It may be tempting to adopt measures that compensate for the increases in NIC and dividend rates, but companies must weigh up the pros and cons.
Hopes that the planned 1.25% increase in Class 1 National Insurance Contributions (NICs) which was announced in the Autumn 2021 budget as part of the Health and Social Care reform bill and due to take effect from 6 April 2022, would be either scrapped or delayed were dashed by the government last month.
There had been hope that the squeeze on household income caused by the soaring cost of domestic energy would add enough ‘fuel to the fire’ of the arguments made by MPs from all parties, business professionals and economists that now was not the right time to increase the tax burden, but the government have confirmed that the increase will take effect as planned from 6 April 2022.
The 1.25% increase applies to all classes of NIC. Class 1 NICs is the main class of NIC that is due on employment earnings and benefits, and is payable by both the employee (primary contribution) and employer (secondary contribution). The 1.25% rate increase applies to both rates of NIC meaning that, unusually, businesses and individuals will suffer the effects of this added cost in equal measure. Unfortunately, though, a problem shared is not always a problem halved.
Rates to 5 April 2022
Rates from 6 April 2022
Employer (Class 1, 1A and 1B)
Employee (Class 1) Main Rate
Employee (Class 1) Higher Rate
Self-employed (Class 4) Main Rate
Self-employed (Class 4) Higher Rate
Although 1.25% does not sound like a significant increase for a business or individual to bear in isolation, in the wider context of a fragile post-pandemic recovery, rising inflation and Brexit, this added cost could stretch some companies and families too far.
Despite the potential for only a modest saving of 2.5% in total, some companies are looking at ways they might legitimately avoid the extra NICs by bringing forward the payment of some earnings normally due after 6 April 2022 so that the monies are paid in the 2021/22 tax year (before the increase applies).
Accelerating the payment of earnings in a way that is effective for tax or NIC purposes, but preserves the nature and intention of the payment, may not be as straightforward as it seems. There are a number of things that companies and individuals need to consider.
When are payments taxed?
Tax rates have generally been static or gone down in recent years. But we may remember a similar situation following the introduction of the 50% rate of tax on earnings over £150,000 (which represented a 10% income tax rise at the time), so there is a precedent for accelerating payments to try to mitigate a tax rise. The key issue to consider is “when are payments liable to tax”?
Legislation dictates that earnings in the form of money are treated as ‘received’ by the employee, and therefore liable to tax at the earliest date of:
when a payment of earnings is actually made or when a payment on account of earnings is made
the time when a person becomes entitled to payment of earnings or a payment on account of earnings
There are further criteria for company directors which bring the following into the assessment:
the date when earnings are credited in the company’s accounts or records
where the amount of the earnings is determined before the end of the period to which they relate, the date that period ends
where the amount of the earnings is determined after the end of the period to which they relate, the date the amount is determined.
Apart from the additional criteria for directors, you might assume this means you can pay an employee early some of the earnings that would normally be due after 6 April 2022, and achieve the desired result. Sadly it’s not that simple.
A payment for the purposes of this legislation happens only when money comes within the control of the employee, so that they can dictate how it is used and enjoyed. To count as a payment from employer to employee (for tax purposes), the employer can have ‘no right of recovery’ over the money. Simply paying an employee’s salary early, but including a payback condition should they leave the employment before a set date (the end of the future month the salary is being paid to), would not be seen as a ‘payment of earnings’ and therefore would not achieve its objective.
Similarly, take a company whose performance year ends on 31 March, with annual performance bonuses paid on 30 June, subject to employees still being in employment on 30 June. The company may consider bringing forward bonus payments, so they are paid on or before 5 April 2022.
For this to be effective, the company would have to abandon the condition of ongoing employment on 30 June. This however carries a HR risk, as their employees are no longer ‘tied’ to the company for the usual three months from April to June. More staff may resign who would otherwise not have left the business until after 30 June.
That’s the dilemma. Is the 1.25% saving in NICs (from which the company would benefit) worth the risk of losing an employee sooner or making employees less committed to their work because they have already been paid?
Dividend rates up
Similarly, the dividend rate is increasing by 1.25% to echo the change in NICs. The dividend allowance of £2,000 remains the same and this will continue to be taxed at 0%. Above this amount, the dividend rates will increase as follows:
Rates to 5 April 2022
Rates from 6 April 2022
Where dividends are usually paid after 6 April, there could be benefit in accelerating these into the current tax year. Another idea is to increase other planned dividends before 6 April 2022 if there are multiple payment dates. In the simplest form, a £100,000 dividend paid before the tax year end could save the individual up to £1,250 in taxes compared to it being paid on 6 April 2022 or later.
But this could increase the individual’s payments on account due for the 2022/23 year, so they may need to make a claim to reduce these if the increased dividends are not planned to continue.
So it may be possible to facilitate payment of earnings before 6 April 2022 in order to make the 2.5% (combined) NIC saving, or 1.25% on a dividend payment. But there are other factors for companies and employees to weigh up in deciding whether to do this.
Payment of earnings before 6 April will, of course, increase the earnings reported and taxed in the 2021/22 tax year. If this takes the employee into a higher tax bracket, they will likely be worse off overall.
When it comes to dividends, companies must consider all the shareholders receiving these dividends. Inadvertently pushing a shareholder from basic rate to higher rate, or higher rate to additional rate, could be more expensive for their personal tax position than the potential saving of 1.25%. It’s therefore quite challenging to gauge, where the shareholders are in different tax bands, whether this would be beneficial. This can also apply for an individual’s bonus.
There are several other earnings barriers for individuals to consider:
The first is £100,000. Taxable income over this amount creates a restriction to the personal allowance for that tax year. It would be illogical to lose a tax-free allowance in order save 1.25%, pushing an individual into the ‘hidden’ 60% tax bracket.
Those earning between £50,000 to £60,000 per annum. Not only is £50,000 broadly the start of the 40% tax band, but child benefit received during the tax year has to be paid back to the Government via the High Income Child Benefit Charge (HICBC) if income exceeds £50,000, over £60,000 the full amount is reclaimed and any increase in income for employees already in this tax bracket will mean they pay back more via the HICBC than they would otherwise.
Similarly, this could affect an individual’s ability to pay into their pension (the Annual Allowance). Higher earners may have their pension contribution limits restricted and, where contributions have already been made, this could lead to a pension savings tax charge on the over contribution at 45%.
So there are many pros and cons for a company, its employees and the shareholders if they change the way earnings are paid to avoid the extra taxes.
We do expect some employers to do this for select employees with special types of pay. But most will probably conclude that the work involved and the potential HR risks far outweigh the potential 1.25% saving. Whereas, smaller, family owned companies may see the benefit in additional dividends.
Overdrawn company director loan accounts
An additional consideration for smaller companies may be to settle their outstanding director’s loan account (DLA). Where a shareholder has an outstanding loan with the company at the end of the accounting period, which is not settled within nine months, there is a Corporation Tax charge (known as s455 tax). This is directly linked to the higher rate of Dividend Tax, so will increase from 32.5% to 33.75% from April 2022.
So it may be time to review settling some of this debt to avoid an increase in the tax charge after April 2022. But should the loan be repaid to the company after the tax has been paid, this tax can still be reclaimed.