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November 28, 2016
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Proposed Alignment of Income Tax and NICs

The Office for Tax Simplification (OTS) has released its second report into the alignment of income tax (IT) and National Insurance Contributions (NICs).

Background

The OTS originally released its first report regarding alignment in March 2016. This latest report follows on from subsequent consultation and expands on the OTS’s previous recommendations.

The OTS is keen to stress that whilst this alignment would result in ‘winners and losers’, overall the system would be fairer, simpler, and more transparent for taxpayers.

Despite calls to do so, the OTS reiterated that merger of the two systems is not within its terms of reference.

Current Rules

Under respective legislation, IT is charged on ‘emoluments’ whilst NICs are charged on ‘earnings’.

For Employees

Employees are subject to IT/NICs (Class 1 Primary) on their emoluments/earnings. For most employees, this is deducted as they earn income through PAYE.

Despite both being collected through PAYE (and often charged against the same source of income, e.g. salary), IT and employee NICs are misaligned in a number of critical areas:

Income Tax                      E/E’s NIC

Thresholds for payment                 £11,000 p.a.                     £8,060 p.a.
Calculation period                           Yearly                                Weekly, Monthly, or Yearly
Cumulative calculation                   Yes                                      No
(i.e. accounts for other income)

These differences can result in large administrative burdens from operating PAYE. It can also result in counterintuitive tax burdens. For example, a taxpayer earning the same yearly salary can have less NIC payable if such income is divided across multiple employments or paid in irregular intervals.

For Employers

Employers pay NICs (Class 1 Secondary) on earnings paid to staff. Despite the name, employer's NICs are more akin to a tax than a basis for a  contributory system. Employers are able to claim back the first £3,000 of their NICs (subject to certain conditions).

Benefits in Kind

Benefits in kind add further complication to this system.

For employees, many benefits in kind are subject to IT (effectively additional income). However it is employers who are liable to pay the NICs (Class 1A) on benefits in kind provided to staff.

The OTS describes the overall misalignment of the two systems as “confusing for almost all and unfair for many”.

Proposed Changes

The OTS's key recommendations for alignment include:

  • Calculating NICs on a similar basis to PAYE
  • Aligning the definitions for IT and NICs
  • Replacing employer’s NIC with a payroll levy
  • Benefits in kind to be fully subject to NICs

Calculating NIC on a Similar Basis to PAYE

This would see employee's NICs receiving their own codes for PAYE as is currently done for IT. These NIC codes would operate in tandem with the IT codes. e.g. ‘8060A’ to match the ‘1100L’.

NICs on one source of earnings could then more easily account for NIC paid on other earnings from second jobs or self-employment.

Aligning the Definitions of Income Tax and NIC

Determining whether income or a benefit is an ‘emolument’ and/or ‘earnings’ can be a lengthy process as each is defined separately under different legislation.

Aligning the definitions would simplify the process considerably and avoid confusion for taxpayers.

Replacing Employers NIC with a Payroll Levy

A number or alternatives are proposed for replacing employer's NIC including:

  • A flat payroll levy
  • A set percentage based on employee’s NICs
  • Replacing the employer’s contribution threshold with:
    • Cumulative annual employee allowance per employment, or
    • Full-time equivalent employee allowance

Benefits in Kind to be Fully Subject to NICs

This would see employer’s Class 1A NICs replaced in favour of taxable benefits in kind being brought into Class 1 NICs instead. This would simplify the administration of benefits and remove the distortions of non-cash remuneration.

UPDATE – 23 November 2016

The government has welcomed the OTS's reports in the Autumn Statement 2016 and has confirmed that it will make a number of changes to NICs. However the Chancellor has stated that, on the basis of the scale of change required, they will not reform NICs to an annual, cumulative and aggregated basis.

The Chancellor's response to the OTS’s reports can be found here.

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