Greg Huitson-Little, partner in our Forensic and Valuation Services team, muses on the recent budget – amused by definitional debates, unpacking what the employer national insurance rises really look like, and wondering whether the nutty issue of “pass-on” in competition damages is about to get its biggest experiment to date.
Introduction
It’s five months now since the Chancellor stood at the despatch box and delivered the first Labour budget since 2010. One of the big changes was Employer’s National Insurance Contributions – and whilst the headlines have just about died down, come April businesses up and down the country will feel first hand the bite that these rises will have. Partners and colleagues across our tax and advisory teams have been helping clients prepare for these changes.
So why is a forensic accountant commenting? Surprisingly, the budget delivered something on contractual interpretations, a lesson around unpacking the numbers and understanding what’s really happening, and a potentially valuable experiment on the question of pass on in competition damages. Allow me some indulgence and I’ll explain.
Definitions defined, or not?
First up was Labour’s manifesto promise of not increasing taxes on working people. Remember that? There was much confusion and ambiguity as to precisely what the Government meant by “working people”. As government minister after government minister tied themselves up in knots trying to explain the meaning of “working people” and who it was meant to refer to, it became a bit of a media nightmare.
But setting the amusement of ministerial squirming to one side, it reminded me of many happy times debating accounting and financial related terms in disputes within our teams, and finding ever more inventive ways to argue or test an accounting point. This usually comes up in Sale and Purchase disputes, where parties try to define specific accounting policies for their deal but inadvertently cause conflict or confusion with standard accounting. We’ve also seen it in royalty disputes, for example where parties define a royalty base and revenues, but end up not quite covering all scenarios. You can see it in JV agreements. Revenue or cost sharing agreements. Insurance and coverage disputes. The list could go on. Part of our practice is around providing views on what a contract means from an accountant’s perspective, homing in first on the words, rather than the numbers.
Dissecting the numbers
But let’s get back to the numbers – and in particular, what the employer’s NIC changes actually look like in practice. A forensic dissection if you like.
Immediately following the budget, most of the media headlines focused on the 1.2% percentage point increase in the employer’s NIC rate, taking it to 15%. Indeed, ask someone today what the change in NIC is, and you are likely be to be given that change in percentages. Although tax rises are never welcome, 1.2% doesn’t sound too unpalatable, does it?
But there was a second part to the NIC change, which hasn’t really grabbed the headlines. As well as the increase in the rate to 15%, the secondary threshold – the point at which employer’s NIC starts to be paid – was reduced. This is where my forensic accounting brain went into overdrive. What does the change actually mean in practice? What are the subtleties – what’s not being said here? And what’s the wider impact?
Let’s break this down. The threshold will be decreasing from £9,100 to just £5,000. Where an employee earns £9,100 or more, and so already subject to employer’s NIC, the change in threshold causes an immediate increase of £565, regardless of how far above the threshold an employee actually is. And that’s before the increase in the employer’s NIC rate is taken into account – if you use the new rate, the increase is £615.
But the change in threshold also drags employees with particularly low earnings into the regime. Previously, there would have been no employer’s NIC for someone earning £9,000. Going forward, the employer’s NIC will be £600. Zero to £600. That’s a near 7% increase in basic employment cost – salary and employer’s NIC – overnight.
Are your antennae twitching yet? They should be.
Pictures… thousand words and all that?
In classic forensic accountant style, we can plot the percentage increase in basic employment cost against salary.
Now we’re seeing something. The biggest percentage rises in employment costs are happening at the lower salaries. It spikes at a salary level of £9,100. It only drops below 2% when you approach a salary level of £50,000.
We can also consider the percentage increase in the employer’s NIC. Running some numbers, at a salary level of £14,000, employer’s NIC doubles. At £20,000, the percentage increase in employer’s NIC is 50%. At £50,000, the increase is about 20%.
This can also be plotted, as follows.
Are your hackles up yet? They should be. The higher the salary, the lower the percentage increase. In other words, the biggest percentage increases in employer’s NICs are actually focussed on the lowest salaries.
Remember that headline 1.2% increase in employer’s NIC? Sounds like everyone is sharing the burden. But the reduction in thresholds? It turns the equation on its head.
Unpack and contextualise: what’s really happening?
As forensic accountants, we’re quite often faced with assumptions, scenarios, explanations, etc., that look very reasonable. We are casually invited to accept them and move on. But invariably, those very reasonable (and dare I say “conservative”) assumptions, scenarios, explanations, etc., could be hiding something. So, spend the time exploring them. Check how sensitive a calculation is to changes in assumptions. Deconstruct calculations and find the hidden assumptions. Unpack and challenge the explanations. Identify what hasn’t been said. Crunch the numbers and work out what’s really happening.
