Introduction to Income Tax and NICs
V23a
Published April 2023
Introduction to Income Tax and NICs Introduction
Copyright © 2023 Chartered Institute of Payroll Professionals (CIPP)
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Whilst every effort has been made to ensure the information included in this course complies with current legislation neither CIPP nor the course tutor can be held responsible for any errors or omissions. If you wish to clarify any points raised, please do so by speaking to the trainer or tutor. If you would like to receive further support from the CIPP, including our Advisory Service and other member services, you can become a member by contacting 0121 712 1073 or membership@cipp.org.uk.
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Introduction to Income Tax and NICs Introduction
CONTENTS
Page Introduction .................................................................................... 7
1.1
Objectives ................................................................................................. 7
1.2
The ideal ................................................................................................... 7
1.3
Key dates .................................................................................................. 7 Earnings ......................................................................................... 8
2.1
What counts as ‘earnings’ ....................................................................... 8
2.2
Benefits in kind ........................................................................................ 9
2.2.1
What a benefit in kind is ............................................................................. 9
2.2.2
Tax and NICs liability.................................................................................. 9
2.3
Payment / earnings period..................................................................... 10
2.3.1
Frequency of earnings periods ................................................................. 10
2.3.2
Two or more earnings periods .................................................................. 10
2.3.3
The effect of the earnings period .............................................................. 10
2.4
Determining basic pay ........................................................................... 11
2.4.1
How weekly pay figures are determined ................................................... 11
2.4.2
How salary pay figures are determined .................................................... 12
2.5
Abbreviations ......................................................................................... 12 Deductions ................................................................................... 13
3.1
Employment Rights Act 1996 ................................................................ 13
3.1.1
Lawful deductions .................................................................................... 13
3.1.2
Exceptions ............................................................................................... 13
3.2
Types of deductions............................................................................... 14
3.2.1
Statutory deductions................................................................................. 14
3.2.2
Contractual deductions ............................................................................. 14
3.2.3
Voluntary deductions ................................................................................ 14
3.3
Implications of deductions .................................................................... 15
3.3.1
Sequence ................................................................................................. 15
3.3.2
‘Free of tax’ deductions ............................................................................ 16
3.3.3
‘Free of NICs’ deductions ......................................................................... 16
3.3.4
Pension schemes and contributions ......................................................... 17
3.3.5
Deductions and benefits in kind ................................................................ 18
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Introduction to Income Tax and NICs Introduction
3.4
Abbreviations ......................................................................................... 18 National Insurance contributions................................................ 19
4.1
What are National Insurance contributions? ........................................ 19
4.2
National Insurance number ................................................................... 19
4.2.1
NI Recording System ............................................................................... 19
4.2.2
NINO format ............................................................................................. 20
4.2.3
Sources of NINOs .................................................................................... 20
4.3
Classes of NI contributions ................................................................... 21
4.4
Definition of ‘employee’ ......................................................................... 22
4.5
‘Earnings’ ................................................................................................ 22
4.6
NICs category (table) letters .................................................................. 23
4.6.1
Factors determining the NICs category letter............................................ 23
4.6.2
Category letters normally encountered ..................................................... 27
4.7
Limits, thresholds and rates .................................................................. 27
4.7.1
Lower Earnings Limit (LEL) ...................................................................... 28
4.7.2
Primary Threshold (PT) and Director’s Primary Threshold (DPT) .............. 28
4.7.3
Secondary Threshold (ST) ....................................................................... 29
4.7.4
Upper Secondary Threshold (UST) .......................................................... 29
4.7.5
Apprentice Upper Secondary Threshold (AUST) ......................................29
4.7.6
Veterans Upper Secondary Threshold (VUST) ......................................... 29
4.7.7
Freeport Upper Secondary Threshold (FUST) .......................................... 29
4.7.8
Upper Earnings Limit (UEL)...................................................................... 30
4.7.9
Limits, thresholds and rates...................................................................... 30
4.8
Calculation methods .............................................................................. 32
4.8.1
The exact percentage method .................................................................. 32
4.8.2
The table method ..................................................................................... 33
4.9
Abbreviations ......................................................................................... 34
4.10
Key forms ............................................................................................... 35 Pay As You Earn and income tax ................................................ 36
5.1
What is PAYE? ....................................................................................... 36
5.1.1
