Written evidence submitted by the Low Incomes Tax Reform Group (LITRG)

1                     Executive Summary

1.1                              We welcome the opportunity to provide this submission to the Committee’s call for evidence. The inquiry is broad and each of the questions could form the basis of their own inquiry. Given various constraints, we have made some high-level comments to contribute to this important debate.

1.2                              We are specialists in tax and related welfare benefits for people on low incomes. We provide online guidance on these matters which, in the 12 months to 30 June 2020, received 5.7 million unique visitors.[1] We are regularly contacted by members of the public via our websites with questions about their tax affairs. These enquiries give us valuable insight into how low-income people interact with the tax and benefits systems.

1.3                              The tax affairs of people on low incomes are surprisingly complex, frequently burdensome and often contain traps for the unwary. We have attached an appendix to this submission which sets out some principles which we believe should be firmly lodged in the minds of those designing and managing the tax system. On occasion there will be conflicts between these principles, as well as tensions with the overarching aim of the tax system – this is inevitable – but it is crucial that any tax reforms take account of all taxpayers, including those who are vulnerable or on low incomes.

1.4                              The coronavirus pandemic has had a major impact on the UK economy and public finances, on top of other long-term pressures on the UK tax system such as the changing labour market and devolution. We recognise that there are no easy answers as to where the money will come from to restore the UK’s overall financial position or to carry out any necessary reforms. Indeed, some of the suggestions in this paper will have a modest cost attached to them. It is important that those on the lowest incomes are treated fairly despite the overall climate, that they do not bear a disproportionate share of the cost and that the system continues to be reformed to ensure it works for all.

1.5                              The pandemic has also highlighted weaknesses in the tax system in areas already in need of reform, which if tackled, could help bring funds into the Exchequer. These include areas where significant review and change may be required, for example:

1.6                              In terms of more detailed points of reform, we would like to see various issues in the tax system addressed, such as:

1.7                              In implementing reform, it is right that the government should capitalise on the opportunities provided by technological advancement with its Making Tax Digital agenda. But no-one should be left behind in a move to an ever more digital system. Alongside this, there is also much to be done to simplify the tax system, making it easier for both taxpayers to interact with it and for HMRC to administer it. On this point, we consider how HMRC should better use the data they have available to them to help taxpayers comply. However, increased use of data, especially third-party data, must be accompanied by increased clarity on the question of whose responsibility it is to ensure the data is correct. There should also be straightforward processes to rectify errors.

1.8                              When making changes, we urge policymakers to be consistent in their use of terminology across taxes and benefits (the word ‘allowance’, for example, can refer to a myriad of different things) as well as ensure that unrepresented taxpayers have accurate, detailed guidance at their disposal. Most people no longer have long-term, stable jobs with one employer and therefore their tax affairs are far more complicated. The need for accurate and detailed guidance is crucial as we enter a period of potential tax rises and potential large-scale reform. Good communication with taxpayers should be a core part of HMRC’s strategy moving forward.

1.9                              Those who need individual tax advice should be given more assistance in trying to find it, and grant-in-aid funding for organisations offering tax advice must be properly targeted. If large-scale changes are to be made, HMRC must, of course, be properly resourced to deal with them. Recent engagement with HMRC on the coronavirus support schemes, made easier as a result of the new virtual way of working, has been positive and we would like to see this kind of collaboration continue. On this point, the longer HMRC officials are in post, the easier it is to build relationships and make joint progress.

1.10                          When implementing tax changes, proper, public debate is essential. As we explain in the context of devolved taxes, a UK Tax Collaborative Forum may be useful in ensuring that policy changes are introduced with full consultation.

1.11                          Whatever changes are made, they must take into account the position of low-income and unrepresented taxpayers and ensure that early efforts are made to identify and address any unintended consequences – for example, how tax changes interact with welfare benefits. Close attention also needs to be paid to the interactions across the devolved parts of the UK, and their own tax systems. Failure to do this can result in well-intentioned policy not achieving its desired result.

1.12                          We comment in more detail on the individual questions below.

2                     About Us

2.1                              LITRG is an initiative of the Chartered Institute of Taxation (CIOT) to give a voice to the unrepresented. Since 1998, LITRG has been working to improve the policy and processes of the tax, tax credits and associated welfare systems for the benefit of those on low incomes. Everything we do is aimed at improving the tax and benefits experience of low-income workers, pensioners, migrants, students, disabled people and carers.

2.2                              LITRG works extensively with HM Revenue & Customs (HMRC) and other government departments, commenting on proposals and putting forward our own ideas for improving the system. Too often the tax and related welfare laws and administrative systems are not designed with the low-income user in mind and this often makes life difficult for those we try to help.

