Alan Pink looks at ways of mitigating the recently announced increase in National Insurance contributions rates or even avoiding the charge altogether.
In what has turned out (not entirely surprisingly) to be a controversial move, the present government has announced an increase of 1.25% in National Insurance contributions (NICs) rates, ostensibly to cover increased care costs.
Double the trouble?
The 1.25% increase in employee’s NICs received a lot of publicity, but less well-publicised was an increase of the same amount in the employer’s NICs. No doubt the lack of attention given to this in the media generally is because employers are in a minority; however, arguably this is effectively a 2.5% increase in practice because the government is taking this amount extra out of a company’s budget to pay their staff.
I’ve always thought that ‘employer’s NICs’ is a serious misnomer in any event. As far as I can see, the payment of employer’s NICs doesn’t give rise to any entitlement to state benefits for staff. It would arguably be much more honest if this was referred to as what it effectively seems to be – a payroll tax.
Of course, NICs planning is a very big subject; so, to make it manageable, this article will be concentrating on how a business can reduce its payroll tax (sorry, employer’s NICs) liabilities on its workforce. I won’t be looking so much at the NICs saving options for owner managers’ own income taken out of the business, but merely on those third-party workers on whom the business depends for its operation. So, here are a few ideas for business owners to consider.
Service providing companies
On the face of it, a good way to avoid having to pay employer’s NICs is to use a third-party service provider; for example, a firm of cleaners rather than employing your own cleaner. But, of course, the apparent advantages of going down this road are likely to be illusory in practice, because if you’re paying another agency to provide staff in this way, you’ll effectively be bearing the cost of the employer’s NICs that those third-party businesses are paying – together with a profit element for them, over and above what the actual cost of the people’s time is.
The real advantage of third-party service providers is likely to be not so much the saving on cost, including NICs, as avoiding being involved in a direct employment relationship, together with all the responsibilities and potential legal problems that entails.
Paying staff in dividends
Again, this is a superficially attractive option until you consider some of the potential drawbacks which may arise. Dividends are still (except in fairly exceptional cases) considered to be investment income by HMRC, even if their true commercial purpose is to reward workers for their services.
If you know that this is how you’re going to do things, right from the original formation of the company, it’s comparatively straightforward to issue shares to workers as well as to the ‘true’ equity owners of the business. By making each issue of shares to the workers a different class, you can ensure that dividends are paid in different amounts, depending on the input of each person. Hence, the common name of this arrangement is the ‘alphabet share’ scheme.
But what about the situation where you’ve got a pre-existing business in a company which only has equity shares issued at the present time? It seems to me that there’s a real difficulty about issuing the alphabet shares in an already existing and valuable company. Under the income tax rules, any shares issued to someone working in the business, which are not paid for at their full current value, result in a taxable benefit on the individual concerned.
Of course, you can argue that the shares issued to John Smith and Albert Brown have no value on issue because they are only actually going to pay dividends, give no rights over the capital (equity) value of the company, and carry no right to vote. These are good arguments, but it isn’t beyond the realms of possibility that HMRC could take a different view. Specifically, a share issued to John Smith, which then immediately starts paying dividends of £2,000 or £3,000 a month, could easily be argued by an HMRC officer to have a value on issue which is more than just the nominal £1 or so that the shares are issued at. So there is a potential comeback in terms of up-front income tax charges.
Self-employment
But are we actually trying to be too clever, issuing a lot of alphabet shares to the various workers? Let’s return to first principles. Employer’s NICs, along with employee deductions and PAYE, only apply where you are paying someone who is an employee of the business. I suspect that very often, this is the default option chosen by a business paying an individual for their personal services because it’s risk-free, as compared with the idea of their setting up as a separate freelance contractor. Advisers quite rightly warn against paying people gross (without deducting PAYE or accounting for NICs) as if they were self-employed when their correct categorisation might actually be as employees. The employer is vulnerable to demands for arrears of deductions going back several years.
However, the whole concept of the difference between employment and self-employment is largely based on outdated notions of the relationship between a worker and the person they’re working for. In particular, the Victorian phrase refers to a ‘master and servant’ relationship. Yes, it’s easier not to think about these difficult ideas and distinguish true employment from self-employment by considering all the details of the working relationship. But simply putting all such people on the payroll could be costing the business huge amounts of employer’s NICs that it doesn’t really need to be paying.
Personal service companies
A small business can easily avoid paying any employer’s NICs on its workers’ services if they supply those services through personal service companies. So instead of Mr A and Ms B being paid for their services to the business, they set up A Limited and B Limited, which invoice the business. This is where the dreaded ‘IR35’ comes in. IR35 is a set of rules that effectively imposes PAYE and NICs on intermediary companies like this where the relationship, if you ignored the existence of the intermediary entity, would be one of employer and employee.
However, IR35 has been a great disappointment for HMRC – to the extent that they have had to change the rules a number of times, including putting the onus of deciding whether IR35 style PAYE/NICs liabilities are due on the paying entity where that is either in the public sector or a large or medium-sized private sector business.
All these changes are, of course, intended to have a dampening effect on employers’ or businesses’ enthusiasm for paying personal service companies instead of individuals. But undoubtedly, it’s still the case that small private sector employers are able to pay their workers through companies without any fear of IR35 repercussions. The onus with small businesses is on the personal service company itself.
Partnerships and LLPs
For those who are absolutely central to the business and earn substantial amounts of money, it’s always worth considering whether they could actually become partners in the business, or members of a limited liability partnership (LLP) which runs the business. This is even possible where (prior to the new arrangements) the business is carried on by a limited company. The company can enter into a partnership or become a member of an LLP and ‘hive down’ its business into that partnership or LLP.
In very broad terms, the question as to whether this is effective (or on the other hand, risks HMRC claims for PAYE), depends on similar factors to the self-employment/IR35 scenarios. If the individual concerned is sufficiently senior, and in the case of an LLP (for example) exerts a significant influence over the way the business is run, they will enjoy self-employed status, and their earnings will be freed from the imposition of 15% plus employer’s NICs.