Operating PAYE ....................................................................................... 36
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Introduction to Income Tax and NICs Introduction
5.2
Tax year and tax calendar...................................................................... 36
5.3
Frequency and date of payment ............................................................ 37
5.4
Tax rates and bands............................................................................... 37
5.5
Taxable income ...................................................................................... 39
5.6
Personal Allowances.............................................................................. 39
5.6.1
Marriage Allowance .................................................................................. 40
5.7
Tax codes ............................................................................................... 40
5.7.1
Sources of tax codes ................................................................................ 40
5.7.2
Code suffixes ........................................................................................... 41
5.7.3
Tax code prefixes ..................................................................................... 41
5.7.4
Other tax codes ........................................................................................ 42
5.7.5
The relevance of the numeric part of a tax code ....................................... 43
5.8
Cumulative and non-cumulative operation of PAYE ............................44
5.8.1
Cumulative operation ............................................................................... 44
5.8.2
Non-cumulative operation......................................................................... 44
5.9
Tax tables ............................................................................................... 45
5.9.1
Pay Adjustment Tables............................................................................. 46
5.9.2
Taxable Pay Tables.................................................................................. 47
5.9.3
Operation of the regulatory limit................................................................ 50
5.10
Tax refunds ............................................................................................. 51
5.11
Holiday pay paid in advance.................................................................. 51
5.12 Appendices ............................................................................................. 51 5.12.1 Abbreviations ........................................................................................... 51 5.12.2 Key dates ................................................................................................. 52 5.12.3 Key forms ................................................................................................. 52 Gross to net and the pay statement............................................ 53 6.1 The gross to net stage ........................................................................... 53 6.2 The pay statement .................................................................................. 53 6.2.1 The legal requirements............................................................................. 53 6.2.2 Additional information ............................................................................... 54 6.3 Abbreviations ......................................................................................... 55 Starters and Leavers.................................................................... 56
7.1
Mistimed payments for starters and leavers ........................................ 56
7.1.1
NICs implications ..................................................................................... 56
7.1.2
PAYE income tax implications .................................................................. 58
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Introduction to Income Tax and NICs Introduction
7.2
Payments after leaving .......................................................................... 58
7.2.1
PAYE income tax implications .................................................................. 58
7.2.2
NICs implications ..................................................................................... 59
7.3
Appendices ............................................................................................. 59
7.3.1
Abbreviations ........................................................................................... 59
7.3.2
Key forms ................................................................................................. 60
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Introduction to Income Tax and NICs Introduction
Introduction
1.1
Objectives
At the end of the course, delegates should be able to:
Calculate gross earnings
•
• Calculate income tax and NICs liabilities
• Handle payments for starters and leavers correctly
• Sequence the required calculations correctly
• Outline the correct process for systems output
Calculate net pay.
•
1.2
The ideal
All Payroll departments will be working towards the ideal:
The Payroll office needs to gather good quality data in a relevant format at an appropriate time, so that knowledgeable and conscientious pay staff using effective and efficient systems can produce timely and accurate payments.
1.3
Key dates
5 April annually
– end of tax year
6 April annually
– start of tax year
6th of each month
– start of new tax period
19th of each month – due date for payment to HM Revenue & Customs (HMRC) for those paying by cheque
22nd of each month – due date for payment to HMRC for those paying electronically
Please note that if the 19th or 22nd (as applicable) falls on a weekend or bank holiday, then the due date is the last working day before that date.
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Introduction to Income Tax and NICs Earnings
Earnings
It will be obvious that in order to run a payroll we must know some basic facts about each employee’s earnings. On any given occasion , we need to know at least:
• What the e mployee’s earnings are , what kind of payments and/or allowances they should receive this pay day and
• How much they add up to in total (that is, the total gross earnings).
This assessment of gross pay is the very start of the process of pay calculation and it must be accurate. It should take into account all the elements that potentially constitute earnings before any appropriate deductions.
2.1
What counts as ‘earnings’
A comprehensive answer to the question “what counts as earnings?” would produce a very long list. It would include:
Basic pay: salaries and wages
•
Fees
•
Overtime
•
Bonuses
•
Commissions
•
Holiday pay
•
• Allowances (for example, for being the designated First Aid person)
Statutory payments
•
Benefits in kind.
•
This list is not exhaustive.
It is worth noting that some of these pay elements need to be calculated with particular care, usually with reference to the contract of employment or other terms and conditions of employment. There are also legal implications such as ensuring that workers are paid at least the statutory minimum wage rates, and that holiday pay calculations take overtime and other payments into account, where necessary.
