Special rules apply to company directors when it comes to calculating their Class 1 National Insurance liabilities.
Why the rules
Directors, particularly of personal and family companies, can control how and when they are paid and, in the absence of special rules, would be able to reduce their Class 1 National Insurance liability by manipulating the earnings period rules. The rules circumvent this.
Annual earnings period
Company directors have an annual earnings period for National Insurance regardless of their actual pay frequency. This means that if they do not opt to apply the alternative arrangements, their National Insurance liability is calculated cumulatively by reference to the annual thresholds.
For 2021/22 these are as follows:
|Lower earnings limit
|Upper earnings limit
A director is paid £8,000 a month. In month 1, he pays no National Insurance as his earnings are below the annual primary threshold of £9,568.
In month 2, his earnings for the year to date are £16,000. By applying the annual thresholds, his total liability on his earnings to date of £16,000 is £771.84 (12% (£16,000 – £9,568)). As he paid no National Insurance in month, his liability for month 2 is £771.84.
For months 3 to 6 inclusive, his earnings for the year to date fall between £9,568 and £50,270. Consequently, he pays employee’s National Insurance at 12% on his earnings for the month of £8,000, equal to £960 each month.
In month 7, his earnings for the year to date are £56,000 (7 months @ £8,000 a month), on which total contribution of £4,998.84 (12% (£50,270- £9,568)) + 2% (£56,000 – £50,270)) are due. He has already paid £4,611.84 (£771.84 + (4 x £960)), leaving £387 due for the month.
As his earnings for the year have now exceeded the upper earnings limit, he will pay National Insurance at the rate of 2% of all future payments – a liability of £160 per month.
Applying the annual earnings period rules means that the contribution liability falls unevenly throughout the year. The liability for the year is £5,798.60 ((12% (£50,270 – £9,568) + ((2% (£96,000 – £50,270))).
As seen in the example above, calculating the liability by reference to the annual thresholds on a cumulative basis each time the director is paid means that their pay is uneven throughout the year. To overcome this, the director can opt for their National Insurance to be calculated throughout the year on their earnings for each earnings period using the relevant thresholds for the earnings period, as for employees who are not directors, with an annual recalculation on an annual basis at the end of the year.
If this basis is adopted, the director in the above example would pay National Insurance of £483.26 (12% (£4,189 – £797)) + (2% (£8,000 – £4,189))) each month for months 1 to 11, with a final payment of £482.74 in month 12.
Over the course of the year, the annual liability (£5,798.60) is the same which-ever method is used, but collected differently.
Directors can choose the method that suits them best.
If you operate through a limited company, for example as a personal or family company, you will need to extract funds from your company in order to use them to meet your personal bills. There are various ways of doing this. However, a popular and tax efficient strategy is to take a small salary which is at least equal to the lower earnings limit (set at £6,240 or 2021/22) to ensure that the year is a qualifying year for state pension and contributory benefits purposes, and to extract further profits as dividends.
However, this strategy requires the company to have sufficient retained profits from which to pay a dividend. If the company has been adversely affected by the Covid-19 pandemic, it may have used up any reserves that it had. As dividends must be paid from retained profits, if there are none, it is not possible to pay a dividend.
Are there other options for extracting funds to meet living expenses?
- Pay additional salary or bonus
Unlike a dividend, a salary or bonus can be paid even if doing so creates a loss – it does not have to be paid from profits. However, this will not be tax efficient once the salary exceeds the optimal level due to the National Insurance hit and the higher income tax rates applicable to salary payments.
- Take a director’s loan
If it is expected that the company will return to profitability, taking a director’s loan can be an attractive option. Depending when in the accounting period a loan is taken, a director can benefit from a loan of up to £10,000 for up to 21 months free of tax and National Insurance. If the company has returned to profitability within nine months of the year end, a dividend can be declared to clear the loan in time to prevent a section 455 tax charge from arising. If the account is overdrawn at the corporation tax due date nine months and one day after the year end, a section 455 tax charge of 32.5% of the outstanding amount must be paid by the company (although this will be repaid after the corporation tax due date for the accounting period in which the loan balance is cleared).
