Taxation in the United Kingdom/National insurance

National Insurance is a system of taxes, and related social security benefits, that has operated in the United Kingdom since its introduction in 1911, and wider extension by the government of Clement Attlee in 1946.

Introduction

The name national insurance was adopted as an expression of the government's aspiration that the system should be qualitatively different from conventional general taxation such as income tax.

The proposed differences that were enacted, or aspired to, included:

• the revenue was expected to roughly equate to current spending on contributory benefits
• no means testing of benefits - the amount of benefit paid in respect of any claim by a claimant was the same whether the claimant was rich or poor, depending only on the completeness of the claimant's contribution record
• a cap on the system's scope for redistribution - above a certain level of earnings or profits no extra contributions were payable
• the payment of a contribution by an employer for each employee comparable to that paid by the employee

Initially, the most important contributory benefits were the State Retirement Pension and Unemployment Benefit.

With the introduction of employer payroll tax deduction (Pay-As-You-Earn or PAYE), employees' national insurance contributions were collected along with income tax. This replaced the old system of purchasing a contribution certificate or stamp, but for many years some older Britons continued to describe making NI contributions as paying their stamp.

In the contemporary United Kingdom budget national insurance contributions are a significant source of government revenue: £90 billion in 2006-2007, approximately 17% of total government receipts.

Contribution classes

National insurance contributions (NICs) fall into a number of classes. Class 1, 2 and 3 NICs paid are credited to an individual's NI account, which determines entitlements to certain benefits - including the state pension. Class 1A, 1B and 4 NIC do not count towards benefit entitlements but must still be paid if due.

Class 1 contributions are paid by employees and their employers. They are deducted from their gross wages by the employer, with no action required by the employee. The employers also match these contributions (with the one exception below). There are three milestone figures which determine the rate of NICs to be paid: Lower Earnings Limit (LEL), Earnings threshold (ET) and Upper Earnings Limit (UEL).

• Below the LEL, no NICs are paid.
• Between the LEL and the ET, NICs are not paid, but are credited as if they were.
• Between the ET and the UEL, NICs are paid at a rate of 11% on earnings by employees and 12.8% of earnings by employers.
• Above the UEL, NICs are paid at a rate of 1% on earnings by employees and 12.8% of earnings by employers.

Unlike income tax the limits for class 1 NICs for ordinary employees are calceated on a monthly basis. However those for company directors are calculated on an annual basis.

Class 1A contributions are paid by employers on the value of company cars and other benefits in kind of their employees and directors at rate of 12.8% of the value of the benefits in kind (from their P11Ds).

Class 1B were introduced on 6 April 1999 and are payable whenever an employer enters into a PAYE Settlement Agreement (a PSA) for tax. Class 1B NICs are payable only by employers and payment does not provide any benefit entitlement for individuals.

Class 2 contributions are fixed weekly amounts paid by the self-employed. They are due regardless of trading profits or losses, but people on small (low) earnings can apply for exception from paying and those on high earnings with liability to either Class 1 or 4 can apply for deferment from paying. While the amount is calculated to a weekly figure, they are typically paid monthly or quarterly. For the most part, unlike Class 1, they do not form part of a qualifying contribution record for contributions-based Jobseekers Allowance.

Class 3 contributions are voluntary NICs paid by people that wish to fill a gap in their contributions record which has arisen either by not working or by their earnings being too low. The main reason for paying Class 3 NICs is to ensure that a persons contribution record is preserved for entitlement to the state pension,generally a person needs either 10 or 11years for a minimum state pension (depending on sex and date of birth),although in certain cases fewer years may be required.

Class 4 contributions are paid by self-employed people as a portion of their profits, calculated with income tax at the end of the year, based on figures supplied on the SA100 tax return. Below the earnings threshold no class 4 NICs are due. Above the earnings threshold and below the upper earnings limit class 4 NICs are paid at a rate of 8% of trading profits. Above the upper earnings limit class 4 NICs are paid at a rate of 1% of trading profits. They do not form part of a qualifying contribution record for any benefits, including the state retirement pension.