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Introduction to Income Tax and NICs Earnings
2.2
Benefits in kind
Included in the list above are ‘benefits in kind’ (also known as BiKs or just ‘benefits’ ). The following is an overview only as the treatment of benefits in kind is beyond the scope of this particular course.
2.2.1 What a benefit in kind is
There is no comprehensive definition of what is or counts as a ‘benefit in kind’. Generally, though, the provision of a benefit occurs when the employer provides goods or services to an employee, often by directly arranging the provision with a third party. Examples of benefits provided by the employer include company cars, medical insurance and Christmas gifts such as hampers. It is also possible for the employer to provide the benefit without using a third party, such as where the employer makes a loan at low or zero rates of interest to enable the employee to purchase a season ticket to commute to work, for example. Another possibility is that the employer gives vouchers (to buy goods from a retail store, for example) or tokens (to obtain access to a car park, for example). Such vouchers and tokens are often purchased from third parties but sometimes they are produced ‘in - house’. Again , these count as benefits.
2.2.2 Tax and NICs liability
Most benefits are subject to income tax and some are also subject to National Insurance contributions (NICs).
Income tax
Almost all benefits are treated as ‘earnings’ for income tax purposes. (There are some exemptions and exceptions, such as goods provided purely for business purposes.) The general rule is that the taxable amount (value) of the benefit is not included as ‘earnings’ through the payroll (unless the employer has registered with HM Revenue & Customs (HMRC) to process the value of the benefit through the payroll, known as payrolling the benefits). There are exceptions to this general rule (such as notional payments like ‘cash vouchers’) but for the purposes of this particular course, we will not treat the value of benefits as earnings. In order that the employee is taxed on the value of the benefit (if it has not been processed through the payroll), the employer has to calculate the value of the benefit each year and report details to HMRC on a ‘P11D Expenses and benefits’ form. The calculations and reporting requirements are beyond the scope of this course.
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Introduction to Income Tax and NICs Earnings
National Insurance contributions
Most benefits are excluded from earnings for the purpose of National Insurance contributions. However again, there are exceptions (for example, almost all vouchers are liable to NICs through the payroll).
Those benefits that are reported at the end of the tax year (see above) are liable to NICs under separate rules (and are not processed through payroll).
If the employer makes a payment to a third party to settle an employee’s bill in full or in part, then the amount is liable to NICs through the payroll.
These are complex areas that are outside the scope of this course.
2.3
Payment / earnings period
The payment or earnings period at which an employee is paid is prescribed in the contract of employment.
2.3.1 Frequency of earnings periods
The most common payment or earnings periods are weekly and monthly, followed by fortnightly and four-weekly. Less common are quarterly, six monthly and annual periods. (Some company directors, for example, may be paid just once a year.) It is also possible for employees not to have a regular earnings period. They could be paid only on completion of the work or contract, which could be of any duration. This would be an ‘ad hoc’ period.
Note that, for NICs purposes, an earnings period cannot be shorter than a week.
2.3.2 Two or more earnings periods
Most employees have only one earnings period but it is possible for an employee to have two or more earnings periods. This can occur where an employee is paid a monthly salary but is also paid a quarterly commission payment separately, for example.
2.3.3 The effect of the earnings period
The earnings period affects:
The calculations of pay
•
• The calculations of PAYE income tax and NICs
Payroll procedures and schedules.
•
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Introduction to Income Tax and NICs Earnings
2.4
Determining basic pay
2.4.1 How weekly pay figures are determined
There are several possible ways to determine weekly pay figures, including the following. These details are normally included in an employee’s contract of employment, although reference may be made to collective agreements, national pay scales.
Payment for work produced
The amount of pay is calculated according to the quantity of items produced and the rate of pay for each. This is often called ‘piece rate’.
For example, an electronics company pays 60p for each item soldered on the basis that the average worker can solder 20 items in an hour. If a worker completes 275 items in a week, then the weekly pay for that work would be £165 (275 x £0.60). A company might pay different piece rates for different types of work so that an employee ’ s weekly pay depends on how many of each of the different items the employee produces.
Hourly rate
The amount of pay is calculated according to the number of hours worked and the employee’s hourly rate of pay.
For example, if an employee worked a standard 40-hour week at an hourly rate of £10.50, then the weekly pay would be £420.00.
A company might pay for additional hours worked, such as overtime, at the employee’s usual hourl y rate or at some other rate prescribed in the contract of employment.
