Before you go, sign up to our free tax saving email course. Get 7 top property tax saving strategies in your email inbox that will help you save thousands in tax. Unsubscribe any time.
Sarah Bradford explores whether landlords need to pay Class 2 National Insurance contributions.
Payment of sufficient National Insurance contributions (NICs) earns the contributor entitlement to the state pension and certain contributory benefits. Employees earn their pension and benefit entitlement from the payment of Class 1 NICs, while the self-employed earn their entitlement via the payment of Class 2 contributions. The self-employed also pay Class 4 NICs on their profits.
Whether or not a landlord is liable to pay Class 2 NICs depends on whether that landlord falls within the definition of a `self-employed earner’ for National Insurance purposes, and if so, whether his profits are in excess of the small profits threshold.
A `self-employed earner’
For National Insurance purposes, a self-employed earner is one `who is gainfully employed in Great Britain otherwise than in employed earners employment (whether or not he is also employed in such employment)’.
Generally, a person who is regarded as self-employed for income tax purposes and who is taxed on the profits from their trade, profession or vocation will also be regarded as a self-employed earner for National Insurance purposes and as such will be liable to pay Class 2 (and also Class 4) NICs.
By contrast, a person who receives investment income is not liable to pay NICs on that income.
Property letting – investment or trading?
In order to determine whether or not a landlord is liable to Class 2 NICs it is first necessary to decide whether his or her property letting activities amount to running a business or whether they constitute an investment. A Class 2 NIC liability will only arise if the level of activities is such that they amount to the running of a business.
Although an investment in property will require some involvement on the part of the landlord to maintain that investment, such activities in themselves are not normally enough to turn the investment into a business. HMRC accept that being a landlord normally involves the following activities simply to maintain the investment:
• undertaking or arranging for external and internal repairs;
• preparing the property between lets;
• advertising for tenants and arranging tenancy agreements;
• generally managing common areas in multi-occupancy properties; or
• collecting rents.
Consequently, for a landlord to be regarded as running a business rather than merely investing in property, his or her property management activities must extend beyond those listed above.
HMRC will look for pointers that suggest that the landlord is actually running a business. For example, if the landlord owns multiple properties which he or she lets out and property management is his or her main occupation, this may be indicative that the landlord is actually running a business and is a self-employed earner for Class 2 National Insurance purposes. When deciding whether the activities amount to a business, any activities which are undertaken by an agent on the landlord’s behalf (whether by a professional managing agent or by a family member) are treated as if the landlord had undertaken them.
Where a landlord also provides other services that amount to trading for income tax purposes, he or she will be regarded as a self-employed earner for National Insurance purposes (and therefor liable to Class 2 NICs). This may be the case where, for example, the landlord receives services for the provision of other services, such as the provision of washing machines and tumble driers in a multi-occupancy block.
HMRC has published the following examples in their National Insurance manual (at NIM23800) illustrating whether they will regard a landlord as a self-employed earner in the following scenarios.
Example 1: Inherited property
`Samantha lets out a property that she inherited following the death of her great aunt. This will not constitute a business.’
Example 2: Full-time active landlord
`Bob owns ten properties which are let out to students. He works full time as a landlord and is continually seeking to increase the number of properties he owns for letting. Bob is running a business for NICs purposes.’
Example 3: Normal landlord duties
`Claire owns multiple properties that are let. She spends around half her working time carrying out duties as a landlord and is not looking to increase the number of properties she owns. If the only duties that Claire undertakes are those normally associated with being a landlord, then this would not constitute a business.’
Example 4: Letting agent
`Hasan purchases properties using ‘buy to let’ mortgages. He places all letting duties in the hands of a property letting agent who acts as landlord on his behalf. If the only duties that the property letting agent undertakes for Hasan are those normally associated with being a landlord, then this would not constitute a business.’
In the above examples, it is only the case of Bob (Example 2) that would be regarded as a business and in respect of which a Class 2 NIC liability would arise. In the other scenarios, HMRC regard the rental income as investment income rather than earnings, taking them outside the scope of NIC. This is even the case with Hasan (Example 4), who uses buy-to-let mortgages to purchase the properties.
A further point to note is that it is not the number of properties the landlord owns per se that determines whether the property letting constitutes a business for NIC purposes, but rather the level of activity associated with managing those properties. Hasan and Claire both have multiple properties, but only undertake those activities necessary to manage their property investments and as such are not regarded by HMRC as being self-employed earners for NIC purposes. By contrast, property letting is Bob’s full-time occupation and he is regarded as being a self-employed earner, liable to Class 2.
The advantages of Class 2
Depending on the level of profits, being within the scope to Class 2 contributions is not necessarily a bad thing. A liability to Class 2 contributions arises where earnings exceed the small profits level, which is set at £5,965 for 2015/16. Where earnings exceed this level, Class 2 contributions are payable at £2.80 per week. However, a person who is self-employed and whose earnings are below £5,965 is eligible, but not liable, to pay Class 2 contributions. In this case, contributions can be paid voluntarily.
Class 2 contributions, especially where no Class 4 contributions are payable, are a very cheap way of building up entitlement to the state pension and certain contributory benefits, particularly if the landlord has no other forms of earnings. Paying Class 2 at £2.80 per week is much cheaper than paying voluntary Class 3 contributions of £14.10 per week.
However, to be eligible to pay Class 2 (even if not liable), the individual must be a self-employed earner. Where a landlord already lets properties, increasing the level of activity such that it is regarded as running a business rather than simply managing investments can be useful if it enables the contributor to buy the right to a state pension for £2.80 per week rather than having to pay Class 3 contributions at £14.10 per week.
Where NICs are not otherwise payable, consider turning the letting into a business to bring it within the scope of Class 2 NICs, as this can be a cheap way to build up entitlement to the state pension.
Being regarded as a self-employed earner and paying Class 2 contributions is not necessarily a bad thing – it depends on the landlord’s personal circumstances.
This is a sample article from the monthly Property Tax Insider magazine. Go here to get your first free issue of Property Tax Insider.