An Umbrella company isn't the only method of trading there is for contractors. For most freelancers an Umbrella company will be the simplest and most straightforward way to do things, but for the minority it may be worth checking out the alternatives to an Umbrella company.

Agency PAYE

Some recruitment agencies will be big enough to have their own payroll department that can payroll contractors as well as their own staff. In this instance, you would become an employee of your agency, and your agency would become your limited company.

This way of operating in probably the simplest method there is, but also financially the worst for you. You are not permitted to claim any business expenses, and your entire salary is subject to income tax & National Insurance.

Going 'agency PAYE' may be preferable if your contract is just for a day or two. However, for many agencies the hassle & administration burden it involves means it's usually just not worth their while to provide such a service. They are likely to suggest you find an Umbrella company.

Running your own company means you become liable & responsible for the correct administration of the business - in addition to fulfilling your contract on a daily basis. You will be a director, with obligations and be responsible for the compliance of the business. There are many detailed and intricate laws to learn, across a wide range of disciplines. Though extremely hard work, it can sometimes be just as rewarding.

• IR35 legislation is an essential factor, which you will need to be fully aware of and make the crucial decision as to whether or not you are caught. You need to make that judgement on each & every contract you accept. You will probably have to pay for specialist legal advice just to be sure.
• Invoicing. Every time your client signs one of your timesheets you then need to invoice your agency - based on the authorised hours and your rate. Make sure you send your invoice, in the correct format, to your agency before any deadlines to avoid having to re-do it and frustrating delays.
• Keeping records. You need to have procedures in place to note all and any transactions you make on behalf of the company, eg invoicing, collecting due monies, making payments etc. in a manner that will be acceptable to HMRC.
• Getting Paid. You'll have to organise for your payslips to be prepared throughout the year, and make sure you pay the right tax at the right times. You'll also have to file your P35, P14, P60 & P11D with HMRC by specified dates.
• HMRC. You'll have to send company accounts in every year. On time otherwise face a fine.
• Companies House. They'll issue you a company annual return that needs to completed and sent on to Companies House, along with their annual fee.
• VAT. Every 3 months you have to complete a VAT return.

An Umbrella company acts as employer to independent contractors who work under temporary contract, usually through a specialist employment agency.

Recruitment agencies will only issue contracts to a Limited Company; since the introduction of the MSC (Managed Service Company) legislation in the budget of 2007 the only way a contractor can comply with this requirement is to set up their own personal limited company or to use an Umbrella company.

An Umbrella company issues invoices to the Recruitment Agency (or client) and, when payment of said invoice is made to the Umbrella company, will typically pay the contractor through PAYE (although historically the term has also been used for salary and dividend type payment structures).

Umbrella companies have become more prevalent since the government introduced so-called "IR35" legislation that makes it less beneficial to start your own company and relatively more attractive to join an Umbrella company.

In December 2006 the UK Treasury introduced the above mentioned draft legislation "Tackling Managed Service Legislation" whose purpose was to address the use of "composite" structures to avoid Income Tax & National Insurance on forms of trading that the Treasury deem as being akin to "employed".

• After a period of consultation and re-draft, the new legislation became law in April 2007 with additional aspects coming into force in August and fully in January 2008.

PAYE Umbrella companies are effectively exempted from the legislation, which also seeks to pass the possible burden of unpaid debt (should a provider "collapse" a scheme) to interested parties e.g. a recruitment agency that has been deemed to encourage or facilitate the scheme.

Whilst many of the Umbrella companies advertise similar offerings, much of the detail should be checked by the user.

• Often Expenses are used as a selling point with potential abuse of "dispensation" (HMRC issue documentation to employers as a more effective way to record Expenses rather than as a method of generating more income) agreements. It is the independent temporary contractor that will be liable should HMRC decide for instance that Expenses have been incorrectly claimed.

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