Another Trap to Avoid

JOHN T NEWTH FCA, FTII, FIIT, ATT highlights yet another complication for self-employed individuals.

The Inland Revenue is very keen to 'recategorise' workers as employees who have previously enjoyed self-employed status. Other individuals may move from employment to self employment or resume employment on a career change.

The direct tax consequences of such changes are well known, complicated enough in themselves and beyond the scope of this article. Here, the writer seeks to highlight little-known National Insurance regulations.

I am indebted to Small Business Tax and Finance newsletter for bringing this matter to public attention in the August 2001 issue at page 46.

A little-known rule

Regulation 67 of the Social Security (Contributions) Regulations 1979 limits the Class 4 National Insurance liability for a year in which Class 1 contributions are also paid.

The basic rule is that the Class 4 contribution is capped at a figure equal to the maximum contributions for the year, plus a figure equal to 53 weeks contributions at the Class 2 rate, minus the Class 1 and Class 2 contributions actually paid.

A further complication of the rule is that where the Class 1 contributions were paid at the contracted-out rate (8.4 per cent for 2001-02), they are notionally 'grossed up' to the non contracted-out rate (10 per cent for that year).

A numerical example illustrates the situation that can arise.

How to claim

The official tax calculation pages of the self-assessment tax return provide no facility for claiming the Class 4 limitation.

The relief is explained in Inland Revenue booklet CA72, which is somewhat confusingly entitled 'National Insurance contributions: Deferring Payment'! In effect, the taxpayer can apply for 'deferment' if he realises the relief is due before he has paid his Class 4 contributions for that year.

In other circumstances he may claim a refund by submitting Form CA5610, which can be obtained from Inland Revenue, National Insurance Contributions Office, Deferment Services, Longbenton, Newcastle upon Tyne NE98 1ZZ (telephone 084591 59464 or 54071).

The time limit for claiming a Class 4 refund for 1996-97 and earlier years is six years from the end of the year for which the contributions were paid (so that 1995-96 goes out of date at the end of 2001-02).

For 1997-98 and later years, it is five years from the self-assessment filing date for that year.

On the basis that the relief is not given automatically, it is worth reviewing all cases where an individual has moved from employment to self employment, or vice versa, since April 1995.

Other situations

The limitation of Class 4 contributions may also give effective relief where a taxpayer is simultaneously employed and self employed. Such a scenario is becoming more common under current working practices.

A final point is that the relief outlined in this article should not be confused with the much better known rule that the total National Insurance liability for a year (Classes 1, 2 and 4 combined) is capped at an amount equal to 53 weeks Class 1 contributions at the upper earnings limit (£2,586.40 for 2001-02). It should be observed that in many cases, including the example in this article, the Class 4 limitation will give substantially more relief than the annual 'cap'.

Example

G Brown was employed until 5 August 2001 and self employed during 2001-02 thereafter. For the 2001-02 tax year his Schedule E earnings were £10,000 and his Schedule D, Case I profit £33,500.

He paid 17 weeks' Class 1 contributions at the standard rate of 10 per cent (maximum) totalling £829.60 and 35 weeks' Class 2 contributions totalling £70. As his self-employed earnings exceeded the highest point of the band for 2001-02 (£29,900), the maximum Class 4 contributions of 7 per cent of (£29,900 – £4,535) of £1,775.55 are due.

The total contributions shown above are £829.60 + £70 + £1,775.55 = £2,675.15. In actual fact, in this example the total cap is £2,586.40 (53 weeks of Class 1 contributions) so that Mr Brown could obtain a repayment of £88.75 on that score, but he has a much better case for relief.

Under the procedure set out above, his Class 4 contributions will be:

This is a saving of £793.60. In theory it could be claimed in advance, but in practice it will be claimed in arrear.

One obvious complication is the effect that this relief will have on self-assessment payments on account for 2002-03, and this is another issue that must be watched carefully.

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