Chancellor George Osborne is intent on simplifying the tax system, even setting his sights on the biggest challenge of them all – the merger of the income tax and national insurance systems. While views are mixed on the feasibility of the project, the obvious worry among corporate advisers is what such a plan would mean for salary sacrifice – a popular means of funding not just pensions but other significant benefits such as childcare.
The Chancellor gave the move encouragement in his recent Budget speech promising a consultation based on a recommendation from the Office of Tax Simplification. Opinion is still divided on just how realistic the prospect is, but no expert thinks it would be simple to get there. And while a few welcome the simplicity in its broad sense, others say the move would be very bad news for employee benefits. Many feel compromises would have to been found, which would still leave incentives for employer contributions for certain benefits.
But will it happen? One of Osborne’s Tory predecessors Lord Lawson has already told Osborne not to bother because it is too complicated.
John Woolley of tax specialists Technical Connection says merging the taxes will make the income tax take sound high to the British public.
He says: “If you have income tax at 32, 52, and 62 per cent, that is quite difficult for a government to explain. I’m not sure whether that merger will take place. I think it has a fair way to go because it would be difficult. You also have issues with investment income and pension income currently not subject to NI so how will those be taken out of a new flat rate tax charge?”
However, unlike Woolley, Hargreaves Lansdown’s head of pensions research Tom McPhail suggests the Conservative Party may be trying to increase awareness of the high tax rate.
“The more that people are cognisant of the fact they are not paying 20 per cent tax, they are paying 32 per cent tax, the more receptive they will be to a diminution of the role of the state. From a right wing perspective, transparency of the tax that people suffer may be what’s driving this.”
However McPhail says it may be a case of trying to get the toothpaste back in the tube. “Maybe it is achievable, but because so many aspects of fiscal policy and the benefits system are specifically related to the National Insurance system rather than the tax system the adjustments would be massive. That doesn’t mean it can’t be done, but you would have to take a very long run at it.”
Scottish Life’s group head of communications Alasdair Buchanan says that you can see why the Government might seek such a change. Initially it will look cost effective.
“The two things are broadly similar but obviously there are some crucial differences. The advantages are cost efficiencies. The disadvantages are unintended consequences. It would be a negative for the Government to undermine the use of salary sacrifice.”
Buchanan makes a plea for any change to be considered in the round rather than simply looked at for its individual impacts and says the pension industry would definitely put the case for retaining some sort of system that at least fulfilled the function of salary sacrifice.
For Scottish Widows head of pension market development Ian Naismith it won’t come to that. He says: “I just think it is going to be too difficult for the Government. It is not going to increase the tax for pensioners, so you are going to get something that is broadly equivalent to national insurance whether that is high level tax for workers. It might just be a change of name.”
Cicero public affairs account director Ben Stafford points out that Osborne has only recognised the theoretical benefits at this stage.
He says: “New measures to review the income tax and NI framework will set policy hearts racing for a range of reasons, mainly because simplification is often promised by governments but almost never delivered. But attempts to portray this announcement as intent to merge the two systems are wide of the mark. The Chancellor has merely recognised the theoretical benefits at this stage expressing intent to x-ray rather than perform restorative surgery.”
Stafford says the Office for Budget Responsibility figures show the Government draws around 44 per cent of its receipts from income tax and National Insurance. He adds: “The Treasury will be meticulous in ensuring no unintended reduction of income. While businesses and individuals may delight at the prospect of a great leap toward simplification, they shouldn’t hold their breath.”
So what if the policy is driven through? What would it mean in practice? Again opinion is divided.
Woolley says: “Salary sacrifice is a method of saving NIC. If you don’t have NIC per se and you are only taxed, then it is difficult to see how salary sacrifice is going to work. If you sacrifice salary it is going to save the employer tax, but the employer is paying tax on behalf of the employee. With NIC the employer is paying tax because he is liable for NIC, so if you sacrifice salary you are saving your employer NIC. He could then contribute to child care costs or a pension. It is difficult. Perhaps they will notionally say some of the tax you pay will go towards state benefits. If it does come in, it is unlikely to work in the way it does now.”
Salary sacrifice is certainly very popular among employers and one of the first things many advisers recommend when setting up a benefits strategy.
McPhail says: “If you look at the numbers now, salary sacrifice is a no brainer. Once you have the system set out, there is virtually no downside. It is something we are increasingly making use of. It is something our clients are making use of. If you were to merge the systems, you eliminate that wheeze.”
The more that people are cognisant of the fact they are not paying 20 per cent tax, they are paying 32 per cent tax, the more receptive they will be to a diminution of the role of the state
“Even if the employer doesn’t hand the money over, and the member is just saving their own national insurance cost, it is a very efficient way of saving for retirement. If they took that away it would mean greater simplicity but less efficiency for the pensions industry.”
Matthew Gregson, managing consultant at Thomsons Online Benefits, also thinks the changes could go ahead. He neatly sums up the divide in the Government’s approach when it comes to taxation but says employees would bear the brunt.
