While New Labour apparatchiks claimed that the government wouldn't increase taxes, it rapidly became clear that NI - which technically isn't a tax - was the target for ramping up spending on the NHS, education and other ailing social services.
Over the last few months, government spinners ensured that the proposed increase in employees’ NIC was heralded by every media outlet in the country, in an attempt to brace a large portion of the electorate for what could be construed as very unwelcome news.
The new 1% employee contribution must be taken seriously because it applies to an individual’s entire salary above the upper earnings limit and, now that the 1% surcharge exists, the temptation to raise the percentage in future Budgets will be irresistible for a determined ‘tax and spend’ Chancellor.
Unfortunately, the 1% increase in employers’ contributions, to 12.8% from 6 April 2003, represents an anticipated #4bn cost to industry – a knock-out punch which will render many SMEs unconscious.
For companies paying corporation tax at the full rate, the hike in national insurance will increase payroll costs by 0.7% after tax relief, driving higher recruitment costs and forcing firms to offer salary increases to employees who are unhappy about making up the loss from their salaries.
How can beleaguered entrepreneurial businesses soften the blow?
Very little can be done to mitigate the NIC for non-shareholder employees.
The obvious route is to make pension schemes non-contributory: paying salary subject to NIC for employees, then making payments into a pension scheme, is pointless. Additionally, salary sacrifices might become more prevalent – instead of receiving bonuses subject to NIC, an employee can ask his or her employer to make additional pension payments, thus avoiding NIC.
It is slightly different for owner-managers, where it is expected that dividends will replace salary whenever possible because NIC doesn’t apply to dividend payments.
Beside pension contributions, dividends are the cheapest way of extracting profits from a company with a taxable profit at the lower or standard rates (0%, 19% or 30%). Additional salary is cheaper than dividends only if the company’s profit is taxable at the marginal rate of 32.75% (£300,000 to #1.5 m, for stand alone companies).
We could witness the beginning of a new model, where owner-managers take a large salary every seven years.
Under the stakeholder personal pension rules, the earnings in one year may form the basis for pension contributions in that and the next five years. After the first year, the director’s salary can drop back to a much lower level, but he or she can still make maximum pension contributions, which are paid for out of dividend income, for the next five years and obtain tax relief on them.