RESPONSE TO HMRC CONSULTATION DOCUMENT: INTEGRATING THE OPERATION
OF INCOME TAX AND NATIONAL INSURANCE CONTRIBUTIONS
INTRODUCTION
The AAT is pleased to comment on the issues raised in the HMRC consultation document on
“Integrating the operation of income tax and National Insurance contributions”.
We have over 49,500 full and fellow members and 65,000 student and affiliate members worldwide.
Of the full and fellow members, there are approximately 3,400 Members in Practice who provide
accountancy and taxation services to individuals, not-for-profit organisations and the full range of
business types.
The AAT is a registered charity whose objects are to advance public education and promote the study
of the practice, theory and techniques of accountancy and the prevention of crime and promotion of
the sound administration of the law.
In pursuance of those objects the AAT provides a membership body. We are participating in this
consultation as part of our contribution towards the public benefit of achieving sound and effective
administration of taxes. We also feel that the issues raised in this consultation paper will affect our
members in practice.
In his foreword the Exchequer Secretary to the Treasury made some key statements which AAT
members welcome in this ground breaking debate on income tax and national insurance
contributions.
Our members share the concerns over the costs and other burdens associated with the separate
calculation regimes of these two taxes and would actively support modernisation of the whole system.
Where we differ, however, is in the solution to this matter and whether the developments proposed
will truly modernise the system to the extent that we would wish. We do not feel that the systems will
support the government’s “ambition for a more predictable, stable and simple UK tax system” whilst
the two separate liabilities exist and would prefer to be discussing a replacement, unified tax rate with
the national insurance fund liabilities being dealt with by transfer from the general tax funds.
As far as we can tell this simplification will go only as far as making the rules for income tax and
national insurance liability generally the same for each form and element of payment made to
employees but will fall short of unifying the application in terms of income and we note that there will
still be at least an upper age limit in respect of contributions but not for income tax.
These fundamental differences will mean that employers have continuing, distinctly different rules to
apply for the two taxes in question and hence will continue to face unnecessary costs and burdens in
their compliance work.
We do, of course, welcome the opportunity to respond to this call for evidence on behalf of our
members and our answers to your specific questions are as follows;
1. The Government believes that integrating the operation of income tax and NICs
may have the potential to remove distortions, reduce burdens on business and
improve fairness. Do you have any comments on these objectives?
The AAT believes that these objectives will be partly met because any form of parity in the
rules governing the application of income tax and NICs will remove the confusion many
practitioners have over the treatment of pay. Unless the calculation rules become the same,
however, we cannot see these changes making enough of a difference. Table 1A shows very
distinctly just how different the principles are and unless these are all removed employers and
their agents will still have to make separate calculations of income tax and NICs whilst
software houses will still have to charge clients for separate routines to deal with them. We do
not necessarily agree that these changes will improve fairness, however, there is the potential
for employees to find the results easier to understand and this, in turn, will mean less cost for
employers in explaining such deductions.
The objectives, on the other hand are sound and we welcome this as a first step towards
removing distortions, reducing burdens and improving fairness.
2. Of the differences between income tax and NICs listed in Table 1A (or any
others that you consider important) which do you see as the most significant
in terms of their impact on:
a) economic distortions;
The AAT sees pay period by pay period NICs calculation as the one which creates the
most distortion. Employees can often see their income tax liability go down, because of
the cumulative effect of calculations, but often comment on the stability of their NICs
calculation. This often needs delicate explanation. Employees and employers are also,
often caught out by the NIC burden on one off fluctuations in pay and the resulting NIC
charges are unfair, particularly if over the tax year as a whole the employee is paid less
than the primary and secondary thresholds.
b) burdens on employers;
Again it is the vagaries of the NICs calculations which cause the greatest burdens for
employers. We accept that removal of the contracted out rebate for money purchase
pension schemes will reduce the first complication and if, as predicted, the rebate for
salary related schemes also goes then employers will only have to worry about age
related categories, though that still places burdens on the process. The introduction of
two separate thresholds for NICs was, in our view, completely unnecessary and a costly
burden to employers and we see nothing in this document which gives us confidence that
this may be removed. Many consider that the real problem lies with the software
developers and service providers, however there is a responsibility on all employers to
comply and they cannot do so unless they have the skills and knowledge to check the
computations. By far the main burden is applying the aggregation rules for NICs and
trying to identify the true earnings period for the purposes of computing NICs liability.
c) fairness?
