A couple of months ago, we wrote an article for the Schmidt Tax Report about ways of saving national insurance entirely legitimately by intelligent structuring of the way you receive your income. It’s almost as if we had been prescient, because, of course, we’ve now had the announcement that the government is breaking its manifesto pledge and hiking both employers and employee’s national insurance contributions rates. Naturally, most of the publicity has been about the 1.25% increase in how much employees suffer on their earnings, and our recent article was all about how to save paying excessive amounts of individual NI. But what took a bit more trawling through the journalistic “write up” of the government announcement is the fact that employers too are seeing a 1.25% increase, it seems, on their contributions.
An Easy Target
It’s not often I find myself agreeing with the political commentary you find in The Guardian, but they’ve made the very valid point that the government announcements are exploiting a general public lack of understanding about what national insurance really is. I’m focusing here on what you might call “the other side of the coin”, which is the amount that employers pay on top of the contributions deducted from employees, referred to euphemistically (ie wrongly) as an “employer’s national insurance contribution”.
We’ve railed for a long time against this hypocritical description of what is really nothing more than a payroll tax. Employer’s national insurance contributions don’t actually serve to increase any benefit available to employees. As always, employers are an easy target for the government, because there aren’t many of them in comparison with the total number of voters: but of course it’s not exactly a devastating insight to point out that an extra 1.25% on the cost of employing your entire workforce is going to put some businesses, which operate on a tight margin, out of business. It will no longer to be viable to run businesses such as theirs: and at best this is going to be an inflationary move by the government since those businesses which are able to survive will do so by correspondingly increasing prices.
How To Save Employer’s NI
That’s the end of the Party Political Broadcast on behalf of the Cynics Party. Now let’s get down to the more constructive task of pointing out practical and legitimate ways of keeping the government’s shovel out of your stores.
First of all, we’ll be concentrating, here, on what you might call the “real” employees of the business. We’ve already talked at some length about avoiding triggering national insurance on what the owners/managers of the business take out themselves (although a few of the ideas that follow will also be applicable to them). The people who really need help, in the face of this latest “punch up the bracket” (to quote Tony Hancock) from HMRC are those who employ large amounts of third party staff and therefore have a big payroll tax (sorry, “employer’s NI”) levy to pay on top the wages bill.
As always with generic articles of this sort, we’ll be putting forward a series of ideas not all of which will be applicable in everyone’s circumstances. In fact, if you’re really unlucky, it’s possible that none of them will: but hopefully, we think you’d be in the minority of businesses if you couldn’t derive any benefit from the suggestions that follow now.
1. Third Party Service Providers
It’s very popular amongst some businesses, for very good reasons, to use third party service providers instead of employing individuals directly. The benefit of doing so is primarily the fact that you don’t incur the heavy and ongoing responsibility that our one sided legal system imposes on the employer in favour of the employee. At least that’s the theory: but even if the transfer of legal hassle to the intermediary agency or whatever isn’t completely watertight, in all probability, at the very least using a third party service provider relieves you, the business person, of the need to operate our increasingly complex and unwieldy payroll/PAYE system. And as you’re not the direct employer of the individuals who come and work for you, of course, you’re not liable to pay any employer’s national insurance contributions. So we’ve put this as our number one in the list of ways of sidestepping the 1.25% employer’s NI hike. But of course, except in cases where the agency or third party service provider doesn’t simply increase their prices to make up for the extra government levy, this benefit is inevitably more apparent than real. You’re already effectively paying, at one stage removed, the payroll tax for the staff that the third party provides to you, and only in a very few cases are they going to refrain from passing on the increase in their own costs to you. But it may be, in some cases, that this will be the outcome, and it’s always worth considering outsourcing the employer’s job in this way in any event.
2. Using Freelancers
But let’s get back to basic principles. The employer’s NI liability only applies where you are actually employing the individuals that you’re paying; and “employing” in that sentence has a highly technical meaning. It means that you and the individual concerned are in what is sometimes quaintly described as a “master and servant relationship”. And of course not everybody you pay for doing a job is in that relationship with you. Your accountant, your insurance broker, and your window cleaner are not typically treated as being in this legal relationship, and so there’s no question of what you pay them having to go through a payroll system, with PAYE and NI deductions, and the addition of the employer’s NI levy.
As so often with the law of this country, the question of whether someone is employed or freelance isn’t derived from anything written down in an Act of Parliament, but is made up of the whole body of judges’ decisions going back to the year dot. So anybody who wants to set up as an expert in the question of whether a person is your employee, or is an independent freelance providing services, needs to get their head round a massive body of information. Summarising drastically, though, what it comes down to is whether you are in control of what the individual does, how they do it, where they do it, when they do it, and so on. An important second arm of the test is the question of whether you have obligations to continue to provide them with work; and, on the other side of the coin, whether they have obligations to work for you if you ask them to. It’s these basic two criteria which give rise to all the other criteria which have been looked at in cases – for example whether a person is paid by an hourly rate or on piecework; whether they are in business on their own account; and whether they can send substitutes to work in their place.
