Integrating income tax and NI operation

The incompatible regulations governing income tax and National Insurance Contributions (NICs) have long placed administrative burdens on payroll departments and employers. Alignment of the two processes has been looked at by the government in previous reviews but no changes have ever been implemented.

In July of this year HM Treasury published a ‘call for evidence’ to gather information from employers on the impact they consider the current systems to have.

For decades, the UK has operated income tax and NICs as two fundamentally different systems with different periods and bases of charge. The resulting anomalies impose costs and complexity on employers, and cost the taxpayer through the administration burden on HMRC. The government believe that greater integration of the two systems has the potential to remove economic distortions, reduce burdens on business, and improve fairness across individual earners.

The government does recognise that income tax and NICs were introduced for different reasons, and believe that they continue to have different rationales. As stated within the Budget earlier this year, the government will maintain the contributory principle that underpins the NI system and ensure that this will be reflected in any proposed reforms. In addition, they will not extend NICs to individuals above State Pension Age or to pensions, savings and dividends.

This table is from the call for evidence document and in simple terms shows just how different the two regimes really are.

Income tax
Income tax is paid by individuals on the basis of their total annual income including earnings, pensions, and income from savings and investments. Every individual is entitled to a personal allowance which is exempt from tax and there are also other exemptions and reliefs. The vast majority of income tax is collected by employers or pension providers through the Pay As You Earn (PAYE) system. This income tax is then calculated on a cumulative basis and offers a certain amount of flexibility because it spreads the individual’s personal allowance across the tax year. Employees also pay income tax on benefits in kind from their employment.

These benefits and certain expenses are generally reported through the P11D process which requires the employer to provide details to HMRC and to the employee after the end of the tax year. The liability is then paid by the employee through a system of self assessment and/or adjustments to the amount of tax they pay in the following year.

National insurance
NICs are paid by individuals on earnings, with each employment considered separately. NICs are assessed on earnings in each earnings period, with a threshold in each period below which NICs are not due. Unlike income tax, NICs are not paid on all types of income. NICs on earnings are collected through the PAYE system. As NICs are not calculated cumulatively no account needs to be taken of earnings in other pay periods. As well as the employee’s liability for NICs, the employer has a separate liability for employer NICs. This is calculated in the same way as employee NICs, but is charged at a single rate collected through the PAYE system. Employers are also required to pay NICs on the benefits in kind that they provide to their employees. These are collected annually through the P11D process.

Real time information
At the end of the tax year employers report the earnings they have paid and the deductions they have made to HMRC and almost all employers are now required to file this information online. Progressively, from April 2013, there will be significant changes to employer payroll processes with the introduction of Real Time Information (RTI). Instead of requiring information at the end of the tax year employers will be required to submit information whenever they pay their employees, such as weekly or monthly.

As well as reducing the burdens of operating the current end of year processes RTI will improve the flow of information between employers and HMRC when people start and leave employment. This in turn should enable the correct amount of tax to be paid in-year in more cases. While RTI will reduce the administrative burdens of operating payroll, the differences between the tax and NICs structure outlined above continue to place administrative burdens on the employer.

The complexity of paye and nics
The CIPP Policy team created a member survey to provide HM Treasury with valuable feedback about the burdens of the current regulations. The survey asked which legislation, PAYE or NICs, was the more complex to operate. Interestingly of those who separated them, NICs was by far the more complex at nearly 48 per cent of respondents compared to just 6.5 per cent for PAYE. However, almost 46 per cent responded by saying that PAYE & NICs are equally complex schemes to operate. When analysing some of the supporting comments, reasons for complexity included the recent changes to childcare voucher assessment of earnings, aggregation across PAYE schemes when having more than one job with one employer, director’s NICs calculations, and finally benefits in kind, which comes of no surprise. The responses and also previous research from the CIPP makes it clear that rather than the calculation of NICs and PAYE being the biggest burden, it is in fact the issue of trying to understand what is taxable and what is subject to NICs.

The results show that if income tax and NICs were to be integrated, 42 per cent of members believe this will have a significant impact on economic distortions. Nearly half feel that, if integrated, the reduction of burdens on business would be very significant, and finally over 40 per cent believe that it would impact very significantly on the fairness of the tax system. Although acknowledging most people do not have complicated tax affairs, CIPP respondents felt that government departments could do more to explain the tax system to customers. Aligning the thresholds and removing the upper NI threshold, but reducing the contribution rate for NICs was suggested as an option to provide transparency to the general public. As expected a number of comments were requesting that benefits in kind be processed via the payroll, and benefits simplified.

The clear message coming from respondents is to keep it simple, with a number of members stating that income tax and NICs should be combined, although this is not within the scope of this paper. Some members suggested that NICs should be cumulative and that the tax code could disappear. With just one allowance that would mean earnings are not subject to tax or NICs up to a band and then you could apply the percentage rates for all. Nearly 70 per cent of respondents feel that considerable time is spent trying to understand HMRC’s requirements, legislation and guidance and identified issues such as share scheme payments to leavers, graduate students, employees not completing the P46 correctly, aggregation of earnings for NICs and the time required to process P11Ds.

Based on the responses received, the CIPP supports the view that integration of income tax and NICs would improve the economic distortions, reduce the burden on employers and allow a fairer and simpler tax system for individuals. In our formal response to HM Treasury we recommended that consideration be given to processing benefits in kind through the payroll, offering NICs relief to Payroll Giving Schemes, the removal of Class 1A NICs, changing the NICs legislation to be cumulative and to ensure that any new legislation treats income in the same way.

So now we wait as the government considers all the responses received from interested parties, and see what proposals are put forward in a formal consultation, which will be issued hopefully before the end of the year.

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