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National insurance and the level playing field

John Colville outlines how NI works and why some consider it controversial

May 2017

We have all read about the Chancellor’s U-turn following the Budget in March. First he proposed to increase the rate of national insurance (NI) for self-employed people. Then, in response to pressure, he reversed that decision. The key to understanding this situation is to sort out how the NI regime that applies to self-employed people actually works.
First though, let us just look at why the Chancellor thought it was appropriate to consider increasing the rate of NI. The starting point is the distinction between an employed person and a self-employed person. Broadly, an employed person is under a contract of service, whereas a self-employed person is under a contract for services.
In many cases the category someone falls into is clear-cut. In others, HMRC have a series of questions that help us to determine the correct category. It is also possible for someone to try to arrange their affairs deliberately to fall into one category or the other.
Why does this matter? There are a number of consequences of the different categorisations, some of which relate to employment protection and rights. However, one of the most important is the treatment for NI purposes. An employed person is liable to Class 1 primary contributions at a main rate of 12% and their employer is liable for Class 1 secondary contributions at a rate of 13.8%. Some of the individual’s earnings can therefore be liable at a rate in excess of 25%.
A self-employed person is liable to two classes of NI, Classes 2 and 4. Class 2 is payable at a rate of £2.80 a week. This gives an annual liability of about £146. This applies provided the individual has not reached state retirement age and has profits in excess of a small profits threshold of £5,965.
Class 4 is then a profit-related charge. It ceases in the tax year following that in which the individual reaches retirement age. Class 4 is charged on the excess of the profits of the business over a lower limit of £8,060. On profits, up to the upper limit of £43,000, Class 4 is charged at the main rate of 9% and on profits in excess of the upper limit it is charged at the reduced rate of 2%. It is no wonder that the Chancellor perceived that there was inequity between employed and self-employed persons.
Not only is the main rate of Class 4 less than that of Class 1, but there is no equivalent of the secondary Class 1 paid by employers. It is worth bearing in mind that this is only one side of the story. Employed and self-employed persons are entitled to different benefits and rights as a result of these different contributions, but this will not concern us further here.
The profits on which Class 4 are charged are the same as for income tax. So all the normal rules regarding adjustments of profit, capital allowances, and the current year basis must be applied.
Both Class 2 and Class 4 are collected through the self-assessment system. Both are payable on 31 January following the end of the tax year. However, Class 4 contributions are also taken into account together with income tax in order to determine any payments on account.
There will undoubtedly be changes to the NI system over the next few years. The abolition of Class 2, with effect from April 2018, has already been confirmed. Combined with this there are proposed changes to the limits for Class 4. It will be interesting to see whether in due course more radical changes are proposed including an overall increase in the amount of NI that will be paid by self-employed persons.
• John Colville is a senior tutor for Tolley Exam Training. He can be contacted on 020 3364 4500 or examtraining@lexisnexis.co.uk

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