The National Insurance Contributions

Published Date: 02 Nov 2017

Income tax was last introduced by Robert Peel in 1842, again as a temporary tax and remains as such today, and for this reason it has to be re-imposed each year by Parliament via the Finance Act. The main statutory charge provisions for income tax are contained in the Income and Corporation Taxes Act 1988. Because income tax remains a temporary tax, it must be reintroduced each year via the Finance Act. This is generally achieved in three stages:

Budget speech: each year the Chancellor will set out the new tax proposals in his or her budget speech.

Finance bill: the finance bill sets out the new tax proposals in detail, which are then debated and may amended before passed by Parliament.

Finance Act: when the Finance Bill receives Royal Assent, it then becomes law, i.e. the Finance Act. Individual, partnerships and trusts that are resident in the UK during a fiscal year are liable to UK income tax on their worldwide income; non resident are only liable to UK income tax on their UK income, ordinary residence and domicile can also affect the tax liability. Certain persons however are specifically exempt from income tax namely: representatives of overseas countries and their staff (ambassadors); UK registered charities; trade unions; friendly societies; and approved pension funds. Beside certain persons being exempt from income tax, certain types of income tax also exempt from the tax as follows, see (Appendix 3)

There are no definition of income in the tax legislation, instead sources if income are identified and if an individual has income from any one of those sources then it is taxed according to the rules of the particular source of income. These sources of income are known as the schedules of income tax. The legislation lays down the rules from calculating the tax liability for each of the schedules with regard to: the basis of assessment; expenses available; and loss relief available. See the schedules of income tax in (Appendix 2)

Income tax collected by either: deduction at source; or by direct assessment. Deduction of income tax at source – certain types of income have tax deduction at source, i.e. the tax is collected from the person paying the source of income rather than from the person receiving the income. This feature was first introduced in the UK in Addington’s income tax of 1803 and has two main advantages: it is administratively efficient and it lowers the risk of tax revenue being lost through bad debts. Income received net of basis rate income tax – income received under a deed of covenant; patent royalties and income portion of a purchase life annuity.

National insurance contributions

The social security system can be divided into two distinct parts:

First, is non contribution scheme – entitlement to receive state benefits is not linked to national insurance contributions but based on some other measure, e.g. means tested benefits such as income support.

Second is contributory scheme – entitlement to receive sate benefits is dependent on the individual having paid the relevant national insurance contribution, e.g. state retirement pension. NICs are payable on an earning related basis and paid into the national insurance fund to help meet the costs of contributory benefits and make a small contribution (approximately 12% of the fund) to the National Health Service, despite the fact that national health care is not dependent on NICs.

The national insurance scheme is administration by the department of social security, which was reorganised in 1991 and spilt into the following agencies: benefits agency; information technology service agency and contribution agency.

The contributions agency is responsible for the contribution made to the NIS. The state benefits that are linked to NICs, i.e. contributory benefits are as follows:

Incapacity benefits;

Jobseeker’s allowance;

Maternity allowance;

Widow’s pension and

Retirement pension.

National insurance contributions are based on earnings and payable by employers, employees and self persons. There are four classes of NICs, each with a different contribution rate, and entitlement to the contributory benefits depends on the class of NIC paid.

Generally persons under 16 age and over retirement age do not have to pay NICs. The liability under each class depends on whether the individual is employed or self employed, therefore, the distinction between a contract of service (employment) and a contract for service (self employment) is important not only for income tax purposes, but also for NIC liability. See four classes of NICs in (Appendix 4)

Corporation tax:

"Corporation Tax is a tax on the taxable profits of limited companies and some organisations including clubs, societies, associations, co-operatives, charities and other unincorporated bodies". The economic effect of corporate taxes depends on the system of corporation tax that is adopted. The main systems for taxing company profits being as follows: Classical system; imputation system and spilt rate systems

Corporation tax was introduced on 1965 and applies to all resident bodies’ corporate including authorities’ unit trusts and unincorporated associations, but not to partnerships, although certain limited liability partnerships are treated as companies or local authorities. The UK tax system did not differentiate between incorporated and unincorporated businesses; they were both liable to pay income tax on their income. However, companies, not being individuals, were not eligible for personal reliefs and allowances, nor were the liable to pay income tax at graduated rates, but paid income tax at the basic rate on all their income. If a company is based in the UK, it will have to pay Corporation Tax on all its taxable profits wherever in the world those profits come from. If a company isn't based in the UK but operates in the UK - for example through an office or branch (known to HMRC as a 'permanent establishment') – it will only have to pay corporation tax on any taxable profits arising from the UK activities.