Workers who set up private companies to avoid paying higher National Insurance contributions may face tougher rules after an overhaul by HM Treasury, the BBC reports.
HM Treasury is currently reforming its IR35 tax rules to target workers claiming self-employed status by setting up ‘personal services companies’, thereby paying less tax, according to a report by the BBC. A rule change may force these workers to pay National Insurance as if they were employees of the company they contracted for.
The new rules could be announced as early as the Autumn Budget 2018, which is scheduled for 29 October.
Which? explains what ‘synthetic’ self-employed means, and looks at how National Insurance could change in the Budget.
What are the ‘synthetic’ self-employed?
Self-employed workers pay less National Insurance than employed workers, but the distinction is not always clear-cut.
Some workers set up private companies – often under the classification of ‘personal services’ – to hire themselves to their employers.
In fact, the Treasury believes a third of people hiring their services as a ‘personal services company’ may rightly be classed as employees.
Both employees and employers pay less National Insurance under these arrangements – a shortfall which could cost HMRC £1.2bn a year by 2023, the BBC report estimates.
The shortfall comes about when these contractors pay themselves a lower salary via their personal service companies, which are subject to both employee and employer National Insurance contributions.
The rest of the worker’s income is then paid as a dividend from the personal service company, avoiding National Insurance on this part of their income.
Dividends are also subject to lower income tax rates than salaries – though the personal service companies will also be subject to corporation tax on their profits.
Under the IR35 rules, a worker employed via a third party, who would be an employee if hired directly, still needs to pay National Insurance in the same way as other employees.
HM Treasury introduced tougher obligations in the public sector in 2017, shifting responsibility to the public authorities to decide whether the IR35 rules apply, rather than the worker.
It’s possible that the latest reform to the IR35 rules could introduce similar obligations for private sector employers.
- Find out more: Self-employed National Insurance
What are National Insurance rates now?
The amount of National Insurance you pay depends on how much you earn, and whether you’re employed or self-employed.
Self-employed national insurance rates only apply to sole traders, rather than people who opt to incorporate (set up businesses) and pay themselves through that, who are treated as employees of the personal service company.
We’ve outlined the rates and income thresholds below:
|How much you earn||Class 1 rate|
|Less than £8,424||0%|
|More than £46,350||2%|
|How much you earn||Class 2 and Class 4 rates|
|Less than £6,205||0%|
|£6,205-£8,424||£2.95 per week|
|£8,424-£46,350||9% + £2.95 per week|
|More than £46,350||2% + £2.95 per week|
|Unemployed or exempt from National Insurance|
|Type of contributions||Class 3 voluntary contributions|
|Amount||£14.65 per week|
- Find out more: National Insurance rates
This means if you’re employed and earn less than £8,424 a year, or self-employed and earning less than £6,205 a year, you won’t have to pay any National Insurance.
If you’re self-employed and earn less than £6,205, you don’t need to pay National Insurance but you can still opt to pay Class 2 contributions to prevent any gaps in your contribution history. Similarly, if you’re a low-earning employee or not working, you can opt to fill gaps by paying voluntary Class 3 contributions.
Employed workers pay 12% on their annual earnings between £8,424 and £46,384, which falls to 2% on higher amounts. Their employers pay an additional 13.8% on earnings above £8,424.
Employed people pay significantly more National Insurance than the self-employed but historically, self-employed people have received lower state pensions, as they were only entitled to the basic state pension. That’s no longer the case with reforms introduced in April 2016.
In 2016, Philip Hammond announced that Class 4 contributions were going to be raised to 11% to close the gap between employed and self-employed contribution rates, but a huge backlash meant that the changes were soon cancelled.
But, just because the government backtracked this time, it doesn’t mean another rise won’t happen in future.
On the flip side, it was also announced last month that the government has scrapped plans to get rid of Class 2 National Insurance contributions for self-employed people with low earnings, so those workers who earn more than £6,205 a year will likely have to continue to pay at least £153 for this tax next year.
To find out how much National Insurance you’re likely to pay in the current 2018-19 tax year, enter your details into the calculator below.
Will National Insurance rates rise in Autumn Budget?
With pressure mounting on public services and benefits, several reports and think tanks have suggested upping National Insurance rates as a possible answer.
We’ve outlined some of the proposals:
Fund the NHS
In order to fund the much-publicised NHS deficit, UK think-tank IPPR suggested raising National Insurance contributions by 1p in the pound – a plan that would reportedly make £350m a week by 2022, which could be enough to keep the services funded.
While tax rises tend to be unpopular among the general public, YouGov reported that 62% of Brits would support increasing National Insurance to fund extra NHS spending.
But there is some concern that choosing to increase National Insurance over income tax would penalise poorer taxpayers, as the earning threshold for paying National Insurance is much lower than the personal allowance of £11,850.
Fund rising care costs
In May, a report from non-partisan UK think-tank Resolution Foundation posited that a projected £2.3bn could be raised by forcing those of state pension age to pay National Insurance if they continued to work.
This money would fund an NHS levy to support the rising care costs of the UK’s ageing population.
The change would mean older workers lose a chunk of their income to National Insurance contributions. At current rates, an employed person earning £30,000 a year would lose out on £97.50 a month, which may be especially galling when they’ve likely already been paying National Insurance for decades.
The idea was criticised on the basis that people working past the state pension age were likely to be financially worse-off than those who could choose to retire, and so this proposal could unfairly penalise them.
What’s more, those currently old enough to claim the state pension may argue that they’ve already made many years’ worth of contributions and should be entitled to claim.
In an exclusive interview earlier this year, Which? asked Pensions Minister Guy Opperman whether pensioners were likely to have to pay National Insurance in future – he confirmed the change was not on the cards at the time.
Fund the state pension
A review from the Government Actuary’s Department (GAD) predicted that the state pension fund will be exhausted by 2032 unless changes are made to National Insurance contributions, which are currently funding this benefit.
This is due to an increasingly ageing population, increases to the standard rate of basic state pension due to the ‘triple lock’ policy, and the fact that the majority of National Insurance contributions are currently used to meet benefit payments for the current year, rather than build up future reserves.
If the shortfall was made up by Class 1 contributions, the GAD stated that contributions would have to rise from the current 22% collected on relevant earnings to 27% by 2035 just to break even.
- Find out more: National Insurance and state pension
Why do we pay National Insurance?
National Insurance is a form of income tax, charged on what you earn.
The contributions you make are paid into a fund, used to pay state benefits such as the state pension, statutory sick pay and some unemployment benefits.
Making National Insurance contributions entitles you to some of these benefits. To receive that state pension, you must have paid National Insurance for a certain number of years.
If you’re employed, National Insurance will automatically be deducted from your salary before you receive it, but if you’re self-employed you’ll need to pay through a self-assessment tax return.
Self-employed National Insurance rates – Class 2 and Class 4 – are different to employed rates, which are Class 1. Our guide on self-employed National Insurance explains how it works.
- Find out more: What is National Insurance?
Editor’s note: this article has been edited to clarify how personal services companies operate.