Pay and Benefits

This year’s Budget announcement that the Government will consult on merging the operation of National Insurance (NI) and Income Tax could have far-reaching implications for payroll and benefits. Indeed, some commentators suggest that it could even spell the end of salary sacrifice – which can lead to tax and NI savings on a broad range of benefits when employees give up entitlement to a proportion of salary in exchange for receiving benefits from their employer.

The Treasury is currently calling for evidence until 19 September 2011, and a full consultation will then follow. However, the key message volunteered by tax experts is that the initial proposals are simply looking at integrating the operation of the taxes, rather than merging the taxes themselves.

“It’s all to do with detailed technical changes about integrating information technology systems and administrative arrangements. The Government has specifically ruled out extending NI to pensioners or other forms of saving and has said that it will maintain the contributory principle, which links the NI you pay with the State benefits you are entitled to,” explains Stuart Adam, Senior Research Economist at the Institute for Fiscal Studies.

“Actually merging NI and Income Tax would be very sensible and hasn’t been completely ruled out, but there is currently little sign that the Government is seriously considering it.”

 

Nevertheless, with paper after paper written outside Government advocating a full merger, it is certainly conceivable that the agenda could have switched to this by the time the consultation process is completed. In addition to stressing that such a move would simplify administration, remove distortion and increase transparency, experts highlight that the link between NI contributions and benefits has already become very weak. They argue that it could become virtually non-existent should proposed welfare reforms go through. Of particular importance has been the announcement that the contributory principle behind the State pension is to be scrapped and replaced by a State pension of £140 a week based on residence criteria.   

Matthew Sinclair, Director of the TaxPayers’Alliance, says: “Our view is that changes in welfare policy are creating an opportunity to have a single tax and the planned changes to pensions mean we are getting to the stage when no-one would miss the contributory principle. The other challenges are the effects on the self-employed and, most critically from a political point of view, on pensioners. However, we don’t think there are any obstacles that can’t be overcome and the obvious thing to do with pensioners is to have a single tax, but to charge them at a separate rate.”

Sinclair feels that, should such a merger materialise, the Budget next March would be a logical time to announce it. However, from then onwards there would have to be a significant time period before the move was actually introduced, and payroll companies have quite enough on their plates as it is.

Charles Cotton, Performance and Reward Adviser at the Chartered Institute of Personnel and Development (CIPD), explains that at the moment a lot of employers are preparing for the introduction of the HM Revenue & Customs (HMRC) Real-Time Information reform, effective from April 2013, and the introduction of the pension workplace auto-enrolment change, which will be introduced in October 2012. Both of these initiatives, plus the proposal to harmonise NI and Income Tax, could create significant complexities and cost as payroll and HR systems are adapted.

“We are talking to our members about the NI and Income Tax merger issue and the feedback I get is that they think that the idea has merit, but they have concerns regarding implementation,” he says. “In addition to the administration complication, you have the problem of what will happen to salary sacrifice. The Government is encouraging people to save more, and a lot of organisations use salary sacrifice to reduce the cost of employer and employee pension contributions.”

Lorica Employee Benefits reports that, outside flexible benefits schemes, between 85 per cent and 90 per cent of its pension clients use salary sacrifice. The approach is used for all its childcare voucher and cycle to work schemes – for which it is actually encouraged by legislation. Within flex, 95 per cent of its employee benefits as a whole are using salary sacrifice.

Matt Duffy, Head of Online Benefits at the national specialist intermediary, says: “Within a flex scheme we always recommend that every single benefit is done via salary sacrifice. However, the biggest savings are made on those that don’t incur a P11D liability for the employee, such as life cover, pensions, income protection and mobile phones. Clients do have concerns that the tax savings through salary sacrifice may be removed due to the volume of people using it. However, the Government has made it clear that it supports childcare and cycle to work schemes.”

So, assuming that the odd scheme could enjoy a special exemption, what would be the impact on benefits generally if NI and Income Tax were fully merged? The answer would depend very much on whether only employees’ NI is merged or whether employers’ NI is also included or becomes part of a separate merger with Corporation Tax.