Payment per shift
The amount of pay is calculated according to the number and types of shifts the employee works (such as night shifts, day shifts). For each shift worked, a standard payment prescribed in the contract of employment is made. For example, a company might pay £80 for an eight-hour day shift and £100 for an eight-hour night shift. If an employee worked two-day shifts and three-night shifts in a particular week, then the weekly pay would be £460 ((2 x £80) + (3 x £100)).
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Introduction to Income Tax and NICs Earnings
2.4.2 How salary pay figures are determined
It is common for the contract of employment to provide that the employee is to be paid an annual salary. The contract may further provide that the annual salary will be paid by instalments over the course of the year, according to the employee’s payment / earnings period. For example, an employee could be contracted to work a standard 37.5-hour week for an annual salary of £27,000 paid in 12 equal monthly instalments. The employee’s monthly salary would be £2,250. A day’s pay may also need to be identified so that pay for part -months or deductions for unpaid leave can be calculated. The method for calculating a day’s pay may be stated in the employment contract; if it is not, then the annual salary would be divided by the number of calendar days in the year.
2.5
Abbreviations
BiK
–
Benefit in Kind
HMRC
–
HM Revenue & Customs
NICs
–
National Insurance contributions
PAYE
–
Pay As You Earn (income tax)
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Introduction to Income Tax and NICs Deductions
Deductions
The following is a brief overview of deductions from pay.
All deductions from an employee’s pay are covered by variou s laws. In particular, the Employment Rights Act 1996 (ERA) prescribes rules for such deductions to be lawful where certain conditions are met.
3.1
Employment Rights Act 1996
3.1.1 Lawful deductions
The Employment Rights Act 1996 states that a deduction from pay is lawful if one of the following is true:
• I t is required by statute (‘statutory deduction’)
• It is authorised by the contract of employment and the employee has received a copy of the contract prior to the deduction being made (‘contractual deduction’) • In all other cases, the employee has given prior permission in writing (‘voluntary deduction’) .
Therefore, all lawful deductions from pay are either statutory, contractual or voluntary.
3.1.2 Exceptions
There are exceptions in ERA covering deductions in respect of overpayments and industrial action.
It is not sufficient for an employer to obtain agreement. A range of case law now exists to emphasise this point. For example, an agreement may state that overpayment of salary will be repaid, but unless it also states when or from what then the employer may still not be entitled to make a deduction. In this type of case an employee may leave a company owing money yet still take all their final pay.
It is always wise to obtain written authorisation in advance of such an event, ideally by including the relevant provision in the contract of employment.
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Introduction to Income Tax and NICs Deductions
3.2
Types of deductions
3.2.1 Statutory deductions
The following count as ‘statutory deductions’:
• Attachment order (such as Attachment of Earnings Order (AEO))
Deductions for Student Loans
•
National Insurance contribution (NIC)
•
• Income tax collected through Pay As You Earn (PAYE)
• Pension scheme contribution (but see ‘ Voluntary deductions ’ below).
3.2.2 Contractual deductions
The contract of employment may provide for deductions from pay to be made in a wide range of situations. Drawing up a comprehensive list of contractual deductions would be impossible, but examples include: • Recovery on termination of employment of overpaid holiday pay (where paid holiday taken exceeds entitlement)
Deductions for poor workmanship
•
Damage to company property
•
• Repayment of training course costs and study fees (such as on termination)
• Private use of a company asset (such as a company car)
• Recovery of medical insurance premiums
• Recovery of loans (such as Season Ticket Loans).
3.2.3 Voluntary deductions
Voluntary deductions are those where the employee either has given consent for the deduction to take place or has asked the employer to make the deduction on the employee ’s behalf.
Examples of voluntary deductions include:
Trade union subscriptions
•
• Charitable Payroll Giving, which is a scheme approved by HM Revenue & Customs (HMRC) (often erroneously called ‘GAYE’ – Give as You Earn)
• Saving schemes (for example to buy shares in the employing company)
Credit union payments
•
Sports club fees
•
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Introduction to Income Tax and NICs Deductions
• Health or dental insurance costs (unless provided for as a contractual deduction) such as to a Hospital Savings Association • Pension scheme contributions (including Additional Voluntary Contributions, AVCs) Usually, the rules of the pension scheme will stipulate that by becoming a member of the scheme, the employee accepts that deductions will be made from pay. It is usually up to the employer to choose whether to make voluntary deductions from an employee’s pay ; it does not need to offer a Payroll Giving scheme, for example. However, an employer may be required to make voluntary deductions in some circumstances. For example, the legislation for pensions automatic enrolment requires the employer to deduct pension contributions from the pay of certain employees without requiring their consent. But these deductions are still considered voluntary because the employees can choose to leave the pension scheme afterwards (and, in some circumstances, have their money back).
