OTS favours NICs and tax alignment- but it will take time

Fri 18 Nov 2016

The tax and NICs treatments of earnings, especially from employment, are now so similar that it can be difficult to understand why they were not made identical from the time when NICs, the newer ‘tax’ was introduced. But when NICs were created the concept was not as a general tax-raising measure but of a contributory fund intended to support the specific aims of providing work-related pension and welfare benefits: in some ways it was probably the first hypothecated tax since the days of Charles I’s Ship Money. Over the years the two systems have converged but there remain a great number of differences of detail, while the Government is not ready for unification of the two and maintains the cloak of the NI fund, even if welfare spending now depends heavily on tax as well as NICs.
The Office for Tax Simplification (OTS) has therefore come up with a report, The closer alignment of income tax and national insurance that:
• recognises the eventual advantages of mirror-image tax and NICs systems;
• sets out long-term objectives in terms of changes necessary to reach such an arrangement of two closely aligned but parallel systems; and
• identifies actions that are feasible within the nearer, five-year term to advance towards those ends.

“Two taxes fit for future working patterns”

That is the OTS’s ultimate objective; a system simplified to tax employees are taxed in the same way for both taxes on the same earnings, while employers pay a payroll based charge. Some differences would still remain between the treatment of employed and self-employed earners.
The OTS also targets a fully joined up approach to policy and administration of the two taxes, clarity for individuals and reduced administrative burdens for businesses and HMRC.

Simplification requiring policy development

The OTS vision of a structure for employee NICs that mirrors Income Tax and a payroll based charge in place of employers’ NICs is not achievable in the immediate future. Among the challenges to be met are that some may pay more, others less. Clarity about who they are, the implications and acceptance that change is necessary.
Uniform treatment for expenses and benefits in kind across both taxes is not seen as achievable within the five year timescale set out for immediate action.
Simplification steps that can be made now
The OTS has concluded that, in its own words:
• the current NICs system no longer supports the UK’s flexible workforce model, diverse business structures and flexible reward;
• the inherent complexity of NICs means the regime is not well understood by employers or individuals, and is complex to administer; and
• there is a distortion built into the system – two individuals with the same gross income, constituted differently, may have very different NICs outcomes, and possibly be entitled to different benefits; some employers use the NICs structure to decide work patterns (part time / self-employed).
Therefore the report sets out steps immediately necessary to:
• eliminate differences in definitions and other common areas between tax and NICs in relation to employee earnings;
• upgrade HMRC guidance and handling for taxpayers and put them in a “one-stop shop”; and
• create a legislative process to enable convergence to be implemented.
The report makes it clear that the reform must be made through a coherent, well-signposted package of measures which all need to be implemented as a properly managed programme if reform is to succeed.
Employees’ NICs would change to an annual, cumulative and aggregated (ACA) assessment
Under the present system most employees’ NICs are not really assessed in any meaningful sense of the word;  they are simply collected piecemeal as they arise, pay period by pay period and employment by employment with the result that between two people with similar earnings one who has a single job may pay more than the other who has a number of small employments. The employee paying more NICs has the benefit of earnings-related National Insurance-related benefits which the one in multiple employments may not be because she does not cross the threshold to pay or be credited with contributions.
The OTS proposes that all employees’ earnings should be cumulated and set against an annual allowance. The upsides to this are that all employees would share a common basis for contributions and benefits, considerably outweighing the downside for some, that they will have to pay more NICs.
The great numbers of employees paying more (6.3m) and less (7.1m) will require that the changes be phased in so as to avoid immediate hardship but the OTS regards the levelling of the playing field as essential to an NIC system that is equitable and fit for purpose in the modern commercial world.

Harmonise cash and non-cash benefits

The scale of the OTS’s ambition is underlined by its recommendation of research towards harmonising tax and NICs on cash payments and benefits in kind.

Employers’ NICs to change to a “payroll levy”

This would be a more fundamental change that would move away from contributions linked to individual employees’ earnings and instead be based on the employer’s annual payroll costs, as used for the purposes of e.g. the apprenticeship levy. The proposal is for a single flat rate of employers’ NIC, possibly underpinned by an allowance that sets a threshold to remove unfair burdens from smaller employers. The OTS recognises that this would need further research to ensure that employers in all sectors bore a fair share of the burden: the report highlights the possibility that without proper safeguards a payroll levy might provide an employers with an incentive to engage workers on a self-employed basis, thereby skewing the employment market. The name change would recognise the ending of the link between employers’ contributions and individual employees’ earnings.

Self-employed contributions to be aligned more closely with employed earner contributions

The OTS notes that there are some 4.7m self-employed earners and that number is rising: also rising is the number of people with mixed earnings, both employed and self-employed. This chimes with the recommendations of the BIS/Treasury/DWP working group which has already called for greater convergence between employment and self-employment. Therefore the OTS wishes to be joined in with that working group to provide a combined, coordinated approach, leading to:
• greater availability of benefits to the self-employed;
• a simpler system providing a common standard of contributions and benefits for employed and self-employed alike; and
• a system in which earnings liable for income tax will also be liable for NICs, including an alignment of reliefs and allowances.
Improve transparency of the “contributory principle” including by use of digital tax accounts
The OTS does not have a standpoint on the continuity principle except to advocate that the basis of this principle should be explained more clearly. This is an area where taxpayers’ individual digital tax accounts could be used to show taxpayers the value of actual and potential benefits they are accumulating in their digital accounts.

An integrated legislative approach

This is a major corollary of the reforms advocated by the OTS but it has the potential to be the most significant and, long-term, most beneficial reform. Alignment of tax and NICs would require significant rewriting of both sets of legislation which should offer the chance for the totality of the legislation taxing earners’ rewards to be codified and simplified at the same time by cutting out unnecessary distinctions that make little or no real difference.

A major undertaking

The OTS proposals are bold, ambitious and far-reaching but they offer the genuine prospect of turning the Topsy-grown tangle of the current legislation to be hacked into shape and made fit for purpose in the twenty first century.
Full details are in the report but be warned: even allowing for the ludicrous number of blanks (GOV.UK standard, not down to the OTS!) it is, at 177 pages, a long read.