September 2006

77.39 National Insurance Contributions (NIC)

National insurance contributions are payments based on the level of earnings of employed and self employed persons. They help to fund the UK social security system. The National Insurance Contributions Office (NICO) collects contributions from employed and self employed persons. How much a person pays and the system for collecting it depends on the "class" of contribution paid. Social Security Benefits are dealt with by the Department for Work and Pensions (DWP). The legislation is in the Social Security Contributions and Benefits Act 1992 and statutory instruments.

Details of the current rates of NIC payable can be found at http://www.hmrc.gov.uk/rates/index.htm and historical rates can be found at http://www.hmrc.gov.uk/rates/archive.htm

77.40 Class 1 contributions

Unless "contracted out" (see below), employees and employers pay Class 1 contributions under the State Second Pension Scheme (S2P) which replaced the State Earnings Related Pension Scheme (SERPS) from 06 April 2002. The contributions are based on a percentage of gross earnings. Payments made by employees are called primary contributions, those made by employers secondary contributions. Certain employees and their employers are exempted from payment of Class 1 contributions. They are [note 1] :-

1. people aged under 16 or over state pension age,
2. people whose earnings are below the weekly lower earnings limit,
3. a wife employed by her husband for a non business purpose and vice versa,
4. people employed for a non business purpose by a close relative in the home where they both live,
5. returning and counting officers and people employed by them in connection with an election or referendum, and
6. certain employees of international organisations and visiting armed forces.

An additional category of contributions class 1A is paid by employers on the provision of benefits in kind, such as cars and private fuel to "P11D" employees (all directors, and employees earning £8500 per annum or more inclusive of benefits.) Class 1 and 1A contributions are collected through the PAYE system.

Employees who are members of occupational pension schemes may be "contracted out" of SERPS/S2P by their employers if they operate a salary related scheme or a money purchase scheme. Contracted out employees are still eligible for the basic state pension but obtain their additional pension from their employer’s scheme. Contracted out employers and their employees pay reduced rates of Class 1 (but not Class 1A) contributions on earnings.

Employees may also contract out of SERPS/S2P by entering into personal pension arrangements, to which their employers may or may not contribute. In these cases both employer and employee continue to pay full national insurance contributions, but the contracting out rebate is paid by the DWP into the personal pension scheme.

HMRC Insolvency Claims Handling Unit is responsible for calculating Class 1 debts and submitting proofs of debt in any insolvency proceeding.

77.41 Class 2 and Class 4 contributions

Class 2 and Class 4 contributions are paid by self employed persons. Class 2 contributions are payable at a flat weekly rate and entitle the contributor to all contributory benefits except contribution based jobseekers allowance and the earnings related supplement to retirement pension. People who become self employed must notify NICO and make arrangements to pay their Class 2 contributions. Payment can be made by monthly direct debit or quarterly in arrear. Those who pay quarterly receive a bill from NICO showing the amount owed.

Class 4 contributions are payable at a fixed percentage on profits from a trade or profession charged to income tax under self assessment; they carry no entitlement to benefits of any kind. The contributions are collected by NICO. The provisional half yearly payments made on 31 January and 31 July under self assessment include Class 4 contributions based on the previous year's figures with any balancing adjustment made in the return on the following 31 January. If Class 4 contributions are paid late, interest is charged. Amounts owed by an insolvent in respect of unpaid Class 4 contributions are included in the proof(s) of debt submitted by HMRC Insolvency Claims Handling Unit.

77.42 Class 3 contributions

Class 3 contributions are a voluntary payment that may be made by those who would otherwise make insufficient contributions to earn a full basic state pension on retirement. They are paid at a flat weekly rate.

77.43 Action on the making of an insolvency order

Notification of the winding up or bankruptcy order is sent to HMRC Insolvency Claims Handling Unit. Data on new cases is automatically extracted from LOIS and sent to the ICHU. It is very important that the official receiver enters the case details onto LOIS as quickly and as accurately as possible. It is not necessary to send a paper copy of the information. See also Chapter 3 Part 3 - Initial procedure when winding up order made and Chapter 4 Part 4 - Initial procedure when bankruptcy order made.

[Back to Part 4 - Income Tax Self Assessment] [On to Part 6 - Partnership taxation]