National Insurance Contributions Bill

Written evidence submitted by the Office of Tax Simpification & the Administrative Burdens Advisory Board (NI 04)

Introduction: ABAB and the OTS

1. The Administrative Burdens Advisory Board (ABAB) is a group set up by HMRC to focus on the burdens imposed on small busiensses by the tax system. About half of its members are themselves in business; other members include advisers to small businesses and others with direct experience of the administrative problems of the tax system. ABAB acts as a challenge panel, progress chaser and initiator of reviews.

2. The Office of Tax Simplification (OTS) was set up by the current government to advise on ways of simplifying the tax system. It is an independent office of the Treasury with a small staff (under six full-time equivalents) drawn from both HMRC/HMT and private sector secondees. It operates by gathering evidences from all those affected by the tax system – businesses, individuals, representative bodies and HMRC front-line staff – and developing ideas and recommendations for simplifying both technical and administrative aspects.

3. ABAB and the OTS liaise closely: the bodies share a common interest in reducing the administrative burdens imposed by the tax system. ABAB’s focus is on small businesses; the OTS has a wider brief but small business issues have been a major area of work.

The importance of simplifying NICs

4. Both ABAB and the OTS have regularly called for progress on simplifying the rules and procedures around NICs. The first OTS report on small business [1] looked at the main sources of complexity imposed by the tax system. Businesses reported that the differing rules and procedures around income tax/PAYE and NICs were the second greatest source of complexity and difficulty [2] .

5. The OTS recommended that there should be integration of income tax and NICs. We set out a series of steps that could be undertaken [3] , pointing out that each stage would deliver simplification dividends and tackling the issue in stages would allow plenty of time to consider the range of problems that undoubtedly exist. We also stressed that a programme of integration could stop short of a formal merger of the two levies. The OTS recommendations led to initial work by the government on integrating the operation of PAYE and NIC. All of these proposals have been enthusiastically supported by ABAB.

6. One of the OTS’s steps was to integrate Class 2 and Class 4 NICs [4] , which has led to the proposals in the current Bill.

The current proposals to reform Class 2 contributions

7. The changes to Class 2 will simplify an aspect of NICs. Both ABAB and OTS support the thrust of the proposals. This Bill does reduce burdens on the smallest businesses – the self-employed – by moving Class 2 to an annual basis and combining its payment with Class 4.

8. However, the proposals do not actually go as far as eliminating Class 2 by completely subsuming them into Class 4. To that extent, the proposals do seem to miss the opportunity of starting to make real, significant changes to the system and to answer some of the repeated calls for simplification.

9. We can understand that there will be nervousness about making significant changes too quickly in an area that can affect many people (often low earners) but we would hope that this reform is regarded as a first step and not the full reform of NICs. We think that we need to make real progress on the sort of agenda OTS has outlined, i.e. harmonise definitions as far as possible for income tax and NICs; get NICs onto annual cumulative basis (so this is a small first step); abolish the contributory principle (which stymies most attempts to do real reform). Perhaps we could also tackle the underlying structural issues that treat NICs are not being a tax (and so allow changes to NICs to be dealt with in the Finance Bill). These may seem radical changes but they reflect what both bodies keep hearing from small business.

10. The smaller administrative simplifications that come with this reform, such as eliminating the need to apply for the small earnings exemption, are welcome

11. There will be a need to make sure that the right messages are put over to the right people – given that class 2 brings entitlement to benefits people need to understand what is going on, not least around voluntary class 2 contributions and how they dovetail with Class 3 voluntary contributions.

The other changes in the Bill

12. We have no particular comments on the anti-avoidance sections of the Bill (follower notices etc.). They are significant at one level but they parallel what has already been enacted for direct tax. They do not seem to impose further burdens on normal businesses other than those involved in avoidance schemes. The only point to note is the inefficiency of having to pass two sets of measures, with the risk that the result is marginally different rules, if only around commencement dates.

13. Specifically on clause 5, the idea of introducing a NIC TAAR seems understandable and acceptable. Assuming it is aimed squarely at the sorts of things mentioned in the Explanatory Notes we have no concerns but there is a risk of ‘mission creep’ and its being used heavy handedly in routine situations.

Conclusion

14. ABAB and OTS support this Bill. Our main concern is that these changes should be seen as the start of the process of NIC reform, not the complete exercise. The OTS continues to emphasise the need for reform, reflecting as always the views of the many stakeholders we talk to [5] . As the current OTS competitiveness report concludes [6] , the main way that progress can be made improving the competitiveness of the UK tax administration in the area of Payroll Taxes, with consequent reduction of burdens on business, is to make progress with PAYE/NIC integration.

15. There are obvious risks with radical change but we have to note that making small incremental changes increases compliance costs in terms of changes to systems, in understanding the changes and in explaining them. The OTS has reported that the greatest source of complexity for small businesses is the volume and frequency of change [1] .  These proposals are on the right side of the dividing line and so are worth making. But what is really needed is a clear strategy for reform – a NIC roadmap.

