal treatment after 12 weeks in the same role. This includes pay, holidays, and working conditions.
Employment Agency Standards (EAS): The EAS Inspectorate enforces minimum standards for employment agencies and umbrella companies, including the right to receive itemised payslips and protection from unlawful deductions.
EOR vs umbrella company: key differences
With an EOR, the worker is a genuine employee. They have a permanent (or fixed-term) employment contract, are enrolled in a pension scheme, and receive all statutory entitlements. The employment relationship is designed to be ongoing.
With an umbrella company, the worker is technically an employee, but the arrangement is designed for temporary or project-based work. The contractor typically has a contract for services with the agency, and the umbrella company processes payments through PAYE. The relationship is inherently short-term.
An EOR provides a full employment service: contracts, payroll, tax, pensions, benefits, compliance, and HR support. It is a comprehensive solution for employing people in the UK.
An umbrella company provides payroll processing and tax compliance. It does not provide HR support, performance management, or the broader range of services that an EOR offers.
EORs operate across multiple countries. If you are hiring in the UK, Germany, and Australia, a single EOR can handle all three markets.
Umbrella companies are UK-specific. They are designed for the UK contracting market and do not operate internationally.
EOR costs are typically a fixed monthly fee per employee, ranging from £300 to £700. This covers the full range of employment services.
Umbrella company costs are usually a weekly fee (typically £15 to £30 per week), plus the employer's National Insurance contributions and pension contributions. The total cost depends on the contractor's rate and the umbrella company's fee structure.
Tax implications: umbrella PAYE vs EOR employment
The tax treatment of workers paid through an umbrella company versus employed through an EOR is different, and it is worth understanding the implications.
Take-home pay comparison
A contractor paid through an umbrella company receives their pay after the following deductions:
- Income tax (via PAYE)
- Employee National Insurance (8% on earnings between £12,570 and £50,270)
- Umbrella company fee (£15 to £30 per week)
- Employer National Insurance (paid by the umbrella company, but often factored into the contractor's rate)
- Pension contribution (auto-enrolment, minimum 5% employee contribution)
An employee paid through an EOR receives their pay after:
- Income tax (via PAYE)
- Employee National Insurance
- Pension contribution (auto-enrolment, minimum 5% employee contribution)
The key difference is that the umbrella company fee reduces the contractor's take-home pay, and the employer's National Insurance is often effectively borne by the contractor (through a lower day rate). With an EOR, the employer's NI and pension contributions are paid by the EOR on top of the employee's salary.
Employer costs
For the end client, the cost difference is significant:
Umbrella company: The end client pays the agency, which pays the umbrella company. The umbrella company deducts employer NI, pension contributions, and its fee before paying the contractor. The total cost to the end client is the contractor's day rate plus the agency margin.
EOR: The end client pays the EOR a monthly fee per employee. The EOR handles all employer costs (NI, pension, apprenticeship levy) on top of the employee's salary. The total cost is the employee's salary plus the EOR fee.
IR35 and the off-payroll rules
IR35 is the single biggest factor in the EOR vs umbrella company debate.
Understanding how it works is essential.
What is IR35?
IR35 is tax legislation that determines whether a contractor is genuinely self-employed or is, in reality, working as an employee. If a contractor falls inside IR35, the business that engages them must deduct PAYE and National Insurance as if they were an employee.
The off-payroll rules, which were reformed in the private sector in April 2021, shifted the responsibility for determining employment status from the contractor to the end client (if the client is a medium or large business). This means the end client must assess each contractor's IR35 status and, if the contractor is inside IR35, ensure that PAYE and NI are deducted.
How IR35 affects umbrella company workers
Umbrella companies are commonly used for contractors who are inside IR35. Because the umbrella company employs the worker and processes payments through PAYE, the IR35 risk is effectively removed. The contractor is treated as an employee for tax purposes, and the end client does not need to worry about IR35 determinations.
However, this comes at a cost. The contractor loses the tax advantages of self-employment, and the umbrella company fee reduces their take-home pay. The arrangement is also inherently temporary, which means the contractor does not get the same level of protection as a permanent employee.
