Employers also pay Class 1 National Insurance contributions on the earnings of their employees. These work in a very similar way to the employee contributions except that they are charged at 12.8% and there is no upper earnings limit. They also have to pay contributions on the earnings of employees over state retirement age. However, no employer contributions are due on earnings up to the Primary Threshold of £110 per week (2009/10 threshold).
Employers must also pay Class 1A NI contributions on most benefits in kind such as company cars and medical insurance. This is also charged at 12.8% and is based on the figures declared for benefits on the annual P11Ds. In addition to this, employers must pay Class 1B NI contributions on benefits declared under a PAYE Settlement Agreement, such as staff entertaining.
As with employee NI, employer contributions for directors must be based on their cumulative annual earnings rather than their weekly or monthly earnings. Care should be taken to calculate NI contributions on the correct basis when a director is appointed mid-way through the tax year, as the pro-rata thresholds must be used.
Employer contributions are deductible against corporation tax for companies and against income tax for sole traders and partnerships. For a company paying tax at 21%, this brings down the true cost of employer contributions from 12.8% to just over 10.1%. A company paying corporation tax at 28% would see the true cost fall to just over 9.2%. For a sole trader paying tax at 40% the true cost is only 7.68%.
It is worth noting that NI contributions are not charged on redundancy payments or ex-contractual payments in lieu of notice by either the employee or the employer. Employers can also save NI by paying dividends instead of salary or by entering into a salary sacrifice scheme.
Employers may also wish to note that they are permitted to pass on to the employee any Class 1A NI liability they incur on the exercise of share options under an EMI scheme, provided this is included in the scheme rules.
Employer NI is not due on the earnings of contractors or other non-employed service providers (providing of course that they really are self-employed). Contractors working through their own limited companies should therefore ensure they negotiate a rate that takes into account the fact that the client does not pay NI on their fees. On the contrary, if the IR35 rules apply or the contractor works through an umbrella company, employer NI will be payable by them.