The vital point we would like to make, here, though, is that in our view there will be an awful lot of cases where people are putting payments they make to other individuals, for those individuals’ services, through the payroll, when it’s not strictly correct for them to do so. Today’s working practices have moved right away from the old Victorian concept of “master and servant”. By a kind of default, anyone who is working for a business with a reasonable degree of permanence, and doesn’t fall within one of the standard exceptions like the business’s accountant or lawyer, is likely to have their remuneration treated as employment income even if it “really” isn’t.
The reason this is such a common default position is because HMRC are never going to challenge this treatment as being wrong, of course. It gives them, generally speaking, far more tax and certainly far more national insurance than they would get if the individual was just paid gross and put their income down an individual self assessment tax return. From the employer’s point of view, this default situation is also the safe situation, because HMRC are not going to come back to you, perhaps after many years, and sting you for a big arrears bill on the basis of a different interpretation. This default situation is safe because you’re already paying the maximum that you possibly can – the only risk free situation in any kind of tax planning.
So, the first and most obvious way of cutting down your employer’s NI bill may be to take a review of all your staff, particularly your senior staff, to see whether they really are in that employment relationship that you have probably always assumed they are. When new service providers come along, don’t just offer them a job on the payroll, but consider whether you could be paying them as self employed. Clearly you are putting yourself into the potential risk area by doing so, however if you genuinely think it’s right that you’re not in an employment relationship with that person, you should be acting accordingly. If you do decide to go down this road with one or mor individuals, it can be very important to make sure that you have a written contract with them, and that that contract says all the right things (eg about responsibility, control, substitution, “mutuality of obligations” and so on). Don’t forget, too, that it’s important not just to have a written contract which says the right things, but also that the way both parties conduct themselves is actually in accordance with what’s written down in their contract.
Brickbats Limited decide that they need an “inhouse” lawyer to advise them on the many legal points that come up in the course of their diverse and international business. They appoint Peter, who has just retired from a city firm of lawyers, on the basis that he will provide them with an average of three days a week. The contract stipulates carefully that he is able to choose which three days, and also has entire freedom about whether he comes into the office or decides that it’s more efficient for him to provide his services from home. Some of his three days a week time is actually spent late at night or in the small hours, because Peter is a “night owl”. He takes complete responsibility for the advice he gives, and is able to refuse to help on a particular question at his sole discretion (for example if he considers his expertise is insufficient).
Instead of unthinkingly putting Peter’s £100,000 a year through the payroll, Brickbats Limited assists him to register for VAT, set up a self assessment account and a set of records, an encourages him to work for others in addition to working for them. By doing so Brickbats Limited adds about £15,000 a year to its bottom line because it’s not paying employer’s national insurance.
3. Paying Service Companies
We think this must easily be the most popular method of avoiding paying employer’s NI. It’s so popular that there’s a whole battery of (hitherto fairly ineffective) anti avoidance legislation aimed in its direction. The simple principle its based on is the fact that limited companies can’t be employees; so any amount that you pay to a person’s company instead to paying to that individual him or herself, automatically escapes the employer’s NI obligation (as well as all the other tax etc obligations).
Now, we’re going to state my assumptions here. We’re assuming first of all that you, the reader of these words, are running a business which qualifies as “small”. You’re “small” if your annual turnover is less than £10.2 million, the total of your assets are worth less than £5.1 million, and you have fewer than fifty employees. If you meet only two of these criteria and not the third, you’re still small. And if you’re small, the dreaded “IR35” doesn’t apply to you.
Under IR35, which is the battery of anti avoidance rules we’ve already mentioned, someone can be made responsible for paying all the PAYE and National Insurance that would have been paid but for a personal service company being put in between the user of the individual services and that individual. IR35 applies where the relationship would otherwise be one of employer and employee (or “master and servant”). So it’s actually still the same test that we’ve talked about in the context of paying someone freelance. But the essential difference is who takes the risk. If you are a small business as defined, it’s the owner of the personal service company that takes the risk, because that company can be called on to pay all the tax and NI. If you’re a medium sized or large business, or if you’re a public sector payer, or if you even go down the road I’ve discussed above and pay the individual direct, it’s you, the user of the services and the person who pays for them, who takes the risk. And that’s what’s behind all the recent fuss there’s been about changes to these rules from 6 April 2021. From that date they didn’t actually change the IR35 criteria at all – they are still the same as they always were. But the question of who pays if gross payments are made when there should have been tax and NI deductions, has changed. Fortunately, our target audience of “small businesses” are not affected by this, and are still effectively free to use personal service companies in the same way they have always been, and thereby eliminate at a stroke all liability to employer’s NI and on what they pay an individual’s services.