2.3                              The CIOT is a charity and the leading professional body in the United Kingdom concerned solely with taxation. The CIOT’s primary purpose is to promote education and study of the administration and practice of taxation. One of the key aims is to achieve a better, more efficient, tax system for all affected by it – taxpayers, advisers and the authorities.

3                                 What are the major long-term pressures on the tax system in the UK, including those arising from changes in working practices, demographics, the environment and other factors?

3.1               There are a number of major long-term pressures on the UK tax system – most existing prior to the pandemic and some likely to come from the consequences of the pandemic on the economy.

3.2               The changing labour market

Gig economy, self-employment, false self-employment, etc

3.2.1                                                   For some time, changes to the labour market and work patterns have been putting pressure on the tax system. As a result of the economic impacts of the pandemic we may see: more people in the gig economy; more people setting up in self-employment; a rise in false self-employment[2] (in an attempt to reduce costs for the engager); an increase in insecure terms and conditions; and more people working from home. These people may have lost their jobs and not been able to secure permanent, full-time employment. Where they are treated as self-employed for tax purposes, they will be paying less tax and National Insurance as a result of the differences between the employed and self-employed. In addition, they will probably not be paying into a pension scheme – therefore building up future dependency on the state.

3.2.2                                                   False self-employment is a problem for low-income workers which may now grow, given the numbers of engagers who may be contending with difficult trading conditions and therefore looking to minimise the costs of employment. Employer’s National Insurance tends to be the driving force behind false self-employment, but avoidance of work protections, including the national minimum wage and auto-enrolment pension contributions, may also play a part.

3.2.3                                                   All of this is likely to mean people come into contact with issues and parts of the tax system they may not be familiar with. They may have multiple jobs, or their work arrangements may be more complex (for example, being self-employed alongside being employed). The more unfamiliar and complex an individual’s working arrangements, the greater the risk that both HMRC and taxpayer will not be able to cope. This could result in HMRC struggling to provide adequate guidance and support, HMRC’s systems (such as PAYE coding) not keeping up with the taxpayer’s movements, and taxpayers not understanding their obligationsall with detrimental consequences for the tax base.

3.2.4                                                   If people’s earnings fall as a consequence of an economic downturn, there are likely to be secondary consequences to public finances other than reduced tax and National Insurance receipts. For example, workers could be living on such low wages that there will be more reliance on in-work benefits. Additionally, if people are under financial pressure, there may be consequent changes in behaviour in respect of tax, such as the use of avoidance schemes or trading in the hidden economy.

Long-term ill-health and disability

3.2.5                                                   Further effects may also be seen. For example, there is the possibility of individuals suffering long-term illness and disability arising from having had coronavirus. Both of these will lead to obvious pressures on the public finances through decreased tax receipts, increased welfare support and associated administration costs. One opportunity to reduce these costs would be to address the confusion over the tax and benefits status of the ‘Access to Work’ and ‘back to work’ schemes used by disabled people and unemployed.[3]

Tax debt

3.2.6                                                   Another impact of the pandemic is likely to be on levels of tax debt. For example, while the recent VAT and Self Assessment payment on account deferral opportunities will have offered very welcome breathing space for some, they will inevitably lead to the ‘bunching up’ of liabilities and problems further down the line, possibly as early as January 2021. This will not only impact on the amount of money HMRC can collect and therefore have available for public spending, but a greater number of taxpayers, especially unrepresented ones, will need support from HMRC in managing these debts. Some of those people may never have been in debt to HMRC before and could find it distressing and difficult to cope with. They will probably not realise that HMRC can provide help such as setting up payment plans over varying periods of time to collect the debt, so HMRC will need to make it clear what options might be available so that debtors who are reluctant to engage come forward.

3.3                              Devolution

3.3.1                                                   Any examination of the tax system in the UK must take into account the fact that parts of it as well as some related welfare benefits are devolved to the UK’s constituent nations and local authorities. The manner in which devolved and reserved taxes interact with one another has a bearing on the overall efficiency and performance of the UK tax regime. The challenges of managing and responding to anomalies arising from the interactions between devolved and reserved taxes – and the relationships between ministers and officials in the UK and devolved governments – are ones that will need to be borne in mind when considering future reforms to the UK tax system.

3.3.2                                                   The general direction of travel over the last decade has been in favour of increased devolution to the UK’s constituent nations, as shown by the devolution of property and landfill taxes, and the responsibility for setting certain bands and/or rates of income tax to the Scottish and Welsh parliaments. There has not been any significant tax devolution to Northern Ireland to date, although the possibility has been explored. Consideration is also being given to the potential for new taxes to be created, representing a further example of the trend towards increased devolution.