Once again our members would point to the manner in which NICs operate as being
unfair, particularly on the low paid and anyone whose pay varies and who could be
caught by one off liabilities for NICs purely because of one off additions to their pay. As a
cumulative calculation income tax liabilities are smoothed across the entire year and
hence any sudden increases in pay, which generate a liability to income tax may be offset
by refunds of that tax so that the final annual amount of tax accords with the pay for the
year. This does not happen with NICs and a sudden, one off, addition can generate NICs
which are not then refunded. Some employers will schedule payments of some additional
work over a longer period in order to avoid such liabilities even though this is technically
non compliant.
3. What do you think are the most important steps that could be taken to reduce
the effects on;
a) economic distortions:
We consider that NICs should be a cumulative calculation in the same way as income
tax. This will ensure that over the tax year the amount of NICs paid will reconcile with the
annual amount of pay due to the employee. We do not see this as representing much of a
burden because most, if not all payroll systems deal with cumulative NICs as it is
generally mandatory for directors pay.
b) burdens on employers;
We feel that the removal of all the complexities from NICs would be of considerable
benefit to employers. At present employers need to understand that there are three
potential NIC categories for each pension contribution choice an employee makes
depending on their age and certain personal circumstances. In addition employers need
to record pay levels even if the employee is not actually paying NICs and finally in order
to successfully and accurately complete the two calculations employers have to go
through and thoroughly understand several distinct steps. Removal of different start point
thresholds will also remove complexity and uncertainty.
c) fairness?
Again we would propose that cumulative NICs computations would introduce much
needed fairness into the contribution system. According to the tables the primary
threshold for paying NICs is £7,228 in the year. We know, however, that employees can
pay NICs where their pay exceeds £139 in a single week even if their total pay for the
year comes to less than the annual primary threshold. Therefore, we feel that NICs
should be calculated on a cumulative basis. The deficiency of NICs of only looking at a
pay period is not present in the income tax system. In fact it would be unlawful for the tax
authorities to hold income tax deductions for a taxpayer whose total income and taxable
sources is proven to be less than the personal allowance. It cannot be right for one tax to
be operating this way when in another the taxpayer can face a liability which cannot be
rectified later.
4. Under the current system, how much staff time and/or other resource is
required to carry out income tax and NICs processes? Please give a score on a
scale from 1 to 5 where 1 is only a small amount of time/resource and 5 is great
deal of time/resource for each of the following:
a) Familiarisation: understanding HMRC’s requirements, legislation and guidance. 4
b) Retrieval of information: obtaining the information required to run a PAYE payroll.
3
c) Record keeping: maintaining the records needed for income tax and NICs
purposes e.g. keeping copies of returns/letters where necessary. 2
d) Calculation: calculating and checking income tax and NICs due (including in-year
and end of year processes). 3
e) Provision of information to HMRC: reporting of information to HMRC e.g. P45s for
new employees. 3
f) Provision of information to employees: reporting and providing information to
employees e.g. year end P60s. 2
g) Payment of liabilities: paying income tax and NICs to HMRC. 1
5. Which aspects of the current income tax and NICs process work well for your
business?
The move to online filing and two way movement of information has, in our view, been a good
one for businesses and agents, however there seems to be a piecemeal process to this which
means some aspects of this work well and others not so well, whilst others are not included at
all.
We mainly have an issue with NICs in the whole taxation and deduction process, however,
there are some aspects of income tax which cause problems.
The income tax computation process is straightforward and relatively easy to remember and
one which can be carried out manually as easily and as swiftly as the computerised methods.
Most employees understand the employer to employer transfer process, P45’s and P46’s,
and it is relatively easy to explain income tax variations during the initial stages of job transfer.
Where agents have an issue is when they, through the self assessment process, take back
the additional personal allowance that the majority of employees receive through payroll.