- Put personal bills through the director’s loan account
Another option is for the company to pay the bills on the director’s behalf and to charge them to the director’s loan account. Again, if the company has sufficient profits to clear the outstanding balance within nine months of the year end, a dividend can be declared to prevent a section 455 tax charge from arising. A benefit in kind tax charge (and a Class 1A National Insurance liability on the company) will also arise if the outstanding balance is more than £10,000 at any point in the tax year.
- Provide benefits in kind
Use can be made of various tax exemptions, such as those for trivial benefits and mobile phones, to provide certain benefits in kind in a tax-free fashion.
- Pay rent
If the company is run from the director’s home, the company can pay rent to the director for the office space. This should be at a commercial rate, and the director will pay tax on the rental income. However, there is no National Insurance to worry about and the rent can be deducted in computing the company’s profits, even if this creates a loss.
As a bonus, if the extraction policy creates a loss, it may be possible to carry the loss back to generate a much-needed tax repayment.
As lockdown restrictions are eased, businesses may need help to re-open and to recover from the impact of the pandemic. Depending on the nature of the business, they may be eligible for a Restart Grant or a Recovery Loan.
The Restart Grant Scheme provides support to help business that were required to close to re-open as lockdown restrictions are eased. The grants are available to businesses in non-essential retail and businesses in the hospitality, accommodation, leisure, personal care and gym sectors.
The grants are available from 1 April 2021 and must be claimed from the local council. Applications can be made on the relevant council’s website.
To qualify, a business must:
- be based in England;
- pay rates; and
- be trading on 1 April 2021.
Non-essential retail business can apply for a Restart Grant of up to £6,000, whereas businesses in the hospitality, accommodation, leisure, personal care and gym sectors can apply for a Restart Grant of up to £18,000. Local councils will use their discretion to determine whether a business is eligible for a grant.
Recovery Loan Scheme
The Recovery Loan Scheme is designed to provide access to finance for UK businesses as they recover from the impact of the Covid-19 pandemic. Businesses of any size can apply for loans under the scheme, and can benefit from a loan or overdraft of between £25,001 and £10 million per business or asset finance of between £1,000 and £10 million per business. However, the amount offered and the terms are at the discretion of the lender.
To encourage lenders to participate, the Government guarantee 80% of the finance to the lender; however, the borrower remains liable for 100% of the debt.
A business can apply for a Recovery Loan if it is trading in the UK. Applicants will need to demonstrate that their business:
- would be viable were it not for the pandemic;
- has been adversely impacted by the pandemic; and
- is not in collective insolvency proceedings.
Businesses that meet the eligibility criteria can apply for a recovery loan, regardless of whether they also have a Bounce Back loan or a Coronavirus Business Interruption Loan. Under the scheme, no personal guarantees are taken on facilities up to £250,000, and a borrower’s principal private residence cannot be taken as security.
The scheme is due to run until 3 December 2021.
The Employment Allowance is a National Insurance allowance that enables eligible employers to reduce their employers’ (secondary) Class 1 National Insurance bill by up to £4,000. However, not all employers can benefit – there are some important exclusions.
To qualify for the Employment Allowance, the employer’s Class 1 National Insurance liabilities for 2020/21 must be less than £100,000. Where the employer is part of a group, the £100,000 limit applies to the group as a whole, not the individual group companies.
The Employment Allowance is not available to companies where the sole employee is also a director. This rules out most personal companies. However, family companies with more than one employee are able to claim.
There are other exclusions too, for example, employers who employ someone for personal, household and domestic work unless the worker is a care or support worker.
Amount of the allowance
The Employment Allowance is set at the lower of £4,000 and the employer’s secondary Class 1 National Insurance liability for the year. Once claimed it is set against the employer’s Class 1 liability until it is used up.
