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NATIONAL INSURANCE is it still fit for purpose

NIC is in a bit of a pickle

With Jeremy Hunt’s ‘Autumn Statement’ just released, the most significant announcement was on changes to National insurance (NI), which has always been an oddball member of the UK’s tax family, with even its name prompting confusion over its status: Is it a tax? Or is it Health Insurance?

History of National Insurance – Part 1

National insurance has had something of an identity crisis since the scheme was conceived in 1911. This is because NI was originally created as two schemes running in parallel. One scheme was to provide workers with health and pension benefits and the other to provide unemployment benefits.; with each run by completely separate bodies. Eventually the two schemes were merged into one in 1948 to support the welfare state and the creation of the National Health Service.

In the early days paying National Insurance Contributions (NIC) gave the contributor entitlement to specific social security benefits. But nowadays, there is virtually no connection between the amount of NICs paid and the level of benefits received, with the single exception of your entitlement to a state pension.

When NI started, workers would buy stamps at a flat rate per week to attach to their NI card, with employers always having to make a separate flat rate contribution per worker. The big change came in 1975 when the flat rates of contributions being replaced with a percentage of earnings collected via PAYE alongside income tax.

The only remaining legacy of the old scheme is the flat rate of Class 2 NI paid by the self-employed, which has always been a curious relic of days gone by in the tax system. The current Class 2 rate for the 2023/24 tax year is £3.45 per week, but this left-over element is set to be abolished in April 2024.

History of National Insurance – Part 2

The rate of NIC paid by an employer hovered around 10% of the employee’s earnings until 1999, when it jumped to 12.2%, with a slightly lower rate for contracted-out employees. 1999 also saw a surge in workers who switched to operating through their own limited companies, known as PSCs.  This allowed the company that workers provided their time/services to (known as the engager) to avoid paying employer’s NIC, notably when PSCs and micro businesses became exempt from audit in 1994.

In April 2000 there was a second surge of small businesses changing their status from partnership or sole trader to that of a small, limited company.  This was as a direct result of Gordon Brown introducing the 10% starting rate of corporation tax, (reduced to nil in 2002). This allowed these micro businesses to incorporate and pay no tax at all on income of up to about £50,000 per year, as long as profits were extracted using a combination of small salary and dividends.

The law of unintended consequences: IR35 & NI

The attractive combination of easy incorporation and major tax savings encouraged employers to push skilled workers off their payrolls into PSCs, although many of those individual workers were more than happy to take control of their own businesses and pay their own tax at a much lower level than before. Gordon Brown realised very quicky that he’d fallen foul of the law of unintended consequences and moved quicky to counter the massive loss of employer’s NIC, by introducing the IR35 rules which in theory placed the NIC burden back on to the employers.

In practice however, after significant lobbying by large businesses, the responsibility for judging whether income from contracts should be treated as employment income was handed back to the operators of the PSCs. It will not surprise you, that just as turkeys are reluctant to vote for Christmas, the vast bulk of PSC and micro company owners, interpreted the IR35 rules rather generously.

In recent years, HMRC have tightened up the IR35 rules, so most large employers now use unregulated umbrella companies to take on the responsibility of calculating payroll taxes for contractors. HMRC is currently consulting on solutions to this issue but we are still waiting for its decision on what happens next.

Why not merge the two?

Accountancy bodies have said that the problem of off-payroll working can only be solved if the total amount of tax & NIC paid by individuals and employers was the same, and that this should also include the self-employed. They went even further and suggested merging income tax and NI. If this was done, then employees would see little difference in their take-home pay and more importantly, the incentive to operating under a PSC would pretty much disappear.

However, other taxpayers would be subject to lower rates of income tax on pensions, rents, and dividends. The fairness of having different income tax rates for different types of income would need to be addressed, as well as the NIC exemption that currently applies to anyone over state pension age. The other major barrier to a full merger with income tax is how to fill the £100bn hole created by abolishing employer’s NIC.

If not merger, why not align NI’s?

If the Chancellor deems that a merger is too difficult, perhaps he should consider closer alignment between income tax and NIC.  In 2016 The Office of Tax Simplification identified a number of relatively easy steps to bring the two taxes into much closer alignment. Unfortunately, as at today’s date, not one of those steps has been implemented by the government. Perhaps it is time to think imaginatively about the NIC paid by both employers and individuals. but the sticking point will always be employer’s NIC.

My somewhat radical solution would be to consider abolishing employers’ NIC. After all, many on both sides of the political divide, consider it a tax on employment, but as £100bn is a rather big hole, it will need to be replaced by an increase in Corporation Tax or perhaps a flat charge of, say 10%, on the company’s Net Profit before dividends, just a thought!

NI & November Autumn Statement

On Wednesday, with a fiscal windfall of £26bn to play with after inflation fell to 4.6%, Jeremy Hunt was able to turn his attention to cutting taxes and top of his list was NI. Wef 6th January 2024, Class 1 NIC will be cut from 12 to 10%, with the self-employed Class 4 rate falling by 1% on 6th April 2024, plus he’s abolishing the SE Class 2 rate of £3.45 per week from the same date. But no change in employers, NIC.

Tax Accountant’s view

There were a few other more modest changes announced by the Chancellor, but the reductions to both the employed and self-employed NI, were by far the biggest. Unfortunately, dear old Jeremy did not take any of the alternatives on offer, many contained in this article, perhaps when he’s had time to reflect, he’ll do something more radical in the Spring Budget. We can but hope!