CHAPTER 23 CLASSES 2 AND 4 NATIONAL INSURANCE

Tolley Exam Training BUSINESS TA CHAPTER 23 CHAPTER 23 CLASSES 2 AND 4 NATIONAL INSURANCE In this chapter you will learn about the classes of NIC paid by the self employed including: Class 2 contributions; Class 4 contributions; the annual maxima tests; deferment of NIC; Class 3 and Class 3A contributions. 23.1 Introduction Certain individuals are liable for Class 2 and Class 4 National Insurance Contributions (NICs). Persons gainfully employed in Great Britain pay Class 1 NlC. Self-employed earners between 16 and the pensionable age pay Classes 2 and 4 NICs. Class 2 ceases immediately on reaching pensionable age. Class 4 stops from the start of the tax year after the one in which pensionable age is reached. Where Class 1 and 2 contributions are not paid, an individual may make Class 3 voluntary contributions to top up their contributions record in order to preserve entitlement to state benefits. Class 3A voluntary contributions can be paid by existing pensioners and those who reach state pension age before 6 April 2016 to increase their additional state pension. Pensionable age is currently 65 for men. For women born before 6 April 1950, the pensionable age is 60. For women born between 6 April 1950 and 5 December 1953, pensionable age is increasing to 65 by November 2018. For men and women born between 6 December 1953 and 5 April 1960 the pensionable age will gradually increase from 65 to 66 by October 2020 with further increases being phased in thereafter. 23.2 Class 2 Contributions When an individual starts to trade, they must notify HMRC in writing immediately that they have become liable to Class 2 NICs. This is done via the HMRC online services or by completing the self employment registration Form CWF1. To avoid penalties, registration for Class 2 NICs must take place by 31 January following the tax year of commencement of trade at the latest. SSCBA 1992, s.11; SI 2001/1004 Reg 87B Class 2 NICs are flat rate contributions, currently payable at 2.80 per week. For the tax year 2015/16 onwards, Class 2 NICs will be collected via self-assessment so that a self-employed individual can pay income tax and Class 2 and Class 4 NICs together through one process. The amount of Class 2 NICs due is calculated based on the number of weeks of self-employment within the tax year. Where profits for the tax year do not exceed the Small Profits Threshold, there is no liability to Class 2 NICs. Profits for this purpose are the same as profits for Class 4 NIC purposes. The small profits threshold is 5,965 for 2015/16. However, an Reed Elsevier UK Ltd 2015 273 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 individual can pay voluntary Class 2 NICs in order to preserve their entitlement to the State Pension and other state benefits. For the 2015/16 tax year onwards, the liability to Class 2 NIC will be due for payment as part of the balancing payment for the tax year. So for 2015/16, Class 2 NICs will be payable on 31 January 2017. Class 2 NICs are not taken into account when calculating payments on account. 23.3 Class 4 Contributions For 2015/16 Class 4 National Insurance contributions are payable at 9% on profits between 8,060 and 42,385, with an uncapped 2% payable on profits above 42,385. SSCBA 1992, s.15(3) For example: Class 4 NIC payable at 9% (42,385 8,060) 9% 3,089 Plus: Additional amount at 2% if profits exceed the upper limit (Profits 42,385) 2% Total Class 4 NIC payable Profits in this context are the Trading profits for the tax year. SSCBA 1992, s.15(1) Class 4 NICs are payable in the same way as income tax under self assessment, ie payments on account are due on the 31 January in the tax year and the 31 July following the tax year, based on the previous year's liability. A balancing payment is due on the 31 January following the end of the tax year. SSCBA 1992, s.15(2) 23.4 Class 4 Contributions and Losses Losses are negative earnings for Class 4 NIC purposes. This is the case even if they have been fully utilised for income tax purposes, for instance where they have been claimed against other income under s.64 ITA 2007. Losses used against non-trading income are still available to be used for Class 4 NIC purposes. Illustration 1 In the year ended 31 March 2015, a trader made a trading loss of 16,000 and had other income of 10,000. In the year ended 31 March 2016, the trader made trading profits of 30,000 and had other income of 5,000. The trader submits a current year loss claim under s.64 ITA 2007. 