3.3.3                                                   In our experience, tax devolution has created a more complicated tax regime for those taxpayers who are directly impacted by these changes. One example of the problematic interactions between devolved and reserved aspects of the UK tax regime is the clash between the 20% tax relief for contributions to relief at source pension schemes when an individual pays the tax at the Scottish rate of 19% or 21%.[4]

3.3.4                                                   In Scotland, the Devolved Tax Collaborative was established in 2013 by the Scottish Government as a forum for taxpayers, agents, academics and representative groups with an interest in the development of the devolved taxes. We suggest a similar forum might be of benefit for the UK generally.

4                                 Do these pressures need to be met with tax reform, and if so, is this the right time for reform?

4.1               Labour market

4.1.1                                                   The pressures created by changes in the labour market described above have existed for some time and we have been supportive of tax reform in this area. The pandemic has shone a light on some of these existing issues and strengthened the case for reform. We have been struck by the numbers of people contacting us in essentially similar types of work, who have experienced widely different outcomes under the various coronavirus support schemes.

4.1.2                                                   For example, two agency workers who may work in the same factory could be treated differently under the Job Retention Scheme depending on whether or not they work through an umbrella company. A worker being treated as self-employed on a construction site may qualify for different support than his work mate who has been paid under PAYE. Two directors working for the same limited company will have had differing outcomes depending on how much they pay themselves as a salary.

4.1.3                                                   The problem stems from the fact that the coronavirus support schemes have been built using as their starting point a tax system that treats people doing the same type of work differently, depending on how they have been engaged and are paid. The issues that this causes have been thrown into even sharper focus in the context of the support schemes. New trends and policies present challenges, but also opportunities, all of which need to be fully explored. Now may be a good time to finally undertake a wholesale review of how the labour market is taxed with a view to smoothing out the opportunities for distortive hiring practices. Not only will this leave the mainstream tax system in a better shape overall but it will mean we are better able to confront, and deal with, future emergency situations.

4.2               Devolution

4.2.1                                                   Devolution itself is not a pressure that needs to be met with specific tax reform, but it is something that must be taken into account in any tax reform. It is important that the UK government actively seeks input from the devolved governments and the devolved tax authorities when considering major changes that may have knock-on effects for the devolved tax regimes. The coronavirus pandemic has perhaps highlighted the fact that in order to ensure the tax system and devolution settlement are as effective as they can be, there needs to be proactive co-operation between the Scottish, Welsh, Northern Irish and UK Governments, both at civil servant level and ministerial level.

5                                 Which areas of the tax system are most in need of reform, and which are best left alone?
What reforms should be considered in response to the pressures on the tax system?

5.1               There are some areas of the system that we feel are in need of reform to directly address the pressures discussed above. More generally, we feel there are other areas of tax system, such as the taxation of trusts and estates and VAT, which are in need of some reform and which we take the opportunity to highlight in this submission. The government’s Making Tax Digital agenda, a cornerstone of its future tax administration strategy, is relevant to many of these reforms but it is vital this is implemented in a way which works for all.[5]

5.2               The gig economy, employment status and different business models

5.2.1                                                   The tax system needs to fit the 21st century labour market. In 2018, the Office of Tax Simplification published a paper on the role of ‘online platforms’ in helping to address tax compliance for those working in the ‘gig economy’.[6] Building on this, serious consideration must be given to how those in the gig economy can be taxed in a way that does not so heavily rely on Self Assessment, which can be complicated for workers to deal with and results in mistakes and revenue losses for the Exchequer.

5.2.2                                                   For example, many entering the gig economy will not usually have had to fill in a tax return before and are unlikely to engage an accountant or tax adviser. As a consequence, these individuals will have to navigate the complexities of Self Assessment on their own, which may result in non-compliance or under-reporting.

5.2.3                                                   Low-income workers frequently contact us with employment status issues and say that their engagers are not operating their PAYE correctly, or at all. As discussed above, we anticipate a rise in ‘false’ self-employment as a result of the pandemic. Reform is needed to address the differentials in the tax system that drive this behaviour – but this cannot be done in isolation and needs to be considered alongside other systems such as national minimum wage, universal credit and tax credits. At the very least, HMRC must make it easier for people to raise employment status issues and to report non-compliance. They also need the resources to be able to follow up and tackle alleged non-compliance.

