Historically umbrella companies were schemes set up to avoid paying the PAYE and national insurance relating to employees. The Managed Service Company Legislation introduced in 2007 has closed all the ‘loopholes’ that allowed this type of scheme and now treats all payments under an umbrella scheme as subject to PAYE and employees and employers Class 1 National Insurance.
The umbrella schemes still exist, but now treat all income as either expenses or PAYE income.
The use of umbrella schemes should be avoided. They are offered to directors of small companies as an easy way to manage their business, but in reality they devolve the decision making to the umbrella company but leave the worker with the liability, and operating using a PAYE Umbrella means that all your income will be treated as though you are caught by IR35, regardless of the actual IR35 status of each contract.