In the newsletter of 19 March 2004, we reported the change to rules governing the recovery of under-deducted NICs that appeared unexpectedly in The Social Security (Contributions, Categorisation of Earners and Intermediaries) (Amendment) Regulations 2004 and that took effect from 6 April 2004.

Where Class 1 NICs have been deducted at a lower rate than they should have been due to an "error made by the employer in good faith", perhaps because contracted-out rates have been used in error or notification that a woman paying reduced-rate contributions has divorced has not been acted on immediately, the employer may recover the under-deduction but the following rules must be followed:

• the maximum that may be recovered from the employee's earnings in a pay period is limited to the amount of primary Class 1 NICs that are due in the pay period, and
  
  
• the recovery may be made during the current and next tax years, beyond which any shortfall is the employer's liability.

Example: An employer deducts Class 1 NICs from an employee's earnings on the understanding that the employee is in contracted-out employment. In February2005, with only one month to go before the end of the tax year, it is discovered that the employee was not contracted-out at all during the tax year. The amount of NICs under-deducted as a result is £;230.

The amount of primary NICs due for March 2005 is £;90. The employer may recover a further £;90 towards the £;230 under-deduction. Under the new rules, assuming that the under-deduction was due to "an error made by the employer in good faith", the employer can recover the remaining £;140 from the employee's earnings in April and May 2005.

The change apparently also took the Inland Revenue by surprise and, as a result, the guidance in booklet CWG2 (2004) Employer's Further Guide to PAYE and NICs and in Help Book E13 (2004) Day-to-day payroll is incorrect. The changes will be reflected in the 2005/06 versions of the booklets.

In temporary guidance recently issued by the Inland Revenue, great stress is placed on the need to ensure that the correct amount of primary and secondary contributions is paid for each tax year. In the above example, the £;230 shortfall in the employee's contributions and the equivalent shortfall in the employer's contributions must be paid over in full for the 2004/05 tax year, ensuring that the employee's P14 and the employer's P35 are correct for the year. To achieve this, the wrong deductions for the pay periods during which the error occurred must be corrected retrospectively.

Although not specifically highlighted in the Inland Revenue's guidance, the worked example in the document clarifies the meaning of an "error made by the employer in good faith". The example is as follows:

"An employer has a female employee for whom a valid 'certificate of election' is held. The certificate authorises the employer to deduct contributions at the reduced rate. The employee gets divorced in May 2004 and therefore becomes liable to pay contributions at the full standard rate. The employer has in place arrangements for employees to notify changes to their marital status but, whilst the employee complies with these, said notification gets mislaid and does not reach the employer until February 2005.

This means that contributions will have been underpaid in the period between the employee's divorce and the date the employer received notification. Because the error giving rise to the underpayment was made in good faith, the employer can if necessary recover the underpayment from any further payments made to the employee in the 2004-2005 year (Year 1) and the following year, 2005-2006 (Year 2). If unable to recover the full amount by the end of this extended period, the employer has to bear the cost of any balance."

It may be noted that the error in this example was the employer's, not the employee's. If a woman fails to follow the employer's notification procedures when she is no longer entitled to pay reduced-rate contributions, that is not employer error. If a woman fails to advise her employer that she is no longer entitled to pay reduced-rate contributions because the employer does not have a notification procedure, the error is the employer's but it could not be said to be an error "in good faith". In either case, the employer may recover the under-deductions in the current tax year, but not in the following tax year. Any shortfall at the end of the current tax year is the employer's responsibility.

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Source:
www.inlandrevenue.gov.uk/employers/recovery.htm