5.2.4                                                   LITRG has heard from many directors of their own limited companies who feel aggrieved that they qualified for little or no support from the Job Retention Scheme, due to a substantial part of their income being in the form of dividends from their company. Dividend income is taxed more beneficially than salary and it is not liable to National Insurance contributions as it is treated as a return on an investment and not employment income or earnings. This differential can be one of the main drivers for operating via a limited company. However, it is evident that dividend payments in many scenarios are simply regarded by directors as employment income, which raises real questions about whether there should be such a distinction in the tax and National Insurance treatment for dividend income received by directors from their owner-managed companies.

5.2.5                                                   Of course, IR35 and the off-payroll rules have been introduced to negate some of the tax benefits associated with dividends for those operating through a personal service company. However, we have concerns over whether the proposals for the private sector, now scheduled to come into effect in April 2021, will achieve their desired intention given the potential reaction of some in the temporary labour market (which may be to seek out alternative, possibly non-compliant, arrangements to protect their ‘profitability’).[7]

5.2.6                                                   We have also come across examples of people who are running their business through limited companies but consider themselves self-employed and therefore mistakenly believed they would get support from the Self-Employment Income Support Scheme. This highlights the need for greater awareness of the different ways of running a business as well as the different business taxes associated with them, especially amongst low-income, unrepresented business owners.

5.2.7                                                   One of the main drivers encouraging people towards self-employment rather than employment is the lower National Insurance contributions paid by the self-employed. In 2018, the Institute for Fiscal Studies observed that the UK tax system attaches a significant tax penalty to work that occurs through employment and therefore offers a tax advantage for self-employment.[8] Originally, this could be justified by differences in access to publicly-funded benefits, but over time this has changed so that the difference in benefit entitlements is now smaller. The Taylor Review concluded that ‘treating different forms of employment more equally in the tax system would be fairer, more economically efficient and support better quality work’.[9] This is therefore an area that should be considered for reform.[10]

5.3               Further alignment of tax and National Insurance

5.3.1                                                   Differences between National Insurance and income tax rules create confusion. One example is the threshold at which contributions and income tax start to be paid, but steps have already been taken towards equalising these figures. In 2020/21, employees start paying National Insurance contributions when they earn more than the primary threshold of £9,500 but they do not pay income tax until they earn £12,500.[11] Further work in this area could build upon the Office of Tax Simplification's 2016 review.[12]

5.3.2                                                   The government might also consider whether people in work should continue to pay National Insurance on earnings after they reach pensionable age. When the current system was put in place, average age expectancy was much lower than it is today and people did not usually expect to live, let alone work, much beyond their retirement. While we do not know how coronavirus may affect these figures in future, average life expectancy is now well into the late seventies or eighties and more people may wish to continue to work after pensionable age if they are able.

5.3.3                                                   Given the fact that National Insurance contributions drop significantly once the upper earnings limit is reached (£50,000 for 2020/21), there appears to be scope for a more progressive rate structure. Such a move might allow for a reduction in rates for the low-paid. Such a strategy would, however, run counter to a move towards closer alignment with income tax (unless a more progressive structure for income tax were similarly introduced as, for example, has been the case in Scotland). As noted above in relation to devolution, any changes to NIC and income tax need to take into account the fact that income tax is partially devolved to Scotland and Wales, but national insurance is wholly reserved. This can produce various interactions that would need to be taken into account when determining what, if any, changes to make.

5.4               Annual reviews of fixed amounts and annual uprating

5.4.1                                                   Frequently, tax measures diminish in value or start to impact on those not intended at the outset because the government fails to uprate thresholds, bands and allowances by an appropriate factor, such as inflation or earnings. Examples include rent-a-room relief, the money purchase annual allowance, and the trading and property allowances. Another example is the £50,000 threshold at which the High Income Child Benefit Charge begins to be payable. This has not been increased since its introduction in January 2013 and as a result the number of families affected has increased by over a third.[13]

5.4.2                                                   Whilst we recognise the benefit of having a rounded and static threshold for the purposes of taxpayer awareness, this must be balanced with measures to compensate for fiscal drag. We believe automatic annual uprating of thresholds, bands and allowances should be put in place unless, in a specific case, a clear rationale has been set out for not doing so (in which case, there should be a statutory commitment for the thresholds to be reviewed regularly).

5.5               Salary sacrifice for those on lowest incomes

5.5.1                                                   The rules on salary sacrifice were changed in Finance Act 2017, but still allow salary to be sacrificed in exchange for certain ‘benefits’ such as childcare vouchers or pension contributions. This saves both income tax and National Insurance contributions for the employee. This can represent a small but significant saving for those on low incomes.

