National Insurance (NI) is the name given to the British social security tax; national insurance contributions are paid by employers, employees and the self-employed to a national fund from which benefits are provided in certain events, such as, unemployment, sickness or other incapacity, maternity, and retirement. In essence NICs are a tax on earned income and are calculated according to an employee’s earnings, and also on benefits in kind that an employer gives an employee.
National Insurance Contributions are divided into four classes, with Class 1 paid by employees (primary contributions) and employers (secondary contributions), Classes 2 and 4 by the self-employed, and Class 3 by anyone wishing to make up payments to meet the requirements for receiving associated state benefits.
People who are self-employed are legally obliged to pay Class 2 National Insurance Contributions as a flat rate payment collected by the Inland Revenue. The weekly contribution rate is £2 for earnings over £4,095 per annum. Contributions are payable between the ages of 16 and retirement age (60 for women and 65 for men). These contributions count for Incapacity Benefit, Retirement Pension, Widow’s Benefit and Maternity Allowance but not for contribution-based Jobseeker’s Allowance. To start making contributions form CWF1 ‘Notification of Self-employment’ must be completed. Any subsequent changes in circumstances, such as a change of address, trading title or even telephone number, should be reported to the Inland Revenue. In addition, a self-employed business may have to pay Class 4 NICs which are based on a percentage of annual profits. It should be noted that a self-employed person does not need to pay NICs if they are sick or have Small Earnings Exception.
Employees are liable to pay Class 1 NIC on their earnings in addition to a further secondary contribution due from the employer but contributions are only due when earnings exceed a ‘primary threshold’ (currently £89 a week). The amount payable is 11% of the earnings above £89 up to earnings of £595 a week. There has been a further 1% charge on earnings above £595 a week since 6 April 2003. Secondary contributions are due from the employer of 12.8% of earnings above the ‘primary threshold’. Employer’s payments have no upper limit and it should be noted that employers providing benefits in kind such as company cars for employees have a further NIC liability under Class 1A. Contributions are payable on the amount charged to income tax as a taxable benefit.
Class 1 contributions and PAYE are payable at the same time (monthly). Class 1A contributions are not due until 19 July after the tax year in which the benefits were provided. Earnings for NI purposes include salaries and wages, holiday pay, bonuses, commissions and fees and certain termination payments. Expense payments will normally be outside the scope of NI provided that they are specific payments in relation to identifiable business expenses. Round sum allowances are not recommended as they give rise to a NI liability. As a general rule benefits do not attract Class 1 NIC liability with the exception of stocks and shares, most vouchers, other assets which can be easily converted into cash and the payment of an employee’s liability by an employer.
Directors are employees of the company and are therefore obliged to pay Class 1 NIC. Employee’s NIC liability is higher than for a Self-employed individual with profits of an equivalent amount. Hence there is an incentive to claim to be self-employed rather than employed. Normally if a person has investment and profit responsibility, managerial control for their operation, the right to employ and dismiss and the right to work and not to work for client, that person is in business for their own account. In practice it can be a complex area where professional advice should be sought at an early stage and in any event certainly before obtaining a written ruling from the Inland Revenue – should Inland Revenue discover that someone has been wrongly treated as self-employed, they will re-categorise them as employed and can be expected to seek to recover arrears of contributions from the employer.
Inland Revenue is expected to make over 100,000 compliance visits annually. It is advisable to keep records supporting any NI payments made as Inland Revenue is entitled to collect any additional NIC that may be due for both current and prior years. Any arrears may be subject to interest and penalties.