Out-Law News 5 min. read

Burden of income tax and NICs systems forming basis of integration reforms, Treasury says


Government plans to reform the UK tax system are supported by companies that consider the current processes too burdensome, the Treasury has said.

Earlier this year the Government announced proposals to integrate the systems that calculate and report income tax and national insurance contributions (NICs). Among the Government's aims is to create a simpler and cheaper single system with a standardised set of rules.

A "call for evidence" was launched earlier this year seeking opinions on current income tax and NICs systems. The responses showed that better integration of the two tax systems would be broadly supported, the Treasury said.

"The majority of submissions to the call for evidence endorsed the Government’s view that closer integration of the operation of income tax and NICs has the potential to reduce burdens, remove distortions and improve fairness," the Treasury said in a document (45-page / 544KB PDF) outlining the next steps in its planned tax systems reform.

"Evidence provided suggests that the differences between income tax and NICs do create burdens for employers: the period of assessment and the basis of charge being the two main sources of difficulty," it said. "Respondents also highlighted several features of the current NICs system which employers find complicated in their own right, rather than stemming from their difference to income tax, such as the process of identifying NICs category letters for employees."

"Most responses focused on making the system of national insurance more like income tax, rather than the other way around," it said.

“It is no surprise that respondents to the consultation lamented the administrative burden of operating the two systems, and in particular the challenges presented by differences in treatment of certain matters for PAYE and NIC purposes," said Jon Robinson, expert in tax law at Pinsent Masons, the law firm behind Out-Law.com.

"The proposals for reform are only in very early outline stage at present and the timetable is long – it is anticipated that reforms will not actually take legal effect until around 2017. Whilst there will be several more rounds of consultation and draft legislation between now and then, the main theme coming out of the next steps document at present is that it is the NIC system which needs to be brought more into line with PAYE rather than the other way round – it remains to be seen quite how aligned the alignment will be," Robinson said.

Income tax is calculated at a percentage rate generally based on all employee earnings, such as salary, bonuses etc and also on pension income, above individuals' personal allowance, subject to some exceptions. The current personal allowance is currently £7,475.

NICs are paid by both employees and employers in a system designed to help fund state benefit and pension provisions for individuals. Employees between the ages of 16 and the state age of retirement generally have to pay a proportion of their earnings as NICs.

Employee’s NICs are generally calculated on individuals' salary earnings but not on many benefits in kind, nor pension income. Employers must also generally pay NICs based on employees’ earnings and some benefits in kind, including those above state age of retirement.

Under the Pay As You Earn (PAYE) system, employers are responsible for collecting income tax and NICs for the UK's tax collector, HM Revenue & Customs (HMRC). HMRC determines individual tax codes for employees that outlines what income tax is owed, whilst employers must work out what NICs are owed based on specific categories HMRC places employees into. A separate Self-Assessment system exists for self-employed individuals and employees with complex tax affairs.

The Treasury said that respondents to its call for evidence had recommended that the system for calculating NICs be altered to reflect how income tax is calculated and also making the same employee earnings subject to the calculations for both taxes.

"The most common suggestion was moving NICs to an annual and cumulative basis, mirroring the system for income tax, although respondents were not clear how this could best be achieved," the Treasury said.

"The second most frequent suggestion was aligning the definition and treatment of earnings such that the basis for charging NICs replicates that for income tax (including benefits in kind, business expenses, termination payments and pension contributions) and a simplification of the systems used to process and report both forms of income," it said.

The Treasury said that companies had identified the time taken to become familiar with the two different tax systems, the time taken to make calculations and the time taken to explain how the systems work to employees as problems with the current systems.

Respondents also cited difficulties in what employee earnings should be taken into account when calculating income tax and NICs, the Treasury said. It also reported that respondents find it difficult to correct the amount of money that may be owed in NICs because the system generates charges based on specific monthly or quarterly earnings rather than over a flexible period that enables income tax under and overpayments to be adjusted.

"The different definition and treatment of earnings and expenses for income tax and NICs was the most common issue cited by respondents," the Treasury said.

"Payroll operators have to understand what tax and NICs should be paid on, which differ in a number of respects. Once these differences are understood, the method for processing benefits in kind and expenses may differ again, and require manual work to determine and pay NICs for employees. Termination payments and benefits in kind were both widely cited as examples of issues which require separate treatment for income tax and NICs," it said.

"The pay period basis for NICs was cited almost as frequently as creating administrative burdens. Respondents argued that making retrospective amendments to NICs payments is difficult, unlike the income tax system which provides greater flexibility to correct any mistakes over the course of a year and beyond the year end. Correcting over and underpayments of NICs (where employees’ or directors’ earnings are aggregated for NICs) and calculating the value of expenses from specific pay periods were highlighted as tasks made more difficult and time consuming to perform under this pay-period system," the Treasury said.

Because NICs are calculated for individuals based on their earnings with individual employers, workers with two or more employers can end up paying less in NICs than those in "single, full time employment, even if their overall annual earnings are the same," some respondents had said.

Further problems highlighted with the existing systems included confusion over the differences in thresholds for calculating NICs and income tax and the "time consuming" process involved in matching NIC rates for individuals with the category provided, which some respondents said was an "ongoing cause of error"

The Treasury identified future objectives based on the calls for reform by respondents and said that working groups involving industry stakeholders will gather throughout the winter to "develop detailed proposals" for the reforms. Further consultation on changes may take place next year and it may be 2017 before finalised reforms take effect, it said.

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