OTS calls for income tax and NICs alignment

The Office of Tax Simplification (OTS) has published a report detailing proposals for National Insurance contributions (NIC) and income tax to be brought closer together and describing the current approach as an ‘outdated system’ in light of changing employment practice

The latest report, which builds on earlier research published in March this year, sets out the case for NICs reform, with an indicative five year timetable.

The OTS’s key proposal is to move employees’ NICs to an annual, cumulative and aggregate (ACA) basis, so that it is calculated in a similar way to PAYE income tax. It says this redesign could result in 5.5m employees paying more NICs and 7.6m employees paying less.

It says the problem with employees’ NICs currently is that an individual’s sources of employment income are treated separately for NICs, so that someone with two part-time jobs can pay less NICs than someone earning the same from one full time job.

These different outcomes are also reflected in the benefits people are entitled to, so some do not build up pension rights. In contrast, PAYE income tax combines sources of income, so this difference does not arise.

The OTS’s proposal is that all employment income in the year would be combined when calculating the employee's annual NICs liability and their potential entitlement to some benefits, arguing that this ACA approach would be simpler for employers to operate. It would work in the same way as income tax, be easier to understand and fairer for taxpayers.

OTS analysis suggests about 40% of those employees paying NICs could see some change (people with more than one job, with fluctuating income or working for only part of a year). Generally, those affected and who would pay less NICs would be part-time employees, women, those under 35 years old and those in lower paid service industries. About 7.6 m people could pay an average of £169 less national insurance, largely in lower income households.

Generally, those affected and who would pay more NICs would be multi jobbers earning above £20,000, the OTS says, with about 5.5m people potentially paying an average of £242 more. The interplay with social security could mitigate the effect for some taxpayers in lower income households, and in some instances the amounts would be a ‘one off’.

The OTS says broadly, the Exchequer would not benefit as the changes would balance each other out. There will be transitional costs for employers, but it should be cheaper in the long run.

HMRC would need to issue a NICs code number to employees and employers, similar to PAYE codes for income tax. As with income tax this would operate cumulatively through the tax year and, for multi jobbers, the annual NICs allowance would be allocated between their employments. Employers would run the two systems in parallel, with payroll software managing the detail. At the end of the tax year, HMRC would reconcile both income tax and NICs in parallel. It would notify amounts overpaid or due, as happens now with PAYE income tax.

Although this looks as if HMRC will have additional work to do, planned automation will deal with the extra load, the OTS argues, and the additional cost is considered modest. Employees would be able to check both income tax and NICs, as well as the impact on state pension entitlement, through their HMRC online personal tax account.

However, the OTS report makes clear that reforming employers’ NICs is more challenging. The simplest approach to this (a 10% levy on total payroll without any thresholds or allowances) would have a major impact on those employing low paid or part-time workers, due to the loss of the £156 weekly / £676 monthly threshold, and could affect particular industries and regions disproportionately.

The OTS therefore explored seven other options, keeping the overall outcome revenue neutral to the Exchequer. It considers the best of these would be to replace the employee threshold with a cumulative annual employee allowance per employer. To take this forward, the OTS recommends that the government further explores the wider impact of different options and choices, and the extent to which these are both desirable and achievable from both a simplification and a fiscal perspective.

The OTS suggest a five-year timetable for introducing the changes, arguing that this would fit in with the move to making tax digital (MTD).

John Whiting, OTS tax director, said: ‘We found near-universal support for reform to the NICs system with many seeing alignment as a simple and obvious step. The potential gains in easier administration, proper transparency and greater understanding are clear.

‘But the impact of change will be considerable: millions of people would pay more in NICs but millions would also pay less. Some paying more would gain contributory benefits but all these impacts need to be carefully worked through and thought about. More work is needed and so is a proper, informed debate about the considerable implications.’

The Low Incomes Tax Reform Group (LITRG) has welcomed the OTS’s call for reform, but suggests the government may need to give financial support to some taxpayers in the transition.

Robin Williamson, LITRG’s technical director, said: ‘We urge the government to make compensation available to any losers on the lowest incomes to help them in the transition. Much can be done by adjusting rates and thresholds, for instance by raising the primary threshold (the point at which people start paying NICs).

‘The OTS’ proposals on employer NIC reforms represents a useful simplification. We call for the employment allowance/threshold for the new payroll tax to be set at such a rate as to protect low-income employers as far as possible, particularly care and support employers.’

CIOT has also declared itself in favour of the proposed changes, arguing that having two different systems charging tax on essentially the same income leads to duplication, complication and additional cost. The institute points out that the weekly and monthly limits that apply for NICs also produce distortions which do not arise in relation to income tax.

Colin Ben-Nathan, chairman of CIOT’s employment taxes sub-committee, said: ‘That said, changing to an ACA system for employee NIC will produce losers as well as winners and so careful thought will need to be given to the transition, particularly to the effect on the lower paid.

‘One approach may be for the government to raise the primary threshold for employee NIC closer to the level of the income tax personal allowance so that the lower paid are properly protected. Such a move will have to be judged against a potential cost to the Exchequer.’

CIOT described the proposal to move employers’ NIC to a payroll levy based on total payroll costs as ‘sensible’.

The OTS further report on closer alignment of income tax and NICs is here.

Pat Sweet |Reporter, Accountancy Daily [2010-2021]

Pat Sweet was the former online reporter at Accountancy Daily and contributor to the monthly Accountancy magazine, pub...

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