Your payroll software works out the correct amount of NI contributions on employees’ salaries but when a director is appointed or resigns special rules apply which can throw the figures out. What steps can you take to avoid this trap?

Special rules for directors

HMRC has special rules for working out a director’s NI contributions. These usually only affect the timing of NI payments rather than the amount payable, but there are exceptions.

Tip. It’s essential that you set the “director” indicator in your payroll software when a director is appointed. If you don’t the director may over or underpay NI. Incorrect NI contributions can detrimentally affect their right to state pension and other benefits and result in enforcement action by HMRC to collect a shortfall.

NI earnings periods

For employees (who aren’t directors) NI is usually calculated for each pay period, e.g. monthly, ignoring previous earnings. Conversely, a director’s NI is worked out taking account of previous earnings in the same tax year. This is known as the annual earnings period (AEP) and it means the various annual NI limits and thresholds must be used and not, say, the monthly figures.

Note. For the tax year in which a director is appointed the annual limits and thresholds are pro rata. Your software will cope with the director’s NI even in the year they are appointed or resign as long as you provide the right data.

Tip. The AEP continues to apply to a director’s pay for the remainder of the tax year in which they resign. In other words, it is not pro rata as it is for the year in which a director is appointed.

Retrospective pay

Sometimes your payroll probably won’t correctly calculate the NI for a director without intervention from you. Two situations that commonly arise are where:

  • an existing employee is appointed a director and paid for work relating to a period when they were not a director, e.g. a bonus
  • a director resigns and is paid in a later tax year in respect of their directorship.

Tip. Earnings as a director are subject to the special NI rules even if paid after they cease to be one. The same principle applies to an employee’s earnings paid when they become a director.

Example. Andy resigned as a director of Acom Ltd on 1 January 2021. He continued to be paid as an employee until 1 June 2021 when he left the company. On 31 May he was paid a salary for that month plus a bonus of £25,000 based on the company’s profit for the year ended 31 December 2020 and approved by the board on 15 May 2021. The NI on the bonus must be calculated using the rules for directors while the normal rules must be applied to Andy’s salary. Intervention is needed to prevent the payroll program using the wrong calculation method to the pay elements.

Tip. There are a few practical solutions. One is to calculate the amounts manually and override the NI amounts if the software allows this; the second is to create a new payroll record for the bonus payment alone and apply the directors’ rules to it. HMRC’s guide to NI for directors may help if you’re in doubt over whether you need to make a special NI calculation.

This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.