“Today, employees are liable to income tax only for benefits-in-kind provided by their employer. If the proposed consolidation occurs, it could mean that benefits are subject to both tax and NIC assessment, thereby increasing the cost to employees.
“Employers already pay NIC on benefits-in-kind, meaning that their costs would not increase there is little financial disincentive for employers to stop providing benefits. In addition to that, key benefits-in-kind, such as healthcare and dental insurance, serve key employer objectives regarding sickness absenteeism further support for their continued provision.”
Gregson also thinks that currently tax efficient benefits from pensions to cycle to work all serve a purpose for the government so he feels they would continue to be supported.
He says: “For tax efficient benefits, such as childcare vouchers, cycle-to-work scheme and pension contributions, we feel that the consolidation will have little impact, as those benefits continue to support specific Government agendas.
The simplification of tax and NIC accounting will be welcomed by many and could even lead to further changes, such as the abolition of P11d, a change which would save the Government significant administration costs year-on-year a further suggestion that the proposal will be taken seriously.”
Jelf head of benefits strategy Steve Herbert is more sceptical. He says: “Can it happen? Yes. But my goodness it will be a change. Even if everything is set fair and they get through the consultation, it can’t happen in this Parliament. It is such a big change and such a massive amount of work.”
He says the advice for employers at the moment echoes the wartime slogan ’Keep calm and carry on.”
“If you can carry on salary sacrifice for a few more years, you should do so,” he says.
Mercer principal David Barker agrees: “If you have got more than a couple of hundred employees then I agree with the logic of that. You have years to pay back the costs with the NI saving.”
However, Barker says a host of issues will be thrown up by any changes including all manner of anomalies around tax reliefs. This could mean that, fundamentally, salary sacrifice is preserved.
Barker says: “The reason pensions sacrifice works is on any employee pension contribution you get employee tax relief, but you don’t get NI relief but the employer gets corporation tax on expenses relief and they don’t pay national insurance. If they merge NI and PAYE, the bigger issue is ’so what does that mean for pensions tax relief?’ If they keep the status quo so you have got pensioners’ tax relief at 20 per cent but normal PAYE at 32 per cent, you have still got a differential, so what has changed? That of course assumes employer pension contributions don’t become subject to national insurance.”
He suggests that it is unlikely that pensioners’ tax relief for employees will jump to 32 per cent, even though it would be a ’nice idea’.
He adds: “The chances of pension tax relief going down to 20 per cent for everybody isn’t what I would call a vote winner and not in the public interest either. So all the time, you have that differential between quasi tax relief on pensions and overall PAYE. Then you have got that differential on the employer side on whether or not they pay NI on the employer contribution. Then fundamentally salary sacrifice isn’t affected.”
Naismith adds: “There is a question of what rate of tax people will get on their pension, so if the rate of income tax goes up to 32 per cent, I think it is unlikely the Government will give 32 per cent relief on individual pensions. So it might still be that you only get 20 per cent tax relief added anyway even though you have paid 32 per cent tax, in which case if the employer pays the same, you don’t pay any of tax and you are still better off as you are at the moment with salary sacrifice or salary exchange.”
If complexity is the big issue, why can’t HMRC not just level the earnings thresholds for both taxes, thus removing most of the complexity at a stroke?
Barker also points out another overlooked difference saying that with PAYE there is case law saying that any contractual change affecting the sacrifice must carry on for at least 12 months but that although HMRC doesn’t shout about, it doesn’t apply to NI salary sacrifice.
“That could complicate things post any simplification. Are we talking about PAYE? Are we talking about NI? What is the tax law situation? With NI you pay it basically on what you get paid. With PAYE you get reliefs all over the place. It will vary with different benefits, whether it is child care or bike to work, let alone pensions.”
Herbert sees other problems: “How will the Government recoup lost employers’ NI. You could bung it on corporation tax, but they are not going to do that or you can create a whole new tax element in which case the concept of making it simple has just gone.”
He is also sceptical about the Government’s justification for its plans.
“The driver behind this happening is that employers are always complaining about the complexity but I have to say that is rubbish. I have never heard any employer complain because the payroll does it for them so there is obviously some hidden agenda behind the scenes. I see hundreds and maybe thousands of employers a year and none have ever said this is too complex.”
In fact Herbert has another suggestion altogether. He says: “If complexity is the big issue, why can’t HMRC not just level the earnings thresholds for both taxes, thus removing most of the complexity at a stroke? The two taxation streams can then continue, and this would not really cost UK plc much or anything to implement.”
McPhail’s suggests that a gradualist approach could then allow an eventual merger. “If they look to eliminate the discrepancies, then ultimately they could merge them and I think the bottom line was if they managed it, it would be fantastic. It would make things simpler. We have two tax systems running in parallel. That is not helpful, it is not efficient, it is not transparent.”