If the merger only involves Income Tax and employee’s NI, then for employer’s pension contributions and other benefits, which are not subject to NI, neither employer nor employee should be at any disadvantage. Let us assume for the purposes of simplicity that a new single tax is payable by basic-rate taxpayers at 32 per cent (20 per cent Income Tax plus 12 per cent NI) and by higher-rate taxpayers at 42 per cent (40 per cent Income Tax plus two per cent NI).

Colin Ben-Nathan, Chairman of the Employment Taxes Sub-Committee at the Chartered Institute of Taxation (CIOT) and a Partner at KPMG, says: “The reason employers are keen on pensions salary sacrifice is to save on NI and so if employee NI was amalgamated with Income Tax they would need to pause for thought. If the employee gets tax relief on their pension contribution at 32 per cent there is no advantage to them of using salary sacrifice as they would get full relief anyway.”

However, if the employer’s NI, or a payroll tax similar to it, remained there would still be an incentive for the employer to keep the salary sacrifice.

Colin adds: “Even if the Government didn’t grant the employee tax relief at the full 32 per cent and limited it to 20 per cent, so that it was not effectively granting NI relief as well, employees would still be no worse off because they don’t currently enjoy NI relief on pension contributions.”

Nevertheless, the consequences would be more severe for benefits that attract P11D liabilities for employees, such as company-paid private medical insurance (PMI), dental insurance, health cash plans, travel insurance and gym membership. There would be no problem for the employer because it already pays employers’ NI based on these benefits. Yet for the employee, the cost of these benefits could potentially go up by 12 per cent for a basic-rate taxpayer and by two per cent for a higher-rate taxpayer if employee NI was charged on taxable benefits.

In theory this could see fewer employees deciding to take up PMI and similar cover and, because younger ones would be the most likely to opt out, it could skew health insurers’ books towards older lives – who tend to claim more – and result in premium hikes. Nevertheless, some commentators stress that the situation could be largely resolved by employers making increasing use of voluntary schemes, and others feel that the impact won’t be anything like as detrimental as commonly feared.

Sean McSweeney, Principal Corporate Consultant at AWD Chase de Vere, believes the ability to save NI via salary sacrifice isn’t the main driver for buying.

He says: “Many employers allow people to have a deduction in salary to cover dependants for PMI, and more and more organisations have switched over to salary sacrifice for this. Interestingly, however, although it has saved employees a bit of money, I haven’t seen it particularly increasing the scheme membership.”

According to Sean, the main drivers for flex are not so much the cost saving but the fact that doing it through the employer is easier, as is spreading payment over 12 months rather than paying annually.

He continues: “If the product is something people perceive to be complex, like pensions and PMI, employees like the idea that the employer has done some due diligence as they may not be confident in their own ability to choose well. So such a move would be disappointing but wouldn’t fundamentally undermine value or affect demand significantly.”

The real nightmare scenario for salary sacrifice would arise if the Government decides to also get rid of employer’s NI (currently 13.8 per cent). Steve Herbert, Head of Benefits Strategy at Jelf Employee Benefits, is among those to fear that this will happen.

He comments: “I don’t think that they will keep employers’ NI or an equivalent because it wouldn’t simplify things, so I expect them to lump it onto Corporation Tax or something similar. Corporation Tax is attached to profit levels, not salary levels, so employers would lose all the savings they were using to make pension contributions and subsidise other benefits. The only real benefit of using salary sacrifice is to avoid NI, and if employers can’t do so any more then why use it?”

Steve believes that salary sacrifice would cease for all products using it.

He adds: “The merger of NI and Income Tax could be a way of shutting salary sacrifice via the back door. HMRC has never liked salary sacrifice but has been essentially powerless to do anything about it as it concerns contract law, not tax law. If I was the Government and seeking to raise extra revenue to reduce the budget deficit this would definitely be something I would consider. The risk gap would be adversely affected but the different Government departments literally don’t talk to each other, so that wouldn’t matter to the Treasury.”

Fortunately, not everyone expresses similar pessimism on the subject. Robin Hames, Head of Technical Marketing and Research at Bluefin, describes the idea that employers’ NI could be got rid of and not replaced with some kind of employers’ payroll tax as “inconceivable.” Katharine Moxham, spokesperson for Group Risk Development (GRiD), also feels employers’ NI will stay, emphasising that if it was wrapped up with Corporation Tax employers would have many ways of getting around paying the tax.

 

Edmund Tirbutt is a freelance Journalist and Protection Consultant