National Insurance increase: How will it affect small businesses?

As if there weren’t enough challenges for UK small businesses post-pandemic, the treasury has today announced it will increase National Insurance to help pay for social care.

Under the change, employers and employees will each be taxed an additional 1.25 percentage points. In his speech in parliament today, Boris Johnson said this will raise an extra £36bn for the NHS over three years and would help to cut hospital wait times.

For mid-sized businesses, 1.25% feels like it might be a grin and bear it kind of figure. But for already resource-stretched small businesses, the increase could have a much more negative impact – particularly for the self-employed.

We look at exactly what the new rules are, what their effect would be on small businesses, and how you can prepare your small firm for the change.

What are the new rules?

As every small business owner knows, National Insurance is a tax paid by employers and employer earnings. It is automatically deducted from workers’ pay packets via the pay as you earn (PAYE) tax code, and goes straight to HM Revenues and Customs (HMRC).

Employers and employees currently pay Class 1 National Insurance, which is based on how much an employee earns. The rate is 13.8% for employers, while employees pay 12% of their earnings, up to £50,000 a year. Anything earned over this amount is taxed at 2%.

The government said in its 2019 manifesto, which promised a long-term solution for social care, that it would not raise National Insurance or income tax. However, due to added pressures placed on the NHS following the COVID-19 outbreak, it today announced a 1.25 percentage point increase in National Insurance for both employers and employees.

It’s estimated that the new rates will cost employers around £6.5bn (staff members would pay an additional £4.3bn). The rule change will come into effect on 6 April 2022, at the start of the new tax year.

How does the change affect SMEs?

In the short-term, the rise in National Insurance will have the most impact on UK small business finances, by making employing staff more expensive.

While newspaper headlines might refer to this as a 1.25% increase, the actual figure is an increase of 1.25 percentage points. However, the new rates actually amount to a 1.25% increase plus 9%.

For example, one staff member on the living wage, outside of London, will currently cost you £2,359.80 in national insurance. However, with the 1.25 percentage point rise, this figure increases to £2,654.68 a year.

That means you’ll pay an additional £241.87 a year for each member of staff. Calculate the amount for multiple employees, and the figures become substantial very quickly.

Rick Smith is managing director at Forbes Burton, an insolvency and company rescue firm. Smith says: “This could be devastating for small businesses as they recover from the pandemic as the increase in contributions will mean less to spend on investment and staff.

The rise could also cause serious damage to the economy. The CEBR estimates that a typical small business with 50 employees will pay an extra £10,000 to £20,000 annually, depending on the size of the tax rise. If a quarter of smaller firms do not hire one extra employee because of the tax, it would cost 350,000 jobs.”

What if you’re self-employed?

The impact will be even bigger if you are self-employed. Self-employed workers pay either Class 2 or Class 4 for National Insurance, which is less than SMEs and is taxed on income after business expenses.

If you’re a sole trader then, under the new rules, you’ll still lose an additional 1.25 pence for every £1 earned. Given you pay your own salary, a tax on earnings is therefore also a direct reduction of income.

Andrew Brookes is senior tax manager at accountancy firm, Menzies LLP. Brookes says: “[The National Insurance increase] is happening at a challenging time for employers, just when they are thinking about hiring new staff or investing in their growth plans. Some business owners may be forced to scale back plans to hire new people or make pay rises, and others may be forced to make pay cuts.

“SMEs should review their remuneration packages in light of these proposed changes and look for ways to minimise the effects of the proposed cost increases. We anticipate that self-employed workers will be affected by the proposed changes to NICs. However, the Government has indicated that change is on the way and they should be preparing for additional increases in the near future to bring them in line with employees.”

What might the long-term effects be?

Another area the new rules will impact is employee benefits. As an employer, looking ahead, you will likely need to cut back on other spending – such as defined contribution pensions – to fund the change. This could lead to difficulties in recruitment.

Plus, the devastating impact of the Covid-19 pandemic has already cost small businesses £126.6bn– double what was initially estimated in 2019 – with 81% of UK SMEs saying that the government’s financial support packages have not been enough.

Given the added expense this rise in tax will bring, and with the furlough scheme due to come to an end on September 30, it’s unlikely that the recovery will get any easier unless further support is introduced.

What has been the reaction from small business owners?

Following months of added strain for UK SMEs – such as delays to Freedom Day and the Pingdemic – the small business owners we spoke to were mostly supportive of the desire to fund social care, but surprised by the timing of the announcement.

Jake Third is managing director of Hallam, a digital marketing agency. Third tells us: “Personally, I support tax revenues being used to fund important services like social care. However, as a business owner, I would question the timing of this NI increase. Employers will cover more of the cost of increased NI than the employee will: this, effectively, is a tax on jobs. The change could be counter productive as it may mean less for salaries or provide a counter incentive to recruit.

For Hallam, we have the financial strength to absorb this cost. However, this increase comes at a time when employers are struggling to recover. I think the government could be doing more to stimulate economic growth and provide support for small to medium sized businesses struggling with the fallout of the pandemic.”

How are small business leaders reacting?

Piers Linney is an advocate of SMEs and a former Dragon’s Den judge. Linney comments: “Government consideration of an increase in national insurance will pile huge financial pressure on the SME community, just as these businesses are recovering from a hugely challenging 18 months.

Taking into account that it’s not just employees who pay National Insurance but also employers, this tax increase could be translated into the form of lower wages or higher prices that may not be sustainable for small businesses in the long term. SMEs generate 50% of GDP and 60% of private sector employment; the economic recovery relies on small business to bounce back. Timing is everything and an immediate rise could dampen down the recovery.”

How can you prepare for the change?

Accounting 

One of the most important ways to prepare for any change in income is to make sure you have a strong understanding of your current financial position. Speak to an accounting consultant to get a run down of the costs your business would incur from the change, to make sure you can afford the new payrolls.

If you’re short on money, investing in accounting software is a low-budget way to get your own analysis of the figures. It’s also a good long-term solution, to make sure that you remain compliant with HMRC and avoid costly mistakes.

You should also keep an eye out on the Gov.uk and Startups website for any further announcements relating to the law change.

Re-examine your employer pension contribution

Salary sacrifice schemes effectively cut your salary, and pay money into your pension, which is free of both income tax and national insurance.

If you offer your employees a salary sacrifice scheme for pension contributions, then they will likely choose to slash their National Insurance bill by accepting a reduction in salary and asking you to pay the difference directly into their pension.

This is a good way to reduce the amount both you and your employee pays on national insurance as it means you will both be earning a lower salary/profit.

Conclusion

Additional funding for social care is a welcome decision. However, given the many challenges which SMEs have faced, this seems like an oddly-timed announcement by the government. UK small businesses are just finding their feet again with record numbers of jobs being advertised, and the change will make it harder for business owners to take on new staff.

Taking early action will help you to be prepared for April 6, and will minimise the impact of the transition period. The good news is that the economy is continuing to grow and, while they’re not out of the woods yet, small business owners are in a much better financial situation to handle the new rates than they were this time last year.