4. Alphabet Shares
Whilst not as popular as the personal service company method of eliminating employer’s NI, alphabet shares do have their advocates. The way this structure works is that you issue shares to the key workers in your business, and pay them dividends instead of some or all of their salary. Despite fears and rumours to the contrary a few years back, the default government view is that dividends are still unearned income even in circumstances like this, and therefore don’t trigger national insurance. Generally speaking, these shares are “low fat” shares which don’t give the holders any entitlement to the capital value of the company, and don’t give them any voting rights. Generally speaking, we’re not entirely happy about recommending alphabet shares, mainly because of their “low fat” nature, which rather emphasises that they’re only there as a device to save NI. Personally we much prefer the situation where dividends are paid on full fat shares, which give full capital and voting rights, even if that’s only over a small fraction of the company.
To our mind, alphabet shares also cause problems with the rules about share related employment perks. If you issue shares to an employee of your company, or transfer shares to them, they’re basically taxable on the value of the shares they get as a benefit in kind. So there can be a major tax price to pay for setting up an employee share scheme of this sort in the first place. And one of the major practical difficulties with the tax rules for giving shares to employees is that you often won’t know for certain how much the tax is going to be. The rules for valuing shares in private unquoted companies are vague and subject to major differences of judgement, in particular between the taxpayer on the one side an HMRC on the other. So it can be very difficult to predict how much tax, if any, the employee is going to have to pay as the price of receiving his shares. The best situation for setting up alphabet share arrangements, in our view, is where a company has just been set up and hasn’t yet traded: so therefore can’t be said to have any value. Or situations where the alphabet shares, at the least, don’t start paying dividends for a considerable length of time. In the situation of the “low fat” shares where there’s no voting entitlement and no capital rights, it should in principle be fairly easy to show that those shares have no significant intrinsic value – but if they immediately start paying substantial dividends right from their issue, that argument is, to say the least, considerably weakened.
So our overall verdict on alphabet shares is: proceed with caution.
5. LLP Membership
Don’t switch off, here, if your business isn’t run through an LLP. It’s relatively straightforward to change that situation, and you may well want to do so if the employer’s NI savings are big enough to justify it. For example, a business which has hitherto always traded as a limited company can easily reconstruct as follows. The company, its shareholders/directors, and other senior employees can form an LLP together, and the company can hive down its business (or part of its business) into the LLP. This hive down can be done without tax liabilities given reasonably careful drafting of the LLP agreement. So you’ve now got a business, or a relevant segment of that business, which was previously carried on by the company directly, which is now effectively being carried on in partnership with a collection of individuals.
The basic principle of how this saves employer’s NI is simple. The senior individuals, who previously received their income for their work as employees, now receive their income as a profit share. That is, they are treated as self employed partners for tax and NI purposes, and hence the employer’s NI, PAYE etc obligations disappear.
This, like “IR35” is another example of how too many people got on the tax and NI planning bandwagon a few years ago, and HMRC decided to take action to staunch the haemorrhaging of NI that these arrangements were giving rise to. Until 2014 the Revenue’s view was that anyone who was an LLP member was treated automatically as self employed, and therefore got all the benefits we talked about. Because that was their view, they changed the law from 6 April 2014 to make it harder for “Uncle Tom Cobley and All” to be brought on as LLP members and therefore save employer’s NI. In principle, although not many planners went as far as this, it was possible for you to put your cleaner and the boy who sorts of the rubber bands and paperclips in as LLP members. What changed was that LLP members were treated as employed for tax purposes from that date unless they met any one of the following criteria:
They had capital invested in the LLP of a substantial amount;
A substantial amount of their income was variable depending on the total profitability of the LLP; or
The LLP agreement gave them the ability substantially to influence the conduct of the LLP’s affairs.
As always with HMRC, the answer couldn’t be a simple one, but had to be a multistage test with difficult areas of judgment involved! But you’ll note that the people who are most likely to meet one of these criteria (with the third being the one found most often in practice, followed by the second) are the senior, and more highly paid individuals who are working for the business. In extreme cases, a senior employee can actually be taking more of the profits of the business out than the business owners themselves, and may be very influential, or even completely in charge of, the way the LLP is run. So this method saving employer’s NI is absolutely tailor made for such situations. Other suitable sorts of business are the very democratically run businesses, which, although hitherto perhaps set up as limited companies, are in commercial reality more akin to partnerships. These should seriously consider structuring themselves as LLP’s, because the partnership structure is actually arguably much more suited to the reality of their business relationship than the limited company structure. I’ts all a case of lateral thinking, as so often. The interesting thing to note is that this is a new feature of the situation since LLP’s were invented in the year 2000, because before that time the only way you could get the tax benefits of being a self employed person was by becoming a partner in a unincorporated partnership, which had the huge disadvantage of potential unlimited liability for all of the partnership’s debts if it went bust. It seems to us that a lot of people still haven’t caught on to this major new beneficial option for structuring a business.
Comments