22 July 2021

Magic Money

Reform class 4 contributions.

By Robert Kilconner

What could it be, that scuttling noise in the corners of the room, the sound of furniture being moved, of carpets being pulled up?  Is it the result of some subterranean upheaval or perhaps even a plague of rats?  No, nothing so dramatic or unusual; it is the sound of the Chancellor of the Exchequer, Rishi Sunak, searching the house in the hope of finding money under the floorboards to fund increased expenditure on health and social care.

It is no easy business being Chancellor.  The Government is always chasing you for money to fund its latest projects and that means borrowing, of which we have quite enough at the moment, or taking the money from elsewhere and leaving other initiatives underfunded, or raising further funds from the public, no easy matter when the last manifesto contain promises not to increase income tax and VAT.  How different from the early days of the pandemic where the job was simply to hand out big cheques and take the plaudits.  Now the hard work has to be done and popularity is unlikely to be the most obvious consequence.  How nice it would be if there was a pot of gold somewhere which could be raided without hurting the needy, without being unfair to the rich, without making the UK a less attractive place to do business.  The odd thing is that there is exactly that.

Let us look for a moment at the system of national insurance contributions.  It has been fingered as a possible provider of the necessary funds but a rise in the rate hits the working man, so it is good politics as well as good administration to keep rises as low as possible.  Are there any honeypots within the system which could be accessed?

The rules governing national insurance contributions evolved over many years and there are thresholds at the lower ends to protect those whose profits or income are small.  Whether they are correctly placed and designed is no doubt interesting but that is not the subject of this article.  We are concerned with the burden of national insurance at the higher end, say on the proportion of remuneration or profits which exceeds £50,000 a year.

In the case of employees, higher levels of remuneration incur national insurance contributions in two ways.  The employer pays 13.8%, deductible for tax, and the employee is liable for a further 2% on the amount paid to him or her.  So if an employer starts with £1000 to fund additional salary, the net amount available, after providing for the employer’s contribution of £121, is £879.  Add in the employee’s contribution of £18 (2% of £879) and you get total national insurance contributions of £139.  If the employee is paying the top rate of income tax at 45% there is also income tax at £396 giving a total tax and nic take of £535.

Now what happens if, rather than being an employee, our highly remunerated person is a partner in the business?  In comes £1000 and the partner to whom it is allocated pays national insurance at 2%, £20, and tax at 45%, £450, making a total of £470.  That means that the profit distributed to him or her bears £65 less than the profit distributed as remuneration to an employee counterpart.

That is certainly a striking difference and perhaps arose originally because partners in businesses took on personal liability and it was felt right that they should receive some reward for that.  But that is thoroughly out of date thinking.  Now those businesses which would formerly have been partnerships, often lawyers and accountants, are structured as limited liability partnerships where clients have no recourse to the partners.  Why should they not suffer the same rate of national insurance as those who take their share of profits by way of remuneration?

There is a lot of money in this because almost all professional firms have adopted the limited liability partnership structure and we are talking about a 6.5% on a large proportion of their profits; that would come to many many millions.

When discussing tax rises one should always look at the downside which is normally that the firms concerned might decide to relocate outside the UK.  But in the case of professional firms that is not really an option; they must conduct their business where their client base is so they are trapped in the UK system.  It is also unlikely that a change at this level would much upset the public.  We are talking about highly remunerated people and the suggestion that they should be taxed on the same basis as everyone else is unlikely to be politically objectionable.

This is the corner to look in, Mr Sunak.

 

 

Official portrait of Rishi Sunak – Creative Commons