10,000 of the loss will be set against the other income in 2014/15, reducing it to zero. The trader will have losses to carry forward under s.83 ITA 2007 of 6,000. Reed Elsevier UK Ltd 2015 274 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 Income tax computations: 2014/15 2015/16 Trading Income 30,000 Less: s.83 loss b/fwd (6,000) 24,000 Other income 10,000 5,000 Net Income 10,000 29,000 Less: s.64 current year loss (10,000) Revised Net Income 29,000 Show the profits chargeable to Class 4 NIC for 2015/16. For 2015/16, the profits for Class 4 purposes will be 14,000 as the full amount of the trading losses will be available against profits for Class 4 purposes, even though only 6,000 will be available in 2015/16 for income tax purposes. We can carry forward the full amount where losses have been offset for income tax purposes against non-trading income. 2015/16 Trading Income 30,000 Full loss b/fwd (16,000) Profits chargeable to Class 4 NIC 14,000 Example 1 Calculate the Class 4 National Insurance due in the illustration above. 23.5 Annual Maxima There is an annual maximum of contributions applying to any individual for a contribution year. The contribution year is the same as the tax year. These annual maxima rules apply where the earner either has two jobs (and is therefore paying Class 1 NICs twice) or he is both employed and self-employed. Employees pay Class 1 NIC and the self-employed pay Classes 2 and 4. If an individual has substantial earnings and profits as both an employee and as a self employed individual, this could add up to a sizeable amount of NIC each year. There is therefore a maximum cap which applies each tax year. There are 2 tests. Test 1 looks at Classes 1 and 2 and may result in a reduced or nil liability for Class 2 NICs. If appropriate there may be a refund of Class 1. Test 2 applies where an individual has both an employment and a self-employment and may result in a reduced amount of Class 4 contributions being payable. For the 2015/16 tax year onwards, where relevant HMRC will calculate the annual maxima automatically, and determine the correct amount of Class 2 and 4 NIC payable, notifying this amount to the individual. The annual maxima rules are complex and difficult to remember. It is therefore important that you are familiar with where to locate these rules in the tax statutes. The annual maxima rules are contained in Statutory Instrument 2001/1004 within the NIC section of the Tolley Yellow Handbooks. Reed Elsevier UK Ltd 2015 275 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 23.6 Test 1 Test 1 applies when either the taxpayer has more than one employment, or has a self-employed trade as well as a job and therefore has a liability for both Class 1 and Class 2 contributions. SI 2001/1004 Reg 21 SI 2001/1004 contains a series of steps which we must follow to calculate the maximum NICs payable in the year. Although we will reproduce the various steps below, we do not recommend that you try to learn them. You should always answer a question on these annual maxima rules by referring to SI 2001/1004. Step 1: Calculate 53 (UEL PT) 34,980 where: UEL is the weekly upper earnings limit for the year (815 for 2015/16) PT is the weekly primary threshold (155 for 2015/16). Step 2: Multiply the result of Step 1 by 12% 4,198 Step 3: For each of the employments, calculate the amount by which earnings exceed the primary threshold but do not exceed the upper earnings limit. Step 4: Figure found by Step 3 Less: Figure found by Step 1 () If this is a negative number, it can be assumed to be Step 5: Step 4 figure 2%. (If Step 4 is a negative number, this will be zero) Step 6: For each of the employments, calculate the amount by which earnings exceed the upper earnings limit. Step 7: Step 6 figure 2%. Step 8: Figure found by Step 2 Figure found by Step 5 Figure found by Step 7 ANNUAL MAIMUM Class 1 and Class 2 NIC The annual maximum is then compared