3.3
Implications of deductions
3.3.1 Sequence
The sequence of deductions is important because this will have a direct impact on the calculation of PAYE income tax, NI contributions and attachment orders. Depending on their purpose, deductions can be made before or after the calculation of income tax and/or NICs.
The following is the sequence that deductions from pay are to be made in:
• Recovery of any overpayment, so that the gross pay is reduced
• Deductions for PAYE income tax and NIC (note that these have equal priority)
• Deductions for attachment orders (such as AEOs)
Deduction for a Postgraduate Loan
•
• Deduction for an undergraduate Student Loan
• Contractual deductions (but including pension contributions)
Voluntary deductions.
•
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Introduction to Income Tax and NICs Deductions
3.3.2 ‘Free of tax’ deductions
‘ F ree of tax’ mean s that the deduction serves to reduce the amount that income tax is calculated on.
The recovery of an overpayment of earnings from gross pay will reduce the amount that income tax (and NICs, attachment orders and so on) is calculated on.
There are two common deductions that often affect the tax calculations by reducing the ‘taxable pay’ before tax is calculated. (Although the step of actually deducting them from post-tax pay is carried out later in the payroll calculation.)
These two deductions are:
• T he employee’s donations to charity through a Payroll Giving scheme that has been approved by HMRC • T he employee’s contributions to a pension scheme that operates the Net Pay Arrangement (NPA) for tax relief (both regular contributions and Additional Voluntary Contributions).
Note that there is no statutory limit to the amount that an employee can contribute tax-free into a charitable Payroll Giving scheme.
There is a statutory limit to the amount of pension contributions that an individual can put into pension schemes in a tax year and get tax relief on, which is known as the annual allowance. Tax relief is available at an individual’s marginal rate. The annual allowance level is currently £40,000 and any unused allowance can be carried over for up to three tax years. From 6 April 2016, high income earners may have a reduced annual allowance. The amount of tax relief available may also be restricted.
Pension contributions that attract tax relief also have a lifetime allowance cap, which is currently £1,073,100 (with various exceptions).
There is another type of ‘free of tax’ deduction that is occasionally encountered. This occurs where the employee enters into a Share Incentive Plan (SIP) that has approval from HMRC. In essence, the employee gives up salary to buy shares in their company. The effect is that the gross pay is reduced before the tax (and NICs) is calculated.
3.3.3 ‘Free of NICs’ deductions
Other than deductions in respect of Share Incentive Plans and recovery of overpayments, there is no deduction that affects the pay on which NICs are to be calculated.
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Introduction to Income Tax and NICs Deductions
3.3.4 Pension schemes and contributions
Generally, a pension scheme can be categorised as either registered with or not registered with HMRC. If the scheme is registered, then amongst other things, the employee’s contributions are tax -deductible. Pension schemes that operate the Net Pay Arrangement require employers to send them contributions that already take the employees’ tax relief into account. This is done through the payroll by deducting contributions from gross pay before calculating the income tax due. Alternatively, pension scheme providers can claim the tax relief from HMRC directly, under an arrangement called Relief At Source (RAS). Contributions to schemes that operate RAS must be taken from earnings after income tax has been calculated. It is very important that the tax relief method operated by an organisation’s pension scheme (or schemes) is understood so that payroll can take contributions from earnings at the correct point. Note that the CIPP’s examples, exercises and exam questions use RAS (unless otherwise stated).
In addition, a pension scheme is generally either:
• A personal pension plan (individual pension, arranged without the employer’s involvement) • A Group Personal Pension (individual pensions collected together for administrative efficiency, where the employer facilitates access to the pension and usually contributes) • An occupational pension scheme (employer more involved in the design and governance of the pension scheme, together with trustees).
Finally, pension schemes can also be categorised as either:
• Defined benefit (DB), where the salary-related benefits at retirement are defined from the outset • Defined contribution (DC), where the contribution levels are defined but the benefits at retirement will depend on what the fund is able to purchase. The amount of the employee’s contributions to the pension scheme will be either prescribed in the scheme rules or decided by the member. Generally, occupational pension schemes specify the amount or rate of contribution to be made by the employee (and employer).
