Plans to more closely align income tax and national insurance published

Out-Law News | 09 Mar 2016 | 4:05 pm | 2 min. read

An independent review of the UK’s main payroll taxes has found “near universal” support for reform, but has warned that self-employed people in particular could lose out as a result of making changes.

The Office of Tax Simplification (OTS) has published a seven step plan for more closely aligning income tax and national insurance contributions (NICs). The process would begin by moving away from calculating NICs based on monthly or weekly salary and instead doing so on an annual basis, as is currently the case with income tax, according to its report.

OTS chair Angela Knight said that the current system was “simply out of date” as a result of the growing number of UK taxpayers with multiple sources of income, such as self-employment alongside part-time work.

“People don’t know what the national insurance contributions they pay gives them in benefits, with the system giving different outcomes for the employee, the self-employed and those with more than one job,” she said. “And employers – who are the collectors of income tax and national insurance – find the current system for NICs complex.”

“Inevitably, some will gain and others will lose from any change. By highlighting both the need for reform and by shining a light on those difficult areas now, the OTS intends this review to trigger a full and informed debate about the impacts, how the changes could be made, how the challenges can be addressed and the timetables required, to make change as seamless as possible and to provide a system that is fit for the future,” she said.

The OTS stressed that no changes should be made without a full assessment of their “considerable potential impacts”. Around 7.1 million people, mainly lower earners, would be better off if the proposed changes were made but 6.3 million people, some of whom would gain contributory benefits, would end up paying more, it said.

Under current rules, income tax is calculated at a percentage rate generally based on all employee earnings such as salary and bonuses, and also on pension income, above the individual's personal allowance. Employees' NICs are generally calculated on individuals' salary earnings but not on many benefits in kind, nor pension income; while employers' NICs are generally based on employees' earnings and some benefits in kind.

Income tax and NICs for most individuals in employment are collected by employers through the Pay As You Earn (PAYE) system, while a separate self-assessment system exists for the self-employed and those with more complex tax affairs. UK tax collector HM Revenue and Customs (HMRC) calculates individual 'tax codes' for employees establishing the amount of income tax they have to pay, while employers must work out what NICs are owed based on specific categories HMRC places employees into.

Through its research, the OTS found little understanding of NICs as distinct from income tax among ordinary taxpayers. In addition to moving towards charging NICs based on annual earnings as is the case with income tax, it has recommended reforming employers' NICs to be based on whole payroll costs and aligning self-employed NICs more closely with employees' NICs. The definitions of 'earnings' and 'expenses' under the income tax and national insurance rules should be aligned, while taxable benefits in kind should be brought within the scope of Class 1 NICs, according to its report.

Share plans and incentives expert Graeme Standen of Pinsent Masons, the law firm behind Out-Law.com, said that although employers and individual taxpayers should "broadly welcome" the work of the OTS, it was "far from clear when they might see practical benefits from it, and also whether there will be the political will to take it forward".

"The report concludes that closer alignment of NICs with income tax on employment and self-employment income is possible and would be worthwhile," he said. "But the OTS also recognises that this would be a major project, and it would generate winners and losers in various ways, an issue which would need to be assessed and balanced at every stage."