to the Class 1 NICs actually paid to determine whether any Class 2 NICs are payable or whether any refund of Class 1 NICs is due. Illustration 2 Alex is employed by a firm of solicitors for 2 days each week earning a salary of 663 per week (34,476 p.a.). For the rest of the time he has his own sole practice and in 2015/16 his trading income was 21,000. Calculate the maximum Class 1 and 2 National Insurance he is required to pay showing any refunds due. Reed Elsevier UK Ltd 2015 276 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 The Class 1 NICs actually paid in 2015/16 are as below: Class 1 primary: 52 (663 155) 12% 3,170 The maximum Classes 1 and 2 National Insurance he is required to pay will be calculated as follows: Step 1: 53 (815 155) 34,980 Step 2: 34,980 12% 4,198 Step 3: (34,476 8,060) 26,416 Step 4: Step 3 26,416 Less: Step 1 (34,980) (8,564) As this is a negative figure, it can be assumed to be Step 5: Step 6: Step 7: Not necessary as Step 4 is a negative number Not necessary as no earnings exceed the upper earnings limit Not necessary Step 8: Figure found by Step 2 4,198 Figure found by Step 5 Figure found by Step 7 ANNUAL MAIMUM 4,198 Less: Class 1 (primary) actually paid (3,170) Less: Class 2 liability (52 x 2.80) (146) 882 As the actual Class 1 NICs paid are less than the annual maximum, there is no refund of Class 1 NICs under Test 1. This is commonly the case where the taxpayer only has one employment. Alex will pay the full Class 2 NIC liability of 146. Illustration 3 Steve has two jobs. He works for a publishing company for 3 days a week earning 900 per week (46,800 p.a.). At weekends he works for a bookmaker and earns 250 per week (13,000 p.a.). Calculate the Class 1 primary NIC refund due to Steve. The Class 1 primary NICs actually paid in 2015/16 are as below: Publishing job: 52 (815 155) 12% 4,118 52 (900 815) 2% 88 Bookmakers job: 52 (250 155) 12% 593 4,799 Reed Elsevier UK Ltd 2015 277 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 The maximum Class 1 National Insurance he is required to pay will be calculated as follows: Step 1: 53 (815 155) 34,980 Step 2: 34,980 12% 4,198 Step 3: (42,385 8,060) 34,325 (13,000 8,060) 4,940 39,265 Step 4: Step 3 39,265 Less: Step 1 (34,980) 4,285 Step 5: 4,285 2% 86 Step 6: (46,800 42,385) 4,415 Step 7: 4,415 2% 88 Step 8: Figure found by Step 2 4,198 Figure found by Step 5 86 Figure found by Step 7 88 ANNUAL MAIMUM 4,372 Less: Class 1 primary actually paid (above) (4,799) Refund due (Class 1) (427) Employed earners who are contracted out of the State Second Pension via a salary related occupational pension scheme, only pay NICs at 10.6% on earnings between the primary earnings threshold and the upper accruals point (a 1.4% contracted out rebate is given on earnings between the lower earnings limit and the primary earnings threshold). However, for the purposes of the annual maxima test above, the rules assume that the employee had paid Class 1 NICs at the contracted in rate (ie at 12% between the limits). Therefore for a contracted out employee who is subject to the annual maxima test, a computation will be necessary to calculate the notional Class 1 primary NICs that would have been paid had the contracted out election not been made. SI 2001/1004 Reg 21(3) 23.7 Test 2 This second test applies when a taxpayer is both employed and self-employed and is therefore liable for NICs under Classes 1, 2 & 4. The second annual maxima test is used to determine the amount of Class 4 contributions payable where a taxpayer is both employed and self-employed. SI 2001/1004 Reg 100 Reed Elsevier UK Ltd 2015 278 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 The annual maxima computation here is extremely complex. Once again, a stepby-step approach is laid down in SI 2001/1004 at regulation 100. Step 1: (Upper profit limit lower profit limit) (42,385 8,060) 34,325 Step 2: Multiply the result of Step 1 by 9% 3,089 Step 3: Figure found by Step 2 3,089 Add: 53 Class 2 NICs 148 3,237 Step 4: Result from Step 3 3,237 Less: Class 1 primary NICs paid at 12% () Less: Class 2 NICs paid () Once we have arrived at the Step 4 figure above, there are three possible outcomes. Case 1: If Step 4 is a positive figure, we