It is essential to note that:
• Not all pension schemes operated by employers are registered with HMRC
• Not all employee pension contributions reduce the gross pay for tax.
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Introduction to Income Tax and NICs Deductions
3.3.5 Deductions and benefits in kind
As mentioned earlier, benefits in kind (BiKs) are generally taxable on the employee. If the employee makes a contribution towards the costs of the benefit, then the amount so contributed can reduce the taxable value.
Example 1 An employer provides medical insurance for employees and their families. Under the employees’ contracts of employment, the employer is authorised to make deductions from their pay in order to receive this benefit. The total amount deducted in the tax year reduces the taxable amount of the benefit.
Note that a deduction from pay to contribute towards the cost of a benefit is made after PAYE income tax and NICs are calculated.
3.4
Abbreviations
AEO
–
Attachment of Earnings Order
AVC
–
Additional Voluntary Contribution
BiK
–
Benefit in Kind
ERA
–
Employment Rights Act 1996
HMRC
–
HM Revenue & Customs
NICs
–
National Insurance contributions
NPA
–
Net Pay Arrangement
PAYE
–
Pay As You Earn (income tax)
RAS
–
Relief At Source
SIP
–
Share Incentive Plan
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Introduction to Income Tax and NICs National Insurance contributions
National Insurance contributions
4.1
What are National Insurance contributions?
National Insurance (NI) is a system of taxation that is related to certain social security benefits, such as the Basic State pension. It was first introduced by the National Insurance Act 1911 . The ‘tax’ is National Insurance contributions (NICs). The NICs collected are paid into the National Insurance Fund out of which benefits such as the Basic State Pension are paid. A small part of the Fund is used to pay for the National Health Service. The social security benefits are usually referred to as ‘contributory benefits’. These are ones where the claimant’s prev ious contribution record determines the availability and amount of the benefit paid. They are usually paid on a weekly basis to participants upon death, retirement, unemployment, maternity and disability.
4.2
National Insurance number
Although the National Insurance number (NINO) does not affect how NICs are calculated NICs, it is important to the Department for Work and Pensions (DWP),HM Revenue & Customs (HMRC) and to employers because it helps identify the employee and the allocation of certain data from various reports.
4.2.1 NI Recording System
National Insurance numbers (NINOs) are issued automatically to every UK young person on the child benefit register, shortly before the age of sixteen. This represents the ‘opening of an account’ on the National Insurance and PAYE Service (NPS), which is maintained by HMRC. That account will hold the individual’s lifelong National Insurance re cord. All the NICs that will be deducted from the individual’s pay will be allocated to their account (as well as NIC credits for periods when the individual is not earning, in certain circumstances). Similarly, all the contributory social security benefits, including State Pension, that the individual will ever claim will be based upon their account. The NINO is the one essential piece of information that uniquely identifies the correct unique NI record whenever NICs are added to the account or benefits are claimed.
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Introduction to Income Tax and NICs National Insurance contributions
4.2.2 NINO format
All National Insurance numbers have the same format: XX NNNNNN X.
The first two characters are letters. The next six are numbers. The last character is a letter in the range A to D or it is a space.
Temporary NINOs
Some payroll software systems require users to enter a NINO in order to create an employee record, or even to process the employee’s pay. In th ese cases, a temporary number might be used as a matter of expediency until the correct number is available. However, HMRC does not accept temporary National Insurance numbers in the information that employers must send to it. HMRC ’s guidance says that if an employer is unable to obtain the National Insurance number, then it must:
• Leave the National Insurance number field empty, and
• Enter the date of birth and gender in the Full Payment Submission (FPS).
Therefore, it is best to avoid entering temporary National Insurance numbers in a payroll system if this is possible.
Temporary numbers would follow a standard format, which is a six-figure date of birth prefixed by TN and suffixed by either M or F signifying male or female: TN DD MM YY M/F. For example, the temporary number for a woman born on 30 August 1986 would be TN300886F.
4.2.3 Sources of NINOs
It is important that the employer obtains and uses an accurate NINO for each employee because it is used by both the DWP and HMRC for recording purposes.
Sources for locating a NINO for an employee are:
RD3 This is the official notification of a person’s NINO, which is issued automatically to those on the child benefit register shortly before they reach age 16. The RD3 used to be a plastic card but, since 2011, it is a letter.
