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My firm has acted for a number of years for two individuals who were in partnership together. On 31 July 2003, the partnership business was transferred into a limited company and on the same date they ceased paying their Class 2 National Insurance contributions.
On 1 August 2004, they became employees of their company, but were not paid any salary until 6 April 2004 as this would have been taxed at the higher rate. In the year ended 5 April 2005, the two directors were paid £4,745 each.
My firm has acted for a number of years for two individuals who were in partnership together. On 31 July 2003, the partnership business was transferred into a limited company and on the same date they ceased paying their Class 2 National Insurance contributions.
On 1 August 2004, they became employees of their company, but were not paid any salary until 6 April 2004 as this would have been taxed at the higher rate. In the year ended 5 April 2005, the two directors were paid £4,745 each.
Unfortunately, one of the directors has now had to retire due to ill health and she made a claim for incapacity benefit on 1 July 2005 which was rejected. The reason given for this rejection was that insufficient National Insurance contributions were paid in the tax year ended 5 April 2004.
My main question is, is the Department for Work and Pensions correct? If it is, can anybody suggest any remedies to the situation?
Query T16,680 — Unsure.
Reply by PMA:
The first thing that has to be said here is that there is a common misconception amongst accountants that Class 2 (self-employed) National Insurance contributions do not count for incapacity benefits. The statement is true of contributory benefits for unemployment (currently called contribution-based jobseekers' allowance, or JSA) but, as Unsure has correctly recognised, Class 2 contributions do indeed count for the benefit that the client is seeking to claim.
The difficulty here is the timing — and I assume that the reference to the two individuals becoming employees on 1 August 2003 actually means that they also became directors at that time and not at some later point up to April 2004 (or even 2005).
One of the requirements to receive incapacity benefits is that the requisite amount of Class 1 and/or Class 2 National Insurance contributions have been paid in both of the two tax years immediately preceding the benefit year in which the claim falls to be made. The benefit year starts on the first Sunday in the calendar year and ends the day before the next benefit year starts (not necessarily the first Saturday in the calendar year!). So here contributions need to have been paid in both of the tax years 2002-03 and 2003-04.
The first of those two years is not a problem as Class 2 National Insurance contributions count and were paid for the whole year. But for the following year there were only about 17 weeks of Class 2 paid and no Class 1 at all. (The requirement is 50 weeks of earnings at the lower earnings limit, one week's Class 2 is the equivalent — for this purpose — of one week's employment with earnings at the lower earnings limit.)
So the Department for Work and Pensions is correct and the claim will not be paid. If a lump sum of suitable size had been paid on 5 April 2004 — with acceptance of the higher rate tax liability — then the director would have had enough contributions paid (or, more accurately, earnings upon which contributions are payable) due to the effect of the directors' annual earnings period. The same might not be true for a non-director employee, depending on what earnings period might be applicable in the particular circumstances.
The state scheme is much like other insurance policies — if one chooses not to pay the premiums, then the claim will be turned down.
A similar position can arise as regards the aforementioned jobseekers' allowance (JSA) where someone becomes self employed for the first time and it does not work out after a year or two. Here, even if all contributions have been paid, the JSA claim may still fail, but here it is not because the policyholder has not paid the premiums, but because Class 2 National Insurance contributions simply do not count for JSA.
In my experience, this last point is a matter that is rarely brought to the attention of new entrepreneurs: if future circumstances then require a claim to be made, the Department for Work and Pension's refusal comes as something of a shock at the worst possible time, much as in the case of Unsure's client.
Reply by The Weather Man:
I have a lot of sympathy with Unsure, because having done a little research into this problem it seems that even the Benefit Enquiry Line (0800 88 22 00) is unable to completely explain the rules for entitlement to incapacity benefit. And if the Benefit Enquiry Line cannot explain them, one wonders what hope there is for the rest of us!
The Jobcentre Plus website (www.jobcentreplus.gov.uk) has some basic information on Incapacity Benefit, and this confirms that unless the claimant was aged under 20, either Class 1 and/or Class 2 National Insurance contributions must have been paid. The current benefit year is the calendar year 2005 and to be entitled to benefit for this year the claimant would need to have paid Class 1 National Insurance contributions on income equivalent to at least 50 weeks at the lower earnings limit. One week's Class 2 contributions equates to one week's worth of lower earnings limit income. I understand from the Benefit Enquiry Line that it might be possible to have some credited contributions, but I was unable to ascertain the actual proportion here.
One wonders if there is anything that could be done to retrieve matters.
The contribution record for bereavement benefits and the state retirement pension can be protected by the subsequent payment of Class 3 contributions and presumably the client will, in due course, receive a letter advising him of the amount that could be paid. This will not, however, count towards incapacity benefit. It is too late to pay director's remuneration for 2003-04 (at least not without incurring a penalty for the late or incorrect submission of a P35 return, and the higher rate liability would need to be offset against any possible benefit receipt).
With hindsight, the client might have been able to have generated some self-employed income for the period 1 August 2003 to, at least, 5 April 2004, which would have enabled the payment of Class 2 contributions to have continued.
An alternative possibility might be a claim to income support. However, unlike incapacity benefit, this is means-tested so entitlement would depend upon other income (potentially, income support is paid to increase weekly income up to a level of £88.15 per week) and also on the level of savings. There is a taper of this benefit when savings exceed £3,000, with no benefit being paid if they exceed £8,000.
Unsure states that his client has 'had to retire', but is he still a director and could he continue to be paid director's remuneration, perhaps at least at the lower earnings limit so as to give a Class 1 credit or perhaps at an amount that would actually cause a small Class 1 liability? Or could he have a self-employed consultancy and a Class 2 liability?
Presumably another claim to incapacity benefit could be made in a future year when there then is a complete two-year contribution record, although some further research would need to be done to see whether such consultancy work or director's duties would affect the question of whether the claimant was actually incapacitated.
As mentioned above, the National Insurance Enquiry Line tells me that the exact calculation of entitlement to incapacity benefit is very complicated, and I would recommend a call to that enquiry line or to the National Insurance Office (0191 213 5000) for further information on this subject and perhaps to discuss the client's detailed circumstances and whether any other benefit entitlement might arise.