must compare it with the result of the following test: Class 1 NICs paid at 12% Class 2 NICs paid Class 4 NICs payable at 9% Comparative total If Step 4 exceeds the comparative total, then Step 4 is the maximum Class 4 NICs payable for the year. Case 2: Case 3: If Step 4 is a positive figure and is less than the comparative total, then Step 4 is the maximum Class 4 NICs payable for the year at the 9% rate. An additional 2% will be payable using the rules we shall look at below. If Step 4 is a negative figure, the Class 4 NICs payable at 9% for the year will be. It is however possible for the 2% rate to apply (see below). Steps 5 to 9 need only be taken if Cases 2 or 3 apply. Step 5: Step 4 100/9 Step 6: Lower of: Actual profits or upper profit limit Less: Lower profit limit (8,060) Step 7: Figure at Step 6 Less: Figure at Step 5 () If this is a negative figure, it can be assumed to be Step 8: Step 7 2% Step 9: (Actual profits upper profit limit) 2% Reed Elsevier UK Ltd 2015 279 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 The maximum Class 4 NIC payable is: Figure found by Step 4 Figure found by Step 8 Figure found by Step 9 ANNUAL MAIMUM Class 4 NIC payable Illustration 4 Continuing illustration 2, Alex had employed earnings of 663 per week and selfemployed income of 21,000 for 2015/16. The Class 1 NIC paid (all at 12%) was 3,170. Class 2 NIC paid was 146. Calculate the Class 4 NIC payable by Alex using Test 2. Step 1: (42,385 8,060) 34,325 Step 2: 34,325 9% 3,089 Step 3: Figure at Step 2 3,089 Add: 53 Class 2 NICs 148 3,237 Step 4: Result from Step 3 3,237 Less: Class 1 primary NICs paid at 12% (3,170) Less: Class 2 NICs paid (146) (79) As Step 4 is negative, no Class 4 NIC is payable at the main rate of 9%. However, we must prepare another computation to see if any Class 4 is due at the additional 2% rate. We assume Step 4 is nil for these purposes. Step 5: Step 4 100/9 ( 100/9) Step 6: Lower of: Actual profits or upper profit limit 21,000 Less: Lower profit limit (8,060) 12,940 Step 7: Figure at Step 6 12,940 Less: Figure at Step 5 () 12,940 Step 8: 12,940 2% 259 Step 9: Not necessary as actual profits do not exceed the upper profits limit The maximum Class 4 NIC payable is: Figure found by Step 4 Figure found by Step 8 259 Figure found by Step 9 ANNUAL MAIMUM Class 4 NIC payable 259 Reed Elsevier UK Ltd 2015 280 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 Illustration 5 Bert has earnings of 12,000 and self-employed profits of 48,000 for 2015/16. Bert's Class 1 NIC paid is as follows: Class 1: (12,000 8,060) 12% 473 Calculate the NIC refund, if any, due to Bert under annual maxima Test 1 and calculate the Class 4 NIC payable by Bert for 2015/16 using annual maxima Test 2. Test 1 is performed first as follows: Step 1: 53 (815 155) 34,980 Step 2: 34,980 12% 4,198 Step 3: (12,000 8,060) 3,940 Step 4: Step 3 3,940 Less: Step 1 (34,980) (31,040) As this is a negative figure, it can be assumed to be Step 5: Step 6: Step 7: Not necessary as Step 4 is a negative number Not necessary as no earnings exceed the upper earnings limit Not necessary Step 8: Figure found by Step 2 4,198 Figure found by Step 5 Figure found by Step 7 ANNUAL MAIMUM 4,198 Less: Class 1 (primary) actually paid (473) Less: Class 2 liability (52 x 2.80) (146) 3,579 As the actual Class 1 NICs paid are less than the annual maximum there is no refund of Class 1 NICs under Test 1. Bert will pay the full Class 2 NIC liability of 146. Moving on to Test 2: Step 1: (42,385 8,060) 34,325 Step 2: 34,325 9% 3,089 Step 3: Figure at Step 2 3,089 Add: 53 Class 2 NICs 148 3,237 Reed Elsevier UK Ltd 2015 281 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 Step 4: Result from Step 3 3,237 Less: Class 1 primary NICs paid at 12% (473) Less: Class 2 NICs paid (146) 2,618 As Step 4 is positive, we must compare it with the total below: Class 1 NICs paid at 12% 473 Class 2 NICs paid 146 Class 4 NICs payable at 9% 3,089 (42,385 8,060) x 9% Comparative total 3,708 As Step 4 is less than the comparative total, we follow the rules in case 2. Step 5: Step 4 100/9 (2,618 100/9) 29,089 Step 6: Lower of: Actual profits or upper profit limit 42,385 Less: Lower profit limit (8,060) 34,325 Step 7: Figure