•
• Form P45, form P60 and letters about tax, benefits and pensions These forms and letters might be supplied by a new employee.
CA4139 Formerly CF383 – certificate of reduced rate election (see ‘Reduced rate’ under ‘NICs category (table) letters’ below).
•
• Any official correspondence from HMRC, Jobcentre Plus
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Introduction to Income Tax and NICs National Insurance contributions
NVR A National Insurance number Verification Request can be submitted to HMRC, which will provide the NINO to the employer through the online submission route. HMRC will also provide the NINO this way if the employer leaves the NINO field empty in a Full Payment Submission, with date of birth and gender completed. CA5403 Individuals can use this form to apply to HMRC to get their NI number by post to the emplo yee’s home address. Personal Tax Account. Employees can also confirm their NINO by checking their online Personal Tax Account or on the HMRC app (https://www.gov.uk/personal-tax- account). From there, they can print or share their NI number confirmation letter.
•
•
•
Occasionally, an employee may not have a NINO. This could happen if this is an employee’s first job since entering the United Kingdom.
Employees who have never had a NINO must apply in person to their local social security office (such as Jobcentre Plus) which is a process known as registration. They must show proof of their identity, such as a passport or an original birth certificate. The employee will be given a form to show to the employer as confirmation that an application has been made because the registration process can take a long time.
4.3
Classes of NI contributions
There are several classes of National Insurance contributions:
• Class 1 — Employee (primary) and employer (secondary) contributions on earnings and certain payments (benefits in kind)
• Class 1A — Employer-only contributions on most benefits in kind
• Class 1B — Employer-only contributions on a PAYE Settlement Agreement (PSA)
• Class 2 — Self- employed person’s flat rate contributions
Class 3 — Voluntary contributions
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• Class 4 — Self- employed person’s profit related contributions.
This course is concerned primarily with Class 1 contributions.
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Note that Classes 1, 1A and 1B are mutually exclusive. If Class 1 NICs are due on the earnings (or on a payment in kind), then Class 1A and 1B NICs are not also due on the same earnings (or payment).
4.4
Definition of ‘employee’
For NICs purposes, an employee is someone who works under a contract of service, rather than a self-employed person who will work under a contract for services. Included within the scope of ‘employee’ are:
• C ompany directors and ‘office holders’ such as Jud ges, MPs
Apprentices
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Agency workers.
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In most cases, it will be obvious who are and who are not employees, but doubts will occasionally arise. For example, someone may be engaged as a consultant or perhaps on a short-term contract and may ask to be treated as self-employed by the employer.
If an employer has any doubt about the status of a worker, then confirmation should be sought from HMRC at an early stage.
4.5
‘Earnings’
Class 1 National Insurance contributions are earnings- related. The employee’s earnings determine the amount due on any given pay day for the period.
When calculating ‘NICable’ earnings, no deduction is made from NICable earnings for charitable Payroll Giving contributions or pension scheme contributions, which can happen when calculating tax. For this reason, the taxable and NICable earnings will often be different, with the NICable earnings figure often being the same as the gross pay figure. The scope of ‘earnings’ in the NICs legislation is drawn very wide ly. It includes certain benefits in kind (BiKs) (or ‘payments in kind’ as they are termed for NICs purposes).
Excluded from the scope is any amount that the employer reimburses for genuine business expenses incurred and met by the employee. Also excluded are:
• The employer’s contributions to the employee’s pension scheme
• Any pension payments made by a pension scheme.
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4.6
NICs category (table) letters
NICs are calculated by applying specific percentage rates that vary according to:
• Earnings between various limits and thresholds (see below)
The employee’s circumstances These are organised in categories that are identified using category letters.
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• Whether the NICs are paid by the employee or the employer.
In order to calculate the NICs for each pay period, therefore, the employer must determine the NICs category letter that applies to the employee for that pay period.
Often, an employee’s category letter will not change during the tax year or for many years. Category letters are also known as table letters.
The employee’s NICs category letter is based on the employee’s circumstances on the date that earnings are paid, not in the period over which they are earned.
Where an employee changes NICs category letter, for example, on reaching State Pension Age, the revised letter category will therefore apply to the whole of any earnings that are paid after the change. The earnings may relate to a period before the change, but that does not matter. What matters is the date of payment. This applies whatever the reason for the change, including a married woman paying reduced rate contributions who divorces, or an employee becoming 21 years old.
