Since the collection of Class 2 National Insurance Contributions (NICs) changed from a separate, regular payment system to being part of the self-assessment tax return in July 2015, agents and their clients have experienced a number of calculation and payment issues.
While the number of taxpayers affected has reduced, ongoing issues remain. There are also concerns that individuals who had Class 2 contributions refunded incorrectly in 2015/16 and 2016/17 may not appreciate that this needs to be addressed to avoid gaps in their National Insurance record for state pension (and other) purposes.
Following the announcement in September 2018 that Class 2 NIC will not be abolished during this Parliament, it is worth understanding the collection systems for this tax.
A brief recap of Class 2 NICs
Class 2 contributions are paid at a flat rate of £3/week (for 2019/20) by self-employed individuals. They are compulsory where the individual earns more than the small earnings limit (£6,365 in 2019/20) and voluntary otherwise.
For many years, Class 2 contributions were collected on a regular basis, throughout the year, usually by Direct Debit. These collections stopped in July 2015 and, for the tax year 2015/16 onwards, with the exception of some special cases such as examiners, Class 2 contributions have been collected via the self-assessment system.
Moving from a regular payment throughout the year to payment with self-assessment was intended to simplify the system, with the ultimate goal being to abolish Class 2 contributions altogether. Self-employed individuals would then only need to pay Class 4 contributions, and not both Class 2 and 4.
A consultation on the proposals was held between December 2015 and February 2016. The Government responded in December 2016 with a plan to abolish Class 2 contributions with effect from April 2018. Those proposals also included details of how those subject to Class 4 contributions would qualify for benefits which had previously been dependent on Class 2 contributions. Such benefits include:
- The Basic State Pension
- Bereavement Benefits
- Maternity Allowance
- Contributory Employment and Support Allowance
In November 2017, the abolition date for Class 2 NICs was pushed back to April 2019. Then, in a ministerial statement on 6 September 2018, following concerns that the changes were unfair to self-employed individuals with very low earnings (who would have been pushed into higher rates of Class 3 voluntary contributions), the Government confirmed that Class 2 NICs would not be abolished during this Parliament.
The key to understanding the operation of Class 2 collection is appreciating that HMRC has two separate computer systems which can issue an income tax calculation for an individual. These are:
- The Self-Assessment (SA) system - which calculates income tax for those in self-assessment.
- NPS (National Insurance and PAYE Service) – which calculates income tax for those not in self-assessment.
Registering for self-assessment via a CWF1 (if self-employed) or SA1 (if a tax return is required for other reasons) sets a flag in the NPS computer so that the SA system will calculate the tax due. This prevents the receipt of two calculations, one from each system, which could otherwise occur.
Of the two, it is the NPS system that holds the master record of an individual’s self-employment status. Completing a CWF1 form updates both the SA and NPS systems with the start date of self-employment.
Following the changes in 2015/16, some individuals in self-assessment have found that, despite declaring liability to Class 2 contributions in their tax return, their computations are amended by HMRC to remove their Class 2 liability and refund any payments made.
This problem occurs because, while the individual’s calculation is made by the SA-system, their liability to Class 2 contribution is driven by the master record held on the NPS. Furthermore, data on the NPS system can be used to overwrite data on the SA-system. Therefore, if an individual has submitted a tax return under self-assessment including a liability to Class 2 (and/or Class 4) contributions, but is not registered as self-employed on the NPS system, the NPS system overrides the information received from their self-assessment return and removes the Class 2 liability. As a consequence, any payment of Class 2 (but not Class 4) contributions are refunded.
The reasons that an individual might have a self-assessment record on the SA-system, but not be registered as self-employed on the NPS include:
- The individual has submitted an unsolicited return, using a UTR that was issued for an earlier period when they were in self-assessment. Since the information on the tax return is not used to update the NPS system and no CWF1 has been received, the NPS system determines that Class 2 contributions are not due and informs the SA-system accordingly.
- The individual cancelled their direct debit in July 2015 when the change in payment mechanism occurred (despite advice to the contrary) thereby accidentally triggering the creation of a cessation date for self-employment on their NPS record. Once a cessation date is recorded on NPS, the system again informs the SA-system that no Class 2 contributions are due.
The importance of paperwork
In order for Class 2 contributions to be collected as expected, it is important that any individual who is starting self-employment completes a CWF1 by the 5 October following the end of the tax year in which they start trading. From HMRC’s perspective, if the correct process is followed, there should not be an issue with the subsequent collection of a taxpayer’s Class 2 contributions.
HMRC can check the NPS record against the SA-system and identify from that anyone who is registered as self-employed on the NPS system but who is not registered as self-employed on the SA-system and needs to be registered. However, it is not possible for HMRC to run the test the other way and identify anyone submitting a tax return with self-employment which is not flagged up on NPS.
If the taxpayer is self-employed and in already self-assessment but the record on the NPS system has either never had, or has lost, the self-employment flag (for whatever reason) it is necessary to update the NPS master record and bring the two systems back into line.
Until recently, it was recommended that the individual submitted a CWF1 form even though they were already in self-assessment. We have now been informed that an individual who is already in self-assessment who has had their Class 2 refunded should contact the National Insurance helpline on 0300 200 3500 instead. The helpline will then assist them to make a payment of Class 2 outside of the SA system, and then correct the record on the NPS system.
An incomplete record of Class 2 contributions
Class 2 contributions are important because, for those eligible to make them, such contributions will entitle them to various state benefits as noted above.
One concern is that self-employed individuals who have had their Class 2 contributions refunded by HMRC might not have realised that the refund was incorrect and that, as a consequence, they may be missing years of contributions which might affect their entitlement to these benefits. For benefits such as the basic state pension, it could be many years before the shortfall is spotted.
An individual (self-employed or otherwise) can check their National Insurance record by logging into their Personal Tax Account (PTA). The PTA will show details of how many qualifying years they have towards the state pension and if there are any gaps. Self-employed individuals should particularly check their record for the 2015/16 to 2017/18 tax years and consider if they would expect to have made sufficient NI contributions in the year.
National Insurance contributions are complex, and anyone who has a shortfall should seek advice. A self-employed individual who has a gap in any of the years from 2015/16 onwards but considers that they should have paid Class 2 should review any paperwork or computations received from HMRC for those years.
For individuals who are not self-employed, there may be the opportunity to make voluntary contributions. For some individuals who are employed as well as self-employed, it may be that they have paid sufficient Class 1 contributions on their employment so that they do not need to pay Class 2 contributions. Details of how to make voluntary contributions can be found on GOV.UK here.