Bring NICs and income tax closer together – report

National insurance contributions and income tax should be brought closer together to create a simpler and fairer system for business and taxpayers, a timely new report says.

But the report author, the Office of Tax Simplification, stops short of calling for a merger of the two separate systems -- a move it has previously recommended to make IR35 obsolete.

Such an outright merger is however the OTS’s “favoured option” on the basis of transparency and simplicity, but it is outside the terms of its report, despite a “great deal” of support for it.

Seeming to allude to IR35, the office also said yesterday than a merger would address “many of the distortions in behaviour encountered around employment status and profit extraction.”

Yet in view of the scale of employer secondary contributions to the exchequer and the significant shift in taxation that would result from its abolition, a merger is “simply not on the agenda.”

Instead, the office recommends a move to an annual, cumulative and aggregated basis for employees’ NICs, and charging employers’ NIC as a levy on total payroll costs with an employment allowance for each employer. Further details are published on ContractorUK today.

“A simpler, and fairer, system would treat everyone’s earnings in the same way, for both income tax and national insurance,” the OTS said.

“This means that national insurance would be calculated in the same way as income tax, making it easier to understand…we found near-universal support for reform to the NICs system”.

But the impact of change will be “considerable,” cautions the report, notably for “millions” of taxpayers who would pay more in NICs, as opposed to an equal chunk who are projected to pay less.

“Some paying more would gain contributory benefits but all these impacts need to be carefully worked through and thought about,” said OTS’s tax director John Whiting. “More work is needed and so is a proper, informed debate about the considerable implications.”

The office’s call for more work on aligning NICs with income tax is timely, as it comes less than 10 days before the Autumn Statement -- which has previously been used to green-light its recommendations.

But its recommendation in 2011 that marrying the two systems into one would have the effect of ‘nullifying’ IR35 is not under consideration, even though OTS knows that it still remains an issue.

“The OTS has long heard the message that maintaining two separate systems of taxation of earned income is one of the drivers distorting business behaviour, in particular in relation to profit extraction from limited companies and hiring decisions around employment status,” it says.

“A good employer tax would not increase the motivation for incorporations purely for taxation reasons. Finally, the charge should be straightforward to operate for the employer and administer for HMRC, with limited need for anti-avoidance provisions.”