People who are unable to work for some reason may be able to claim NIC credits. These are equivalent to Class 1 NICs, though are not paid for. They are granted either to maintain a contributions record while not working, or to those applying for benefits whose contribution record is only slightly short of the requirements for those benefits. In the latter case, they are unavailable to fill "gaps" in contribution records for some benefits.

The National Insurance number

The National Insurance numbercard is issued by the former Department of Health and Social Security. Children born and resident in the UK are assigned an NI number (referred to internally as a NINO), and receive a plastic card of similar proportions to a credit card with the number raised on the front shortly before their 16th birthday, and are advised to keep the card safe (only one replacement card may ever be issued over the lifetime of an individual). However, allocation of this number might occur a long time before this occasion (the date can usually be established from the prefix letters used), and siblings may have consecutive numbers - this is dependent on the payment of Child Benefit.

Persons from abroad looking to work in the UK, or those to whom a number was not initially allocated as children, may apply for a number through the Department for Work and Pensions (DWP). The prefixes used are typically different from those used in the normal run.

The format of the number is two letters, six digits, and one optional letter. The example used is typically AB123456C. It is usual to pair off the digits - such separators are seen on forms used by government departments (both internal and external, notably the P45).

In the case of AB 12 34 56 C, the first and second letter cannot be D, F, I, Q, U and V. The second letter also cannot be O. The six digits are sequentially issued (siblings who are few years apart may notice their numbers are consecutive when the numbers are issued together), and the suffix letter is A, B, C, D or absent. The number is unique without the last letter - if there is AB 12 34 56 C, then there will be no AB 12 34 56 D (though it is possible that there will be AB 12 34 57 D). A common error found on documents containing an individual's NI number is the final letter being incorrect, though this error is non-fatal in that an individual can be identified without the last letter.

It is worth noting that, while an individual may be issued with a second NI number when all traces of their original number has been lost, these numbers never change. Some accountants often mistakenly advise their customers of a change, particularly in the suffix letter, where A referred to employment, B to self-employment, etc. The actual meaning of the suffix letter dates back to before NIRS (see below), and referred to the quarter in which that individual's annual record card was due for return, and is roughly (but not directly) linked to their date of birth.

As Britain does not (yet) have a system of personal ID cards, and not everyone has a passport, the NI number is, along with the NHS number, the only system which provides every adult in the country with a code number. Consequently, NI numbers are sometimes used for identification purposes in other contexts which have nothing to do with their original National Insurance purpose. This is despite a clear claim on the back of the NI card that it is not proof of identity.

NIRS

National Insurance contributions for all UK residents and some non-residents are recorded using the NIRS computer software package (National Insurance Recording System, pronounced "nurse"). NIRS is currently in its second generation and is known within the Civil Service as NIRS/2 ("nurse two").

The original NIRS was a more archaic system first used in 1975 without direct user access to its records. A civil servant working within the Contributions Office (NICO) would have to request paper printouts of an individual's account which could take up to two weeks to arrive. New information to be added to the account would be sent to specialised data entry operatives on paper to be input into NIRS.

NIRS/2 is a Microsoft Windows based system with several applications under its umbrella. These include individual applications to access or update an individual National Insurance account, to view employer's National Insurance schemes and a general work management application.

There has been some controversy regarding the NIRS/2 system from its inception in 1996 when problems with the new system attracted widespread media coverage. Due to computer problems, deficiency notices which used to be sent out on an annual basis stopped being issued in 1996. The Inland Revenue is currently (as of August 2004) running an exercise to catch up on a backlog of deficiency notices for the 1996-97 to 2001-02 tax years on the instructions of the Paymaster General. The exercise is due for completion in March 2005. Deficiency notices are due to be issued on an annual basis again from October 2004.