at Step 6 34,325 Less: Figure at Step 5 (29,089) 5,236 Step 8: 5,236 x 2% 105 Step 9: (48,000 42,385) 2% 112 The maximum Class 4 NIC payable is: Figure found by Step 4 2,618 Figure found by Step 8 105 Figure found by Step 9 112 ANNUAL MAIMUM Class 4 NIC payable for 2015/16 2,835 23.8 Deferment of NIC Deferment of Class 1 primary contributions is possible where an individual can demonstrate that they will be due a refund of Class 1 NICs due to having more than one employment. The application should be made as soon as possible before the start of the tax year on form CA72A although they will be accepted until the end of the year (if there is time for HMRC and the employer to process it). NICO will determine for which of the employments deferment will be granted. In those employments where Class 1 deferment is granted, the employee will continue to pay Class 1 contributions at 2% on earnings in excess of the primary threshold. Deferment used to be possible where an individual could demonstrate they would be due refunds of Classes 2 and 4 contributions. However, for the tax year 2015/16 onwards deferment of Classes 2 and 4 contributions is no longer possible as HMRC will calculate the correct amount payable and only this amount will be paid via self-assessment. Reed Elsevier UK Ltd 2015 282 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 Example 2 Margo is employed part time and earns a salary of 235 per week (12,220 p.a.). She is also a sole trader with trading profits of 50,000 in respect of the tax year 2015/16. You are required to calculate the Class 4 National Insurance payable by Margo for 2015/16. 23.9 Annual Maxima There is an annual maximum of contributions applying to any individual for a contribution year. The contribution year is the same as the tax year. These annual maxima rules apply where the earner either has two jobs (and is therefore paying Class 1 NICs twice), or he is both employed and self-employed (and liable to Classes 1, 2 and 4). If an individual has substantial earnings and profits as both an employee and as a self employed individual, this could add up to a sizeable amount of NIC each year. A similar issue could arise if an individual has two jobs. There is therefore a maximum cap which applies each tax year and any excess over this amount will be refunded. This maximum amount is there essentially to ensure that an individual with two or more employments, or an employment and self employment, does not pay more NICs than an individual with one source of income, but instead pays the same as if the incomes had been combined. The maximum amount is not a fixed amount and will vary according to the combination of employments and self employments as well as the amounts earned. There are 2 tests. Test 1 looks at Classes 1 and 2 and may result in a reduced or nil liability for Class 2 NICs. If appropriate there may be a refund of Class 1 NICs. Test 2 may result in a reduced amount of Class 4 contributions payable. For the 2015/16 tax year onwards, where relevant HMRC will calculate the annual maxima automatically, and determine the correct amount of Class 2 and Class 4 NIC payable, notifying this amount to the individual. The annual maxima rules are contained in Statutory Instrument 2001/1004 Regulations 21 and 100 within the NIC section of the Tolley Yellow Handbooks (book 3). 23.10 Deferment of NIC Deferment used to be possible where an individual could demonstrate they would be due refunds of Classes 2 and 4 contributions. However, for the tax year 2015/16 onwards deferment of Classes 2 and 4 contributions is no longer possible as HMRC will calculate the correct amount payable and only this amount will be paid via self-assessment. Deferment of Class 1 primary contributions are still permitted where the taxpayer has more than one employment. NICO will determine for which of the employments deferment will be granted. In those employments where Class 1 deferment is granted, the employee will continue to pay Class 1 contributions at 2% on earnings in excess of the primary threshold. Reed Elsevier UK Ltd 2015 283 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 23.11 Class 3 Contributions A person who is not working and who is not paying