Annex 1

OTS recommendations on reforming Class 2 contributions

Assessing & collecting Class 2 National Insurance Contributions through the self-assessment form

4.11 We discussed above the need for structural reform to NICs that might lead to a combination of Class 2 and Class 4 NICs. In the meantime, some administrative benefits would flow from modernising the way Class 2 contributions are assessed and collected.

4.12 Most self-employed persons are liable to Class 2 NICs. The maximum liability is currently £124.80 per year rising to £130 from 6 April 2011. This is usually collected by monthly or quarterly direct debit, which is simple once set up. From 6 April 2011, payment of Class 2 NICs will be collected on 31 July and 31 January in the year of liability. From that date quarterly billing will be superseded by biannual or monthly direct debit payments, but this is not being collected thro ugh the self-assessment system.

4.13 Problems can arise after the tax year end. HMRC has to calculate and refund any NICs paid by an individual which is in excess of the annual maximum NICs for the tax year. A self-employed person who has employment income will be liable to national insurance Classes 1, 2 and 4 and may pay more than the effective annual maximum. Such individuals can apply in advance to defer paying their Class 2 and Class 4 NICs until after total income for a tax year is known. The deferment process is paper based and has several stages.

4.14 Further, where business profits are below a ‘small earnings’ threshold, the individual may apply for a ‘small earnings exception’ ("SEE") from paying Class 2 NICs (Class 4 NICs would not be due) but cannot apply for deferment. This separate form and process, with different time limits, is confusing and frustrating for those whose earnings fluctuate above and below the threshold.

4.15 Given that all self-employed individuals must complete self-assessment tax returns, the OTS recommends that the calculation of Class 2 and 4 NICs could become part of the self-assessment process. Over 3.4million taxpayers are estimated to be liable to Class 2 NICs. Data shows that, in 2006, 9,195 individuals applied for deferment, 78,000 applied for the SEE 2 and 10,400 applications were submitted to have Class 4 NICs repaid.

4.16 A potential problem in changing the mechanism through which Class 2 NICs are collected is that any liability would become due 9 months after the end of the tax year (though some could come in earlier via payments on account). This could affect an individual who becomes entitled to benefits from the National Insurance Fund. For example, if the individual’s entitlement to benefits arose on 1 January 2011, the Department for Work & Pensions ("DWP") would calculate the entitlement based on contributions to 5 April 2010. As the 2009/10 liability would not be payable until 31 January 2011 the individual may not receive his full entitlement.

4.17 We think the DWP, HMRC and HMT could find a workaround for such individuals.

Annex 2

OTS proposals for general reform of NICs

NIC reforms: Stages in integration

3.12 Although full integration of income tax and NICs offers clear benefits but presents clear problems, combination could be achieved in stages, each of which would pose fewer problems at each step but each of which would deliver incremental simplification benefits.

3.13 Steps which could be taken to align the tax bases 9 :

· Consistency in the definition of earnings: e.g. tax and NICs on benefits in kind and reimbursed expenses;

· Consistency in the required calculations: this includes aligning thresholds, calculating NICs based on annual and cumulative earnings, and assessing NICs liability on a per person basis rather than per employment;

· Reliefs and exemptions on either income tax or NICs: some of these discrepancies have been highlighted in the final report of the OTS review of tax reliefs 10 ;

· Treatment of pensioners: one of the major issues identified is with the taxation of pensioners, as noted in paragraph 3.12. We also believe that any review would also need to cover issues such as the married couple’s allowances and the age related allowance;

· Treatment of self-employment: including examining current differences in NICs between employees and self-employed and recommending potential, costed, methods to align the rates. As noted in Chapter 4, a potential initial step could be to combine Class 2 and Class 4 NICs; and

· Treatment of savings and dividend income: these are currently exempt from NIC and the OTS view is that the difference in the treatment to earnings is central to the tax motivation for incorporation and is a major incentive to operate a personal service company. This should be examined in more detail to see whether this income should be taxed at a lower or higher rate than earnings (this should be looked at in conjunction with the treatment of the self-employed, and employer NIC).

3.14 If the Government is minded to explore this proposal further then we would recommend that it sets out a clear timetable for these stages and work commences by the end of 2011.

October 2014


[1] The first OTS small business report of March 2011 can be found at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/199183/05_ots_small_business_interim_report.pdf

[2] Top of the list was change, i.e. the volume of change that businesses have to cope with.

[3] These are set out in Annex 2 to this note.

[4] The OTS’s recommendations are in Annex 1 to this note

[5] See section 7 of the report on Employee Benefits & Expenses January 2014

[5] https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/275795/PU1616_OTS_employee_benefits_final_report.pdf

[6] See https://www.gov.uk/government/publications/competitiveness-of-uk-tax-administration-review

[1] See the Small business report already cited

Prepared 22nd October 2014