How an EOR handles IR35 compliance
An EOR eliminates the IR35 question entirely. Because the worker is a genuine employee from day one, there is no ambiguity about employment status. The worker is employed, paid through PAYE, and receives all statutory entitlements.
This is one of the main advantages of using an EOR over an umbrella company for roles that are genuinely ongoing. The worker gets proper employment protection, the end client gets certainty about compliance, and there is no risk of an HMRC investigation.
If you want to understand IR35 in more detail, see our guide to IR35.
When to choose an EOR over an umbrella company
An EOR is the right choice when:
If you are hiring someone for a permanent or long-term role, an EOR provides proper employment protection and compliance. An umbrella company is designed for temporary work.
An EOR employs the worker from day one, so there is no ambiguity about employment status.
If you are based outside the UK and want to hire someone in the UK, an EOR handles everything. An umbrella company requires a UK agency in the chain.
Workers employed through an EOR get a proper employment contract, pension, and all statutory entitlements. Workers paid through an umbrella company are technically employed, but the arrangement is less secure.
If you have been using contractors and want to move them onto proper employment contracts, an EOR can handle the transition. The EOR issues a new employment contract, sets up payroll, and ensures the employee receives all statutory entitlements from day one.
When an umbrella company makes sense
An umbrella company is the right choice when:
If you need a contractor for a specific project with a defined end date, an umbrella company provides a compliant way to process payments.
If the end client has determined that the contractor falls inside IR35, an umbrella company provides a straightforward way to process payments through PAYE.
Some contractors prefer to work through umbrella companies because it gives them flexibility to work for multiple clients.
Umbrella companies are designed to work within the agency chain, and many agencies have preferred umbrella companies that they work with.
From umbrella to EOR: the transition path
Many businesses start by engaging contractors through umbrella companies and then transition them to employment through an EOR. This is common when:
- The contractor's role becomes permanent.
- IR35 changes make the umbrella arrangement less attractive.
- The business wants to offer better employment protection.
- The contractor requests a permanent employment contract.
The transition process is straightforward. The EOR issues a new employment contract, sets up payroll, and ensures the employee receives all statutory entitlements from day one. The umbrella company arrangement ends, and the worker becomes a full employee.
If you are considering this transition, our guide to the best Employer of Record providers in the UK can help you choose the right EOR for your needs.
Agility EOR is far more than just a service provider. We’re flexible, innovative and focused on outstanding client service. Supporting you every step of the way – and valuing your people as the cornerstone of success.
Frequently asked questions
An EOR is the sole legal employer of your workers and provides full employment services. An umbrella company is an intermediary that processes contractor payments through PAYE. An EOR is for genuine employment; an umbrella company is for temporary or project-based work.
Yes, umbrella companies are legal and widely used in the UK. However, HMRC has been increasing scrutiny of umbrella companies, particularly those that fall foul of the Managed Service Companies (MSC) legislation. It is important to use a reputable umbrella company that complies with all relevant regulations.
Umbrella companies are commonly used for contractors who are inside IR35. Because the umbrella company employs the worker and processes payments through PAYE, the IR35 risk is effectively removed. However, the contractor loses the tax advantages of self-employment.
It depends on the nature of the role. For temporary or project-based work, an umbrella company may be appropriate. For ongoing roles, an EOR provides better employment protection and typically a more favourable cost structure for the worker.
Yes. The EOR issues a new employment contract, sets up payroll, and ensures the employee receives all statutory entitlements from day one. The transition is straightforward and can be completed in a matter of days.
The MSC rules, introduced in 2007, target companies that provide services to contractors in a way that reduces their tax liability. If HMRC determines that an umbrella company is a managed service company, the contractor and the company's directors can be held liable for unpaid tax.
Speak to an expert
If you are considering using an Employer of Record in the UK, Agility EOR can help. Our team of CIPD-qualified specialists handles contracts, payroll, tax, and compliance, with a dedicated account manager for every client. Get in touch to find out how we can support your UK hiring.