either Class 1 or Class 2 contributions in respect of an earnings period may be entitled to pay Class 3 contributions. For instance, this could apply to students or to non-working parents who stay at home to look after their children. Class 3 contributions are set at a fixed weekly rate which is 14.10 for 2015/16. Gaps in an individual's Class 1 or 2 contribution record could affect their entitlement to certain benefits including basic State Pension and bereavement benefits. By paying voluntary Class 3 contributions, the individual is able to preserve their entitlement to such benefits. For example, the amount of State Pension that an individual receives depends on the number of qualifying years the individual is credited with making national insurance contributions. The higher the number of qualifying years an individual has, the greater the State Pension they will receive when they reach pensionable age. Payment of Class 3 voluntary contributions will increase the number of qualifying years and therefore increase the amount of State Pension they receive. 23.12 Class 3A Contributions In addition to Class 3 voluntary contributions, an individual can also pay a Class 3A voluntary contribution, otherwise known as the State Pension top up. For people who reach pensionable age on or after 6 April 2016, the current pension system is being replaced by an increased new State Pension. In order to allow existing pensioners and those reaching State Pension age before 6 April 2016 the opportunity to increase their State Pension, Class 3A voluntary contributions can be paid from 12 October 2015 to 5 April 2017. An eligible individual can choose to top up their State Pension by between 1 and a maximum of 25 per week through the payment of Class 3A contributions. The amount of the contribution varies according to age and the amount of pension required. For example, the one-off contribution required for an extra 1 of pension per week for a person aged 65 is 890, 1,780 for an extra 2 per week and so on, up to a payment of 22,250 for an extra 25 per week. (You do not need to know the actual amounts of the contributions for the exams). Reed Elsevier UK Ltd 2015 284 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 ANSWERS Answer 1 Class 4 NIC for 2015/16: (14,000 8,060) 9% = 535 Answer 2 Margo's NIC paid would be as follows: Class 1 paid: 52 x (235 155) 12% 499 First of all apply Test 1 for the maximum classes 1 and 2 payable: Step 1: 53 (815 155) 34,980 Step 2: 34,980 12% 4,198 Step 3: (12,220 8,060) 4,160 Step 4: Step 3 4,160 Less: Step 1 (34,980) (30,820) As this is a negative figure, it can be assumed to be Step 5: Step 6: Step 7: Not necessary as Step 4 is a negative number Not necessary as no earnings exceed the upper earnings limit Not necessary Step 8: Figure found by Step 2 4,198 Figure found by Step 5 Figure found by Step 7 ANNUAL MAIMUM 4,198 Less: Class 1 (primary) actually paid (499) Less: Class 2 liability (52 x 2.80) (146) 3,553 As the actual Class 1 NICs paid are less than the annual maximum, there is no refund of Class 1 NICs under Test 1. Margo will pay the full Class 2 NIC liability of 146. Reed Elsevier UK Ltd 2015 285 FA 2015

Tolley Exam Training BUSINESS TA CHAPTER 23 Moving on to Test 2: Step 1: (42,385 8,060) 34,325 Step 2: 34,325 9% 3,089 Step 3: Figure at Step 2 3,089 Add: 53 Class 2 NICs (53 x 2.80) 148 3,237 Step 4: Result from Step 3 3,237 Less: Class 1 primary NICs paid at 12% (499) Less: Class 2 NICs paid (146) 2,592 As Step 4 is positive, we must compare this with the total below: Class 1 NICs paid at 12% 499 Class 2 NICs paid 146 Class 4 NICs payable at 9% 3,089 (42,385 8,060) x 9% Comparative total 3,734 As Step 4 is less than the comparative total, we follow the rules in case 2. Step 5: Step 4 100/9 (2,592 100/9) 28,800 Step 6: Lower of: Actual profits or upper profit limit 42,385 Less: Lower profit limit (8,060) 34,325 Step 7: Figure at Step 6 34,325 Less: Figure at Step 5 (28,800) 5,525 Step 8: 5,525 2% 111 Step 9: (50,000 42,385) 2% 152 The maximum Class 4 NIC payable is: Figure found by Step 4 2,592 Figure found by Step 8 111 Figure found by Step 9 152 ANNUAL MAIMUM Class 4 NIC payable for 2015/16 2,855 Reed Elsevier UK Ltd 2015 286 FA 2015