Whilst many self assessment taxpayers do not notice the small variation many do and find it
hard to understand why this happens. We would favour the removal of tax codes from payroll
and its replacement by the full personal allowance as a way of removing this anomaly.
The keeping of records by employers and agents is, as far as we are concerned relatively
straightforward though many agents report that their clients have difficulty with it. This, we
feel, is more to do with the client than any confusion in the requirements laid down by HMRC
and statute.
Payment of PAYE to the HMRC accounts office is also relatively straightforward and we
would imagine that most employers and agents would find no difficult in complying with the
requirements. Where we feel improvements are needed is with the ability to check the correct
allocation of employer or client payments and better acceptance by HMRC accounts of those
employers permitted to pay quarterly.
6. Do you carry out income tax and NICs obligations together? Are there any
elements you carry out separately?
We are aware that most employers and agents look at these two areas completely separately.
Since the value of the pay for NIC purposes is completely different to that for income tax we
advocate employers and agents making the computations in a specific sequence, that being
pensions, NICs, pre tax deductions then income tax followed lastly by other statutory
deductions and post tax deductions.
The rules are so different that any other sequence will cause significant problems. It may
appear within payroll systems that the whole process is carried out simultaneously, however
in practice it is not.
Even the record keeping for income tax and NICs is completely different and hence, again,
the process necessitates them being kept separate. Finally the statutory reporting is different
for income tax and NICs and again it forces upon employers and agents the need to deal with
each one separately.
7. What effect do differences between income tax and NICs have on wider payroll
processes such as expenses and benefits, statutory payments and student
loans deductions?
Here again a completely different set of rules applies. The fact that benefits in kind are liable
to NICs in a completely different way causes issues for employers, such that many employers
use specialised advisers and providers to manage them. This separation of duties can cause
issues at income tax year end but is needed to ensure the right skills, knowledge and
experience is applied.
Employers and agents encounter significant problems when applying Class 1 NICs to certain
benefits and to expenses which fail the requirements laid down and end up being considered
under the benefits code. On many occasions this is only discovered at tax year end and
employers and agents hence find themselves trying to deal with NICs payroll problems long
after the event. Such vagaries of the system should not be present in a 21st century tax
process.
Employers and agents are often caught up in discussions with employees over the effect of
tax exemptions on deductions like student loans where pay for NIC purposes is used and
where this is generally considerably different to taxable pay. Again, in the 21 st century
employers and agents should not have to explain such intricacies, they should be more
obvious and simpler to understand.
8. Which of the differences between income tax and NICs are dealt with largely
automatically by payroll software and which require manual working? Where
manual working is required how straightforward is this?
All of the differences in pay for the various purposes are dealt with automatically by the
majority of payroll software products, with some doing so more efficiently and effectively than
others.
None are able to retrospectively deal with NICs Class 1 where at year end the employer or
agent discovers an item of cost, either benefit in kind or expenses claim, which fails the
general rules and for which the relevant information was not available to payroll.
Employers and agents should never be required to obtain software for the purposes of
compliance, this should be a business decision based on the requirements of the business
and any vagaries of the income tax system should not be part of that decision.
9. Are there issues that occur in the calculation of income tax and NICs?
Very few issues occur with income tax as the cumulative nature of the computation tends to
ensure that variations in the amount of pay are smoothed out over the year. Any errors which
occur are often sorted out, again by the cumulative computations.
Employers and agents often encounter significant problems with tax issues which extend over
a single tax year. Recovery of overpayments is a serious issue which involves employers and
agents complying with both employment law rules (the British Rail case), tax law (trying to
apply old tax year rules to a new tax year recovery process or one where the recovery will
take several years) and the non cumulative nature of NICs computations.
With NICs employers and agents have significant issues trying to match pay to a particular
period, particularly where the true relevant period is not known initially. Several interpretations
of the out of sequence computation rules exist and even then many employers and agents
struggle to understand them.
The aggregation rules for NICs, especially where the employee has a variety of pensions
membership decisions applying to their multiple employments, are almost impossible to follow
and comply with and our members report that many HMRC compliance staff make no attempt
to check compliance in this area because they do not understand the rules. Once again, this
should not be a feature of a 21st century income tax system.