5.5.2                                                   The national minimum/living wage rules do not allow salary to be sacrificed where it would mean the cash payment the employee receives is less than the statutory minimum. This prevents these employees from taking advantage of something that is available to those on higher incomes.

5.6               Trusts and estates

5.6.1                                                   While the general public might view trusts as being the prerogative of the rich, they are in fact much more common than many people realise. Unfortunately, trust taxation is extremely complicated and is almost impossible for unrepresented taxpayers to navigate alone. We recommend that work on reviewing the taxation of trusts[14] should continue and reform be considered.

5.7                              VAT

5.7.1                                                   Alongside income tax and national insurance, VAT is one of the largest taxes. There is some debate about whether the numerous zero and reduced rates in VAT are well targeted in relation to those on  the lowest incomes. Our CIOT colleagues have made some comments on the effectiveness of zero-rating more generally in their response and float the possibility that those on lower incomes could be more than fully compensated for ending zero rating for only modest proportions of the overall saving.

5.7.2                                                   One way of doing this would be to redistribute some of the savings towards the benefits system. This would reduce VAT complexity and potentially ensure that the money is targeted at those who need it most (by giving them 100% support rather than tax relief). However, the benefits system is already complex and those who do not qualify for any means-tested benefits, but who are still lower income, would potentially miss out on necessary support. It would also need some detailed work to address issues relating to frequency of payments, especially given that you would be replacing several reliefs that all have different objectives. For example, increasing weekly benefit payments to offset the loss of zero-rating on food might be possible, but helping with the one-off purchase of a large item of equipment or adaptation needed due to a disability may not lend itself as well to an increase in regular benefit payments. There are of course other options that could replace zero-rating for specific reliefs outside of the benefits system – for example by providing additional funding to the social care system.

5.7.3                                                   It would also depend to some extent what the Government’s policy objective is and that may be different for each relief. For example, we understand that the original policy intention for the VAT relief available to disabled people on adaptations to their private residence was to ensure that those who would not have to purchase something were it not for their disability are not penalised by the tax system for doing so. It is therefore designed to offer support regardless of the means of the person. This is similar to the rationale behind Personal Independence Payment and Disability Living Allowance – the two main disability benefits which are to help with extra costs if you have long term ill-health or disability. For that reason, they are not means-tested.

5.7.4                                                   Further work and analysis should be undertaken to understand the full impacts and consequences of removing zero-rating/reduced rates across all of the reliefs.

5.7.5                                                   If zero-rating is to remain, there are certainly improvements that could be made in relation to VAT reliefs for disabled people on adaptations to their private residence. Currently some works qualify for the zero-rate but others do not (even if done as a direct result of that person’s disablilty). The result of this is that the Government’s original policy objective is not being met consistently. Furthermore, there is no corresponding relief in respect of workplace modifications which, for partially exempt employers, may make it more expensive to employ employees for whom such adjustments may be necessary.

5.8               Making Tax Digital (MTD)

5.8.1                                                   As the majority of the UK workforce who were able to continue working during the coronavirus pandemic were forced to work from home for several months, it quickly became apparent that good quality digital resources were imperative for this to be successful. It seems likely this will hasten our reliance on digitisation in many areas of our lives, and it has been made clear that this is definitely the direction of travel with the tax system, as confirmed in the recent announcements about the expansion of the Making Tax Digital programme.[15]

5.8.2                                                   While we understand this initiative can have benefits for some, we do not agree that digitisation in this way should be mandatory; if a system is good and provides obvious benefits to the user, they will naturally gravitate towards it, as was the case with online Self Assessment. This should be the objective of the Making Tax Digital programme, particularly for income tax.

5.8.3                                                   As the intention is for the new rules to apply to all businesses with a turnover of £10,000 or more, even very small traders and landlords will need to comply with the new regime. We believe that some will find this extremely difficult. Currently, we understand HMRC do not intend to provide their own free software to enable businesses to make the necessary returns that will be required (at least five per annum under current proposals). We find it completely unacceptable that a government department can mandate businesses to file information about their taxes in a particular way but then not provide the tools to enable them to do so.

5.8.4                                                   The roll out of Making Tax Digital will have cost implications for traders (both in terms of cash and time) which they may not be able to afford, particularly if they have suffered financially as a consequence of the coronavirus pandemic. Their immediate attention is more likely to be on trying to keep their business viable over the short to medium term, rather than looking to get to grips with computer software for bookkeeping systems and making quarterly returns to HMRC.