A Ltd is eligible for the Employment Allowance. Its secondary Class 1 National Insurance liability is £1,500 a month. It claimed the Employment Allowance at the start of the 2021/22 tax year. The allowance is used as follows:
Month 1: £1,500 of the Employment Allowance is set against the liability for the month of £1,500, leaving nothing to pay. The remaining Employment Allowance of £2,500 (£4,000 – £1,500) is carried forward.
Month 2: £1,500 of the Employment Allowance is set against the liability for the month of £1,500, leaving nothing to pay. The remaining Employment Allowance of £500 (£2,500 – £1,500) is carried forward.
Month 3: The remaining £500 of the Employment Allowance is set against the liability for the month of £1,500, leaving £1,000 to pay. The Employment Allowance has now been used in full.
Months 4 to 12: The Employment Allowance has been used in full, so the employer’s Class 1 National Insurance liability for the month of £1,500 is payable in full.
Claiming the allowance
The Employment Allowance is not given automatically and must be claimed each year. This can be done through the payroll software, or via HMRC’s Basic PAYE Tools if the payroll software does not have an Employment Payment Summary (EPS) feature.
Although claims can be made at any time in the tax year, the earlier the claim is made, the earlier the employer will start benefiting from the Employment Allowance.
Claims can also be made retrospectively for the previous four tax years if the employer was eligible for the Employment Allowance, but did not claim it.
The financial impact of the Covid-19 pandemic is unprecedented and borrowing levels in 2020/21 of 16.9% of GDP represent the highest level of peacetime borrowing. To meet some of this cost, the Chancellor, Rishi Sunak, announced in the 2021 Budget that various thresholds and allowances would remain at their 2021/22 levels until April 2026.
The personal allowance is increased to £12,570 for 2021/22 – an inflationary increase of £70 over the 2020/21 level of £12,500. However, the allowance will remain at this level for 2022/23, 2023/24, 2024/25 and 2025/26. As incomes rise with inflation, people who currently do not pay tax may start to pay tax once their income rises above £12,570.
Income tax rates and bands
The basic rate band is increased to £37,700 for 2021/22. This means that where someone is in receipt of the personal allowance of £12,570, they will start paying higher rate tax once their income exceeds £50,270. This remains the case for tax years up to and including 2025/26.
The basic rate band and higher rate threshold will remain at these levels until April 2026. As incomes rise in line with inflation, more people will pay tax at the higher and the additional rates. Tax is payable at the additional rate of 45% on taxable income in excess of £150,000.
Capital gains tax annual exempt amount
The capital gains tax annual exempt amount remains at £12,300 for 2021/22 and is frozen at this level until April 2026.
However, there may be changes to capital gains tax on the horizon as this is something that the Government are looking at.
The upper earnings limit for Class 1 National Insurance contributions and the upper profits limit for Class 4 contributions are aligned with the rate at which higher rate tax becomes payable. Both are set at £50,270 for 2021/22. For Class 1 purposes, this is equivalent to £967 per week and £4,189 per month. These too will remain unchanged until April 2026.
All other National Insurance thresholds will be reviewed at the appropriate time.
The nil rate band has been frozen at its current level of £325,000 since 2008/09. It will remain at this level up to and including 2025/26. The freezing of the threshold brings more estates within the ambit of inheritance tax.
The residence nil rate band (RNRB) remains at its 2020/21 level of £175,000 for 2021/22. It too will remain at this level for the 2023/24 to 2025/26 years inclusive. The RNRB is reduced where the value of the estate is £2 million or above by £1 for every £2 by which the value of the estate exceeds £2 million.
Pension lifetime allowance
The pension lifetime allowance places a cap on the value of tax relieved pension savings. The tax relief on pension savings in excess of the lifetime allowance is recovered in the form of a 25% tax charge where the excess is taken as a pension and a 55% tax charge where the excess is taken as a lump sum. The lifetime allowance remains at £1,073,100 for 2021/22 and will stay at this level until April 2026. This will limit the ability of anyone with pension savings at or near this level to make further tax-relieved pension contributions during 2021/22 and the following four tax years.