10. How often is it necessary to correct income tax or NICs calculation and which
are the most time consuming to correct?
It is actually more frequent than people think. A number of very small employers and agents
who deal with such employers often have weekly pay periods, in fact they are a very common
feature at this level. Many make current week payments and are therefore constantly making
subsequent adjustments to pay in future weeks when the actual performance of the employee
is compared with the expected when payment was being calculated.
In most cases the correction to income tax passes relatively unnoticed because of the
generally cumulative nature of the computation, however, with NICs the technically correct
method of making such adjustments is to match the computation with the period in which the
payments was originally due and recalculate NICs accordingly.
As soon as the adjustment period stretches back into the old tax year the employer or agent
is faced with a whole new set of difficulties. Again with income tax there are generally few
issues unless the marginal tax rate alters from one year to the next but with NICs there comes
a time when the adjustment has to be applied for rather than managed locally.
The whole process of claiming back overpaid NIC’s is cumbersome and overly bureaucratic
with employers having to obtain the employees authority to recover the primary contribution.
This is often necessary if the employer wishes to manage the whole process and make it
efficient, however if the correction relates to a former employee a whole new set of difficulties
are created.
In summary we feel that our members have little concern about the work involved in
correcting income tax errors but do not have the same confidence with NICs.
11. Do you have any comments about difficulties in designing or using software
resulting from the differences identified in Table 1.A (or any others that you
consider important)?
We would expect the software representatives to be able to comment more specifically on
this. Our members will, by and large, be using software to carry out the computations and
store the data needed to satisfy annual returns and any questions posed to the employer or
the agent.
This makes the job of managing the differences much easier, however, the difficulty comes
when questions are asked or queries posed about the final computations. Members are
required to and must know the rules so that they can apply them manually and explain the
implications of them fully and correctly and the very existence of these differences, some of
which are fundamental, creates a problem in itself.
Often employers will be sceptical about the explanations given for differences in calculations
and employees even more so as they are more directly affected by the calculations made.
A much simpler set of rules and easier to understand calculations will ensure this situation is
resolved.
12. What do you see as the main differences between income tax and NICs in
relation to employees you have who work internationally?
Our members will deal with these situations on a regular basis and again it is the complication
created by the very significant difference in NICs treatment which poses the most problems
for employees, employers and agents.
The fact that income tax continues to be deductible but NICs only for a certain period creates
an anomaly which could be avoided if the rules were the same or sufficiently similar to ensure
that all three parties can understand what is going on.
The computations are not difficult to understand or complete but the explanations for the
employee and employer can be.
13. Which of the differences outlined in question 12 are dealt with largely
automatically by payroll software and which require significant manual
working? Where manual working is required how straightforward is this?
We know of few systems which are sufficiently robust to manage the exact date upon which
liability for NICs ceases when an employee is working outside the EU for an extended period
of time.
We would expect most employers to manage this manually to ensure there is no error in
treating the employee correctly.
What bothers many agents and employers is the need to ensure those employees who are
working outside the EU, and even in some cases outside the UK, just what the implications
are for them and their families, we do not consider the advice and guidance to be clear
enough.
14. Do you have any views on how the introduction of Real Time Information (RTI)
may affect the cost and benefits of income tax and NICs integration?
It is our opinion that if there is any scope for integration then RTI should be delayed until this
is in place. We have been quite clear that members consider the cost of them implementing
RTI on behalf of HMRC is high and much of it unnecessary, particularly if any form of
mandatory payrolling of benefits occurs as a result, something which we have opposed from
the beginning.
If RTI is followed soon after by another restructure, that of integration, then employers and
agents will face another set of costs. Agents in particular need to consider just how the costs
of such changes can be recovered from clients and in many cases this should not mean that
the agent is absorbing costs which should be met by HMRC.
Long term we would expect integration to make the payroll process much easier, however,
unless integration results in a unified single tax rate then there will still be a need to store and
report much more data for NICs than will ever be needed for income tax.
We cannot see, under the proposals in this consultation document, that the requirements for
RTI will be affected.