5.8.5                                                   While digitisation is clearly the sensible way forward, care must be taken to ensure this does not progress at such a pace that it leaves too many people behind, including those who are not generally digitally competent and those who are genuinely digitally excluded. Provision must continue to be made for those who need non-digital methods of complying with their legal obligations, and the process for claiming exemption from MTD compliance must be straightforward.

6                                 What is the role of tax reliefs in rebuilding the economy and promoting economic growth and efficiency? Does the current regime of tax reliefs perform this role well?

6.1               General comments on tax reliefs

6.1.1                                                   Tax reliefs can be thought of as levers that encourage certain behaviours. For example, giving relief on pension contributions aims to encourage people to save for their retirement. However, reliefs can be costly if they are not targeted. In 2011, the Office of Tax Simplification reviewed tax reliefs and found a staggering 1,042 reliefs.[16] Before any further reliefs are introduced, it is important that careful thought is given to the impact of further reliefs on complexity and whether any particular reliefs are targeted enough to achieve specific objectives. A lot of money is spent on tax reliefs and it seems that the government needs to undertake further work to understand whether they still fulfil their original purpose or if they have outlived their usefulness.[17]

6.2               Improving the administration of tax reliefs

6.2.1                                                   In addition to looking at tax reliefs on a structural level, there are aspects of the regime of tax reliefs applicable to low-income taxpayers which need work in order to ensure they function effectively and can be administered easily. If a taxpayer does not get the tax relief to which they are entitled, then it is difficult to make a fair judgment on the economic impact of the relief.

6.2.2                                                   For unrepresented taxpayers, tax reliefs are not well understood. This fact can be taken advantage of: for example, relief for employee expenses is a particular area which needs reform in order to help address the problem of some unscrupulous High Volume Repayment Agents[18]. These agents are known to submit large numbers of claims, some of which have no merit, and they take a large proportion of the refund (which is mandated to them before paying the balance to the taxpayer). This can leave the taxpayer with little means of redress when HMRC identify that the claim was incorrect. The factors which drive taxpayers to use these agents must be addressed – for example, improving the process through which taxpayers are able to make the claim themselves (for free) and increasing taxpayers’ awareness of this possibility.[19] Given the increase in home-working as a result of the pandemic and possible expense claims as a result (compounded by some individuals potentially being in precarious financial circumstances and desperate for any tax refund they can get), the government should address these issues urgently.

6.3               Inequities created by tax relief being given to some and not others in similar circumstances

6.3.1                                                   There are also areas where we think reform is needed to the existing regime of individual tax reliefs on grounds of fairness.

Travel expenses

6.3.2                                                   The rules surrounding employees travel expenses are particularly complex. Broadly, an employee can deduct from their taxable income travel costs that are not reimbursed by their employer if they are necessarily incurred in performing their job and are not costs of ordinary commuting. Non-taxpayers obtain no tax relief on such costs. Many care workers – especially those working part-time – find themselves in this situation. We think there is merit in exploring giving relief to such non-taxpayers for their travel expenses, especially given the vital role that care workers have played during the coronavirus pandemic supporting the ill and vulnerable.

Tax relief on pension contributions

6.3.3                                                   For some time LITRG and other individuals and organisations have been campaigning to ensure all low-income earners benefit from tax relief on pension contributions. HM Treasury have issued a call for evidence on various options for reform.[20] The current difference in operation between relief at source (RAS) arrangements and net pay arrangements means that an estimated 1.75 million people in net pay schemes are not benefiting from the same government incentive as those in RAS schemes. Over 75% of those affected are female.[21]

7                                 What are the areas for simplification?

7.1               General comments

7.1.1                                                   The tax system is complex. The more complex the system is, the more likely people are to make mistakes due to confusion and a lack of understanding. This is more likely to be the case if they are unable to pay for advice to help them meet their obligations. Complexity also means the system is more difficult for HMRC to administer. All of this contributes to error in the system and makes fraud more likely. It also means people are less likely to access any reliefs they may be entitled to, because they do not understand them or how to claim.

7.1.2                                                   It is important to note that simplification can take two possible forms – simplifying the law itself, or simplifying its administration. Both have their part to play in making the system run smoothly.

7.2               Overall structure of tax administration for individuals

7.2.1                                                   One area that would benefit from review and potential reform is how Self Assessment, Simple Assessment and PAYE interact. To run smoothly, the tax system must be clear in terms of who is supposed to do what and when. The current system for individuals is a mix of tax deduction at source and Self Assessment. Simple Assessment (under which individuals do not have to submit a tax return, but instead HMRC send them a formal calculation of their tax liability) may now alleviate the full Self Assessment burden for some taxpayers.