And then, put it in context. For there is a very serious point here. The increased employer’s NIC burden falls disproportionally on employers of lower earners – this could be employees on or close to the minimum wage, or people who work part time and because of that hover around the thresholds. Think supermarkets and other retailers, think restaurants and hospitality, think health and social care providers. Furthermore, by their very nature many of these businesses tend to employ larger numbers of people. For these businesses, just by virtue of sheer numbers of employees, the effect of change in thresholds is going to be significant.
This is not the only change coming. The budget also included increases in the National Minimum Wage rates. So businesses paying at or around the National Minimum Wage – many in the sectors noted above – are facing a double increase of both the underlying wage cost and employer’s NIC. For these businesses, already tight margines become even tighter.
Businesses will need to react to these increased costs; the question is how.
The great pass-on experiment?
Which leads me to one final point. Has the Government inadvertently set off the biggest experiment in the quantification of pass-on in competition damages claims? The ingredients are (mostly) there: increased costs to businesses, affecting all market participants. The classic pass-on question arises: what will they do about these increased costs?
Just to explain, “pass-on” is a concept and form of defence in competition damages. The basic idea is that a defendant – accused of charging increased prices to a claimant – can allege a claimant “passed-on” the increased prices in some way, and so did not in fact suffer loss.
The Competition Appeal Tribunal (CAT) neatly summarised the options for pass-on in Sainsburys v Mastercard ([2016] CAT 11 at paragraph 434), echoed by the Supreme Court ([2020] UKSC 24 at paragraph 205). It said that faced with unavoidable costs, a business could (and I paraphrase slightly):
- do nothing, suffer the cost themselves, and make less profit;
- seek to reduce discretionary spending, such as marketing or advertising, or reduce capital expenditure;
- seek to negotiate costs with its various suppliers, including employees; or
- pass-on the increased costs to its customers, through higher prices.
Our clients are grappling with this very issue right now: what should their response be to increased employer’s NIC? It’s a careful balance and one our advisory and tax teams are assisting clients with. It’s not straightforward. Even just thinking about the third option above and how businesses might seek to change costs with employees, there is a whole range of choices. This might include limiting salary increases and/or bonuses, reducing recruitment, looking for productivity increases, or amending working patterns to change the balance of lower earners. It may also include more nuanced approaches such as increasing the use of salary sacrifice schemes for pension contributions and the provision of certain non-cash benefits, so as to avoid employer’s NIC.
We can be certain that businesses will likely use a combination of the four basic options outlined by the CAT. But the CAT also noted a further complexity: what businesses do will change over time. It’s quite possible that in the short term, the immediate reaction is to do nothing make less profit, but that’s unlikely to remain the case. Longer term, businesses will seek to maximise their profits through the second, third and fourth options above. Thus, the balance between the different options will likely change over time as the market adjusts to a new normal.
What happens next is undoubtedly going to be complex. But observing what businesses do in response to increases in employer’s NIC, and how the market changes alongside, may provide a rich source of information for the question of pass-on. The information and data that’s going to be generated will be very revealing about how different businesses, across all sorts of sectors, react to changes in costs. Importantly, these are known increases in costs, and businesses are (or should be) actively considering their options and how to deal with the changes. The qualitative data in particular – the discussions and decisions made by businesses – will chronicle how businesses deal with these changes both immediately and over time, how they perceive and respond to competitors, and how the wider market influences or responds to those decisions. It’s pass-on Jim, but not as we know it.
Final thoughts
The effect of the change in employer’s NIC is not as straightforward as might seem at first blush. Unpacking the numbers and looking at what happens at different salary levels reveals that the highest percentage increases are focussed on the lowest salary levels, and the increased employer’s NIC burden falls disproportionally on employers of lower earners. Employing part time employees starts to look expensive. The change in thresholds could have some far-reaching consequences for our economy and for the jobs market.
Our advisory and tax teams are helping clients consider their options and how to manage the increases in employer’s NIC. Come April, we’ll start to see what businesses choose to do. Will they do nothing, and take the losses? Or seek to reduce discretionary spending? Will they look to reduce costs with suppliers – including their own employees? Or will they seek to pass on increased costs to customers?
Competition litigators, economists and quantum experts might want to take notice of what happens next. It is the pass-on question on a country-wide scale.
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