How to apply NICs to employee benefits

A little noticed change with far-reaching implications for employers came into force last April. The tax, known as class 1A national insurance contributions (NICs), previously paid by employers only on the provision of company cars and fuel for private use, was extended to almost all benefits in kind.

Benefits that are subject to class 1A contributions now include:

• company assets that are transferred to employees
• living accommodation
• beneficial loans
• private medical treatment and insurance for an employee
• the supply of services to employees
• relocation expenses and benefits exceeding £8,000
• subscriptions and professional fees

After the end of this tax year, the taxable values of all these benefits will need to be reported to the Inland Revenue on P11D forms, the annual returns completed by employers for individual employees who have received benefits in kind. Employers will then have to pay class 1A contributions amounting to 12.2 per cent of the values reported for those benefits subject to the tax.

Employers will have to make provision in their accounts for the increasing cost of this tax, bearing in mind that their liability for class 1A NICs depends on movements in other tax rates. Experience suggests that some will not be prepared for the changes. Many organisations were caught out by the big increases in class 1A NICs in the 1999-2000 tax year, when they were paid only on company cars and fuel for private use. The car change increased by up to 28 per cent, the charge for providing fuel for private use rose 20 per cent - and the standard rate of NICs, which is used to calculate class 1A contributions, was raised by 22 per cent. The combined effect of these changes was an increase of 50 per cent or more in the amount that employers were charged.

Further fuel-scale charges have been announced for the next two years and a new tax structure for company cars, based on carbon dioxide emission levels, is due to be introduced in 2002-2003. As a result, the tax liabilities for many high-mileage drivers with expensive cars will more than double, as will the employer's class 1A NICs on those cars.

On the other hand, the fall in the national insurance contribution rate to 11.9 per cent from April 2001 means that the cost of other benefits in kind will not rise in the near future - unless, of course, insurance companies and other benefits providers raise their prices.

The annual task of completing P11D returns is the responsibility of the payroll department in some firms and of personnel managers or accountants in others. With the job of calculating and paying class 1A contributions now inextricably linked to P11D reporting, it would seem appropriate for the same people to do both jobs. But the question is, who should it be?

Know your NICs

If you have responsibility for P11D reporting, or even if you don't, try deciding whether the following benefits and payments fall into situation A, B or C.

Situation A: income tax and Class 1 NICs due through the payroll
Situation B: reported on P11D return but Class 1 NICs due through the payroll
Situation C: reported on P11D return and Class 1A NICs due

1. Retail vouchers awarded as an incentive [ ]
2. A Christmas box in cash [ ]
3. Private medical insurance, contracted by employee, employer pays provider direct [ ]
4. An interest-free loan of £6,000 to buy a car [ ]
5. Cash prize for winning an in-house competition [ ]
6. Receptionist is reimbursed the cost of buying smart clothing that may be worn at any time [ ]
7. Manager claims reimbursement of a restaurant meal with his secretary [ ]
8. Working lunch in the director's office [ ]
9. The gain on exercising an unapproved share option [ ]
10. A cash alternative to a company car [ ]

Click here for the correct answers

A pointer comes from the fact that the NICs issues associated with P11D reporting are not to do only with class 1A contributions. Indeed, some of the benefits and payments that may have to be reported on P11Ds are not liable for class 1A NICs. These fall into three categories:

• items that are specifically exempted from class 1A NICs liability
• items that are liable to class 1B contributions because they are included in a PAYE settlement agreement
• and items that are already liable for class 1 contributions

A comprehensive knowledge of all aspects of the rules governing national insurance is therefore critical for anyone completing P11D returns, arguably making payroll managers the people best placed to appreciate the issues involved.

Whoever does the job must be able to distinguish between those payments that have both income tax and class 1 NICs deducted through the payroll at the time they are provided and those that have a class 1 liability - rather than a class 1A liability - even though they are reported on the P11D return. The former category includes most cash payments and all notional payments, such as shares. The latter, takes in vouchers, credit card purchases, mileage allowances and payments that are made on employees' behalf.

The extension of the scope of class 1A NICs raise several issues that employers should have addressed before April 2000. The tax year is nearly over and some decisions are overdue. In particular, the cost of providing well-established benefits such as private medical insurance is rising by 12.2 per cent. Employers will have to consider carefully whether to continue these benefits, especially as there is now no difference in the cost of providing benefits or paying cash.

Many are already providing a cash alternative to company cars because of the year-on-year growth in class 1A NIC liabilities. Given the tax increases based on carbon dioxide emissions, employees should be encouraged, or even required, to order models with low emission levels. The lower the tax liability for the employee, the lower the class 1A liability for the employer.

Lastly, P11D reporting now demands a thorough understanding of the highly complex rules for the payment of NICs. If employers decide that responsibility for P11D reporting should stay with personnel managers, they must be trained in the intricacies of class 1, 1A and 1B NICs. Alternatively, the payroll manager, who already deals with these issues routinely, should take on the job of P11d reporting. There are only a few weeks left for employers to make this decision.

NICs in Employment

Class 1 NICs are paid on earnings through the payroll by employees, office holders and employers

Class 1A NICs are paid annually by employers on benefits-in-kind

Class 1B NICs are paid annually by employers on PAYE Settlement Agreements, under which employers pay their employees' tax liabilities on some benefits and payments