7.2.2                                                   The onus is on the taxpayers to take reasonable care to check that their affairs are correct and, in certain circumstances, people must notify HMRC of a liability to tax. However, HMRC are increasingly gathering data that may be used to establish an individuals tax position without a tax return. This increased data-matching ability, facilitated by digitisation, brings into question whether the balance of responsibility between HMRC and individuals is correct.

7.2.3                                                   We understand that HMRC aim to do even more pre-population of information, through their plans for building a trusted, modern tax administration system.[22] We hope that steps towards the objectives set out in this plan are made as soon as possible, given that such a strategy could help to simplify the system for people and improve tax compliance – even without major structural change.

7.2.4                                                   One example of where HMRC could simplify the administration of the tax system by making better use of data already held can be found in the steady stream of appeals heard by the First-tier Tribunal in relation to ‘failure to notify’ penalties for those subject to the High Income Child Benefit Charge (HICBC). Others challenge the charge itself on legal grounds.[23] Many of these individuals find it unfair that HMRC is seeking to impose backdated assessments to the charge alongside failure to notify penalties for a number of historic tax years, because HMRC have not joined up the dots between PAYE records and child benefit records sooner. The amounts payable are frequently several thousand pounds and many taxpayers are not in a position to clear the debt straight away. We appreciate HMRC’s arguments that ignorance of the law is not necessarily a reasonable excuse, and that they are under no obligation to notify taxpayers of the change in the law which might affect them. We also understand that it can be difficult, for example, to connect a taxpayer earning more than £50,000 with an unmarried partner who claims child benefit. However, the number of cases at the Tribunal clearly demonstrate that the HICBC itself is deeply flawed and its administration has proved to be challenging. It needs urgent review.[24] At the very least, the £50,000 threshold should be uprated, as we suggested above.

7.2.5                                                   However, the more HMRC reinforce taxpayers perception that they already know everything about them by replaying data through digital, prepopulated systems, the greater the risk of people simply assuming the information is correct. At the very least, the taxpayer knows that submitting information which agrees with data already held on HMRC’s systems is much less likely to lead to an enquiry, so they are perhaps less likely to verify the figures independently. It also means that people do not need to tell HMRC about changes. We have suggested above that HMRC review how PAYE, Self Assessment and Simple Assessment work, but at the very least HMRC need to be clear as to:

7.3               Simplifying terminology and using it consistently

7.3.1                                                   In considering any tax reforms, there are some things that should be considered in order to help reduce complexity. It is within the control of both policymakers and HMRC to help towards people’s understanding of tax, by using consistent terminology when making new law and in guidance explaining that law.

7.3.2                                                   For example, it is confusing for people in the extreme that tax legislation uses the term ‘allowance’ to mean a number of different things, operated in different ways. The personal and blind person’s allowances are deducted from taxable income, whereas the personal savings and dividend allowances are in fact nil rates of tax. With the latter, the income remains taxable, which means that a person can remain a taxpayer albeit at a nil rate. By assuming that all ‘allowances’ work in the same way, serious miscalculations of individuals’ tax liabilities can arise – as illustrated by the case study below (based on an enquiry to our website). The differences also make the law very hard to explain by HMRC and others, such as ourselves, when seeking to support taxpayers.

Case study – dividend allowance
 

An individual incurred an unexpected tax liability of over £15,500 on his state pension lump sum,[25] having thought he was a non-taxpayer. In fact, he was a basic rate taxpayer, but his dividend income that fell within the basic rate band was taxed at a nil rate due to the dividend allowance. His (understandable) mistake was in thinking that the dividend allowance acted to ‘exempt’ the income rather than being taxable at a nil rate.

7.3.3                                                   It may be difficult to align existing definitions without a great deal of work and evaluation of winners and losers. However, it is possible to avoid introducing new or subtly different definitions of the same term, by including a formal step in policymaking to address this, and review how existing definitions might be aligned as and when other changes are made.

8                                 What is the best way to tackle tax reform, including what changes might be needed at HMRC to support implementation, and how should the Government consult with stakeholders and Parliament?

8.1               Full review and consultation

8.1.1                                                   Any tax reform should be supported by public debate and proper and open consultation. Where major reform is taking place, this should be planned out through the use of road maps. It is also important that any changes are subject to full parliamentary scrutiny and that there is proper analysis and identification of any ‘winners’ and ‘losers’ of any reforms.

8.1.2                                                   We think that Government should resist the temptation to tackle particular areas without ensuring ‘bigger picture’ thinking and direction is considered first. For example, in 2017, plans were introduced to abolish Class 2 NIC which was then abandoned due to the negative impact it could have on some of the lowest earners and that any options to mitigate this would introduce greater complexity into the system. At the time LITRG highlighted that, given the significant changes in people’s working patterns, we would like to see the whole system of National Insurance reconsidered rather than tinkering and piecemeal changes.

8.1.3                                                   This remains our view and is even more important given some of the areas – such as reviewing how earnings are taxed – that we have highlighted earlier in this response. Some of these areas require fundamental reviews of how people are taxed. This is not something that can be implemented overnight – and the urge to make small changes without such fundamental review should be resisted.

8.2               Watch out for interactions/unintended consequences

8.2.1                                                   The other important factor for any tax reform is that tax cannot be considered in isolation. Changes to the tax system, especially for those on low incomes, can have unintended consequences on the benefits system. Interactions between the tax system and other systems need to be considered as part of any tax reform.

8.2.2                                                   For example, in Finance (No. 2) Act 2015, the government announced changes to the rules for residential landlords from 2017/18. The objective was to restrict the amount of tax relief on finance costs to basic rate (20%) instead of 40% for higher rate taxpayers (or 45% for additional rate taxpayers). The restriction operates by denying a deduction for the full amount of finance costs in the calculation of rental profits and instead giving a tax reducer at the 20% at the end of the tax computation on the amount disallowed. The government confirmed that the majority of basic rate taxpayers would be unaffected by the change (unless they were close to the higher rate threshold). But actually, those on lower incomes were impacted. Tax credit claimants stood to lose a significant amount of their tax credits because their ‘top line’ taxable income would increase overnight – even though they would not pay any more tax.[26] Similarly, we have seen an impact on child maintenance payments, student loan repayments and even drama grants given to children. In some basic-rate cases, such as those who were eligible for the starting rate for savings, the amount of tax payable actually increases. None of these impacts were publically acknowledged or communicated to those affected.

8.3               Ensure HMRC have adequate resources to deliver reforms

8.3.1                                                   HMRC’s ability to implement major reform requires them to have adequate resources. We commented above about the use of Simple Assessment, but HMRC’s plans to expand that were put on hold as their resources were diverted to Brexit activity. With the transition period coming to an end at the end of this year, this is likely to continue to impact on HMRC’s resources.

8.4               Make people aware of changes, and provide them with clear and complete guidance

8.4.1                                                   We continue to have concerns about the standard and depth of guidance on GOV.UK. The various coronavirus support schemes have shown how vital it is to have clear and unambiguous guidance for taxpayers when implementing tax changes. In relation to the Self-Employment Income Support Scheme (SEISS), for example, we have seen the difficulties of mixed messaging in people’s understanding of how the grants will be taxed. There has been (and likely continues to be) much confusion over the three-month periods to which the grants supposedly relate, and it has been almost impossible for HMRC to step back from this idea as the SEISS policy has been distilled in real time. As a consequence, we have seen some taxpayers confused over when and how the grants are taxed, and over what period they need to consider the ‘adversely affected’ test.

8.4.2                                                   Related to good guidance (about which we refer to the Office of Tax Simplification’s 2018 report[27]), is the importance of unrepresented taxpayers being able to access high-quality tax advice when they need it. It is very important, for example, that funding which HMRC provides for this purpose is properly targeted to organisations with appropriate tax expertise, such as the charities TaxAid and Tax Help for Older People.[28]

8.5               Engage with stakeholders

8.5.1                                                   In terms of engagement, the introduction of the SEISS scheme by HMRC has been a good example of positive engagement from our perspective. We were able to work with HMRC on a confidential and trusted basis despite the time pressures on them. The ability to connect with HMRC remotely, without the need for physical attendance in London and space to hold meetings, has meant we can engage far more flexibly and frequently.

8.5.2                                                   Based on our engagement over the years, one problem we have observed is that HMRC officials move roles often. When significant changes are being implemented, this is unhelpful and it often means that people take over without any historic knowledge. We would encourage HMRC to ensure officials are property trained and remain in posts for a reasonable amount of time to avoid a high turn-over especially for significant reforms such as MTD.

 

September 2020

Appendix

 

LITRG believes that the tax system should be:

 

Clear and up to date

 

  • Clear, unambiguously written law that keeps pace with the times
  • Clear division of responsibility between the state and the taxpayer
  • To be supported by accurate, comprehensive and accessible guidance

Simple

 

  • Aim for simplicity when writing the law
  • Even when the law is complex, aim to reduce this complexity through its administration, so that it is as easy as