Alan Pink looks at ways that businesses can avoid overpaying National Insurance contributions to HMRC.
National insurance contributions (NICs) are often overlooked in tax planning, but are a major source of income for the Government. Many regard NICs as being no more, effectively, than another tax. I have to say that this point of view has a lot going for it.
First of all, let’s look at the basics. If you’re a sole trader or a partner (including a ‘partner’ in a limited liability partnership), some of the ways of saving NICs are the same as straightforward planning techniques to cut down the size of your income tax bill.
For example, if you’re a sole trader liable to NICs at the self-employed rates on all your income over about £12,500 a year (currently), you can reduce this by sharing the income with another (often a spouse or ‘significant other’) who can be brought in as a partner in the business. They have their own NICs threshold just as they have their own income tax personal allowance, if they’re not using it elsewhere. So a worthwhile NICs saving can be gained by this relatively straightforward arrangement.
Employee or partner?
Another way of achieving a similar result, which tends to be more popular in practice than bringing in a spouse or similar as a partner, is paying them a wage.
If the wage is below the NICs threshold, it reduces the trader’s profits and therefore reduces both their income tax and NICs liability. But this alternative, whilst in some ways more straightforward because it involves no structural changes to the business, has to come with a health warning. Wages (unlike a partnership profit share) must be justifiable, if HMRC ever ask, by reference to the work that the other person actually does. Unless you can show that you would have paid someone unconnected just as much money for their services to the business, you can end up with HMRC disallowing the wages as an expense.
In practice, HMRC don’t seem to attack partnership profit shares on the same basis, and in my view this is because there’s a difference in principle between sharing out profits between a number of people and claiming that your profits have been reduced by an expense.
Limited companies
But you might be saying that the obvious answer is staring us in the face. Limited companies don’t pay NICs, because only individuals are within the scope of this ‘tax’. So why not run your business as a limited company, and eliminate all the NICs?
Well, the seemingly simple solution to the problem of paying NICs turns out to be not quite so simple when you look at it a little bit further. Of course, if you put your business income through a limited company, and the company then pays you director’s remuneration, you’re back in the position of paying NICs. The NICs on your wages will probably be a significantly higher figure, in fact, than you would have paid as a sole trader or partner, because the rates of NICs are higher for employment income than for self-employed income. In the employment sphere, the rate of contributions on earnings equivalent to basic rate income tax is currently 12%, as against 9% for the self-employed. And in the employment sphere you also have employer’s NICs at 13.8% to pay, for which there’s no equivalent in the self-employment regime.
But of course, you don’t have to pay yourself an income from the company as remuneration. If you’re a shareholder in the company, and the situation is a relatively straightforward one, you can pay yourself in dividends, which don’t attract NICs. This was a lot better planning before the ‘dividend tax’ was introduced a few years ago, because currently there is effectively an additional levy of 7.5% or thereabouts when money is taken out of companies in dividend form.
To take a simple numerical example, let’s assume you’ve got £10,000 of income which is within your 20% income tax band. In most cases, the rate of self-employed NICs on this £10,000 will be 9% (i.e. £900). But if you pass this £10,000 through your own personal company instead, you need to take into account the effect of both corporation tax and income tax. At the current corporation tax rate of 19%, the company would pay £1,900 on this slice of income. This then leaves, at least notionally, £8,100 to pay out to you as a dividend. As it’s within your basic rate band for income tax, the ‘dividend tax’ on this is 7.5%, so you pay another £607.50 in income tax. The total rate of tax you’ve paid is just over 25%, which isn’t so much better than 29% (20% income tax plus 9% NICs) that you would have paid as a sole trader.
The sums change radically again if you’re likely to be in the new 25% corporation tax rate that was announced in the last Budget as coming into effect from 2023.
Other methods of profit extraction
All the above numbers really just illustrate that you need to ‘do the sums’ in each case, or ask your accountant to do so, if you’re deciding whether it’s better to go down the company and dividend route, thus saving NICs, or go down the sole trader or partner route. The amount you end up with after tax and NICs combined is the only important figure. But there are other ways of extracting income from a company which give you ‘the best of both worlds’.
If you have a loan outstanding to your company, perhaps a director’s loan account, consider paying interest on this at a commercial rate (interest paid over a commercial rate is effectively treated as if it were dividends). Like dividends, interest is treated by the NICs system as unearned income, and therefore there are no NICs on this. There is an administrative issue with paying interest, though, which you need to be aware of, and this is the need to deduct tax on interest payments by the company and account for it to HMRC quarterly. This administrative burden can take some of the gilt off the NICs saving gingerbread.
No such disadvantage applies to rent paid by your company for occupying a property that you own personally, which the company uses for its business. This need not necessarily be a large factory or office building; it could even be part of your home that the company occupies for business purposes. But like interest, rent is treated for NICs purposes as unearned income, and therefore outside the scope of NICs completely.
And then, of course, there are other ways of taking money out of the company which aren’t income at all, and therefore save both income tax and NICs. The simplest form of such profit extraction is a repayment of amounts owed to you by the company, on director’s loan account or similar. And if the company doesn’t owe you anything, look at any possible ways of bringing about the situation that it does, as in the following example.
Example: Transferring an asset to the company
Griselda owns a Tesla electric car, which she sometimes uses to visit the clients of her consultancy business. She incorporates this consultancy business in Griselda Limited, and transfers the car to the company.
There is no capital gains tax on cars, so no tax liability arises on this transfer. But it results in a credit in Griselda’s favour, which she can then draw down tax-free out of the consultancy income passing through the company. And from now on, all the depreciation on the car is suffered by the company, of course. At present, the benefit-in-kind rules are favourable to electric cars.
One more thing…
This article has concentrated entirely on the direct NICs liability that hits your business income, and ways of reducing or eliminating it. Arguably an even bigger scourge on business, if that business employs a lot of people, is this so-called ‘employer’s NICs’ charge. But eliminating that needs to be the subject of a separate article.