4.6.1 Factors determining the NICs category letter
Exemptions from NICs liability may be partial (employer-only pays) or complete (neither employer nor employee pays).
Type of employee
There are some types of employee that special NICs category letters apply to. These types of employee are members of the armed forces and mariners.
Gender
There are two ways in which the employee’s gender can affect the NICs category letter. These relate to the right to pay reduced rate NICs and to the end of the liability to pay NICs when the person reaches the State Pension Age (SPA) because SPA differs according to whether the employee is male or female. Both of these are explained below.
Note that if an employee changes gender, then the NICs category letter may also change.
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Complete exemptions
Payroll practitioners are likely to encounter the following examples of complete exemption from NICs.
Employees under age 16 No liability whatsoever arises on earnings paid before someone’s sixteenth birthday. Note again that it is the date of payment that determines liability and not the period over which the payment may have been earned. Occupational pension payments There is no liability on payments of occupational pension, regardless of the age of the recipient. Such payments do not count as earnings for National Insurance purposes so no NICs are due. Employees seconded overseas There is also an exemption applicable to employees seconded to work overseas. This a very complicated area, and the actual rules that will determine complete or partial exemption take into account such issues as the countries or region that the employee comes from or goes to and the period of the secondment.
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Partial exemptions
There are several types of partial exemption that Payroll will encounter. Exemptions for employer or employee NICs will apply in the following circumstances.
Employees under 21 years old From April 2015, employers pay reduced NICs on the earnings of under 21 years old up to the new Upper Secondary Threshold (UST)
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• Employees who are apprentices and under 25 years old From April 2016, employers pay reduced NICs on the earnings of employees aged under 25 years old on approved apprenticeships up to the new Apprentice Upper Secondary Threshold (AUST)
• Veterans in their first 12 months of civilian service
From April 2021, employers are entitled to NICs relief on the earnings of veteran employees within the first 12 months of civilian employment up to the Upper Secondary Threshold (UST). The relief is available from April 2021, however between April 2021 and March 2022 employers needed to calculate and pay the secondary NICs on these earnings as normal and then claim it back retrospectively from April 2022 onwards. From April 2022, the relief is applied in real time through PAYE.
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Workers at Freeports From April 2022, employers who are registered at one of the new ‘Freeport tax sites’ in Great Britain are entitled to pay reduced NICs on earnings of eligible employees up to the new Freeport Upper Secondary Threshold (FUST) for up to three years. An eligible employee is one who spends at least 60% of their working hours at the relevant Freeport site and whose employment started between 6 April 2022 and 5 April 2026. They must not have been employed by the employer or a connected employer at any time in the previous two years.
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• Employees over State Pension age (SPA)
The State Pension is a benefit of the National Insurance scheme so, once the employee is old enough to receive this benefit, contributions into the scheme stop for the employee. (The employee does not need to be actually receiving a State pension.) There is no liability for employee ’s (primary) NICs on earnings paid after reaching this age but employer’s (s econdary) NICs are still due at the appropriate rate. The employer needs some authority in order to stop deducting the employee NICs or clear proof of the employee’s date of birth and knowledge of their SPA. The employee may produce form CA4140 (formerly CF384) Certificate of Age Exemption (sometimes called Certificate of Age Exception), which employees can apply for by contacting The Pensions Service (part of the DWP). An employee can also write to HMRC to obtain a letter confirming that they have reached their SPA and do not need to pay NICs (https://www.gov.uk/tax-national-insurance-after- state-pension-age/stopping-paying-national-insurance). Appropriate proof of the employee’s date of birth can include a birth certificate or valid passport. A copy of the evidence should be kept on the employee’s file. The SPAs for men and for women used to differ but are now aligned (and increased). During this alignment, the ages at which people reach SPA vary according to their gender and date of birth and so each person’s SPA must be confirmed in appropriate tables (https://www.gov.uk/government/publications/state-pension-age-timetable). Deferment In any single tax year, there is a maximum amount that an employee is required to pay in NICs on earnings up to and including the Upper Earnings Limit (UEL). The amount is 53 times (not 52 times) the Class 1 employee NICs payable on earnings at that year’s weekly UEL. Employees with more than one job who expect to pay the annual maximum NICs in any one job or mixture of jobs can apply to defer paying most of their NICs in any subsequent jobs. This avoids them overpaying. If they do overpay, then they have to wait until after the end of the tax year for a refund. While refunding is an automatic process, it can be protracted.
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