What is an umbrella company? Insights and considerations

There’s no question about the demand for umbrella company services. With so many multinational companies nervous about what constitutes a full-time salaried employee, interest in partnering with umbrella companies is quickly growing.

For instance, in the U.K., where a new tax law known as IR35 changes the way companies designate contractors, 91% of professional recruitment firms say they’re “turning to umbrella companies.”

Companies seeking to expand globally, but who need help paying foreign contractors accurately and efficiently, can benefit by partnering with an umbrella company. If, that is, they do some much-needed due diligence first.

An umbrella company is a third-party company that handles payroll for professional contractors on behalf of client companies.

Usually, client companies include multinationals expanding overseas or professional recruiting companies that often need solid contracting help, but don’t want to deal with the payroll and tax compliance issues that can arise when hiring in foreign countries.

The key benefit of such a provider is that it offers quality contractors and handles the contractor payroll requirements while also reducing tax and compliance liabilities.

Here’s a snapshot of what both client companies and contractors can expect.

Client company: The umbrella company enables a client company to hire an employee on a contract basis, without the legal entanglements and benefit obligations of hiring a full-time salaried employee.

Because it’s the umbrella employing the contractor, the client company operating overseas doesn’t have to create a foreign entity and avoids a host of potential regulatory problems—especially with thorny tax and immigration statutes.

Contractor: The contractor not only signs an agreement with and gets paid by the umbrella company, that company also provides full employment rights. Those rights may include health benefits, access to a retirement fund, holiday and sick pay, and HR services.

The contractor pays a fee, or has that fee deducted from their paycheck, to have the umbrella provider handle their paycheck, along with accompanying tax withholding obligations and HR benefits, perks and services.

If you’re looking to add to your foreign workforce and want to hire more contractors, an umbrella service is certainly worth a closer look. When you get to that juncture, target these key areas of focus before signing on the dotted line.

Operationally, here’s how an umbrella service works.

A contractor will complete 40 hours of work for ABC Company. The umbrella provider will issue an invoice to ABC Company for that contractor’s work, receive payment and transmit it to the contractor, and handle all the payroll requirements stemming from that payment.

Although the responsibilities of an umbrella provider may vary, its primary responsibility is payroll-related. It mostly handles common payroll paperwork on behalf of contractors, such as processing invoices, reviewing and approving timesheets, and paying contractors after deducting appropriate taxes.

The contractor completes their on-the-job tasks, logs their hours on a timesheet or files an invoice, and submits the information to the umbrella for payment. In some instances, the contractor may have to file an expense report, which also goes to the umbrella, and is then submitted to the client company for payment.

To the contractor, the entire process is transparent. They file an invoice and get paid by the umbrella company, which turns around and bills the client company where the contractor actually works.

Although there are several benefits to partnering with an umbrella provider, there are potential downsides.

For example, contract employees are essentially freelance employees, and may not be legally bound to protect intellectual property agreements. An umbrella provider does not protect any intellectual property or trade secrets.

Finding a reputable provider in a foreign country can be a challenge, as well. Make sure to thoroughly vet any umbrella companies you’re considering, and ensure they actually have legal contracts available for the contractors they offer to companies (some say they do, but actually don’t). Here are some ways to protect your company:

Ask for references. You’ll want the opportunity to interview and vet any contractor the umbrella team offers for potential work. Any reluctance to allow that process to happen is a red flag.

Also ask business partners and overseas contacts for recommendations. References from trusted business associates in the foreign country your company is entering can mean the difference between having a good umbrella experience or a negative one.

Hire a global employer of record. There is another way to handle international payroll and employment for overseas operations—hire workers through a third-party employer of record.

Contrary to an umbrella provider, whose main objective is to provide payments to contractors, an employer of record, like GEO, ensures your workers’ welfare during their time of employment, providing compliant employee contracts in local languages, salary payments in local currencies and competitive employee benefits packages.

Below are some key differences between an umbrella provider and GEO:

With GEO you can meet your international hiring needs as easily as you would in your home country without having to set up a foreign entity. And by hiring contractors as employees, you'll gain more control over your workforce in a market that could prove beneficial in the long term.

Talk to a global solutions advisor today, and take the first step in being fully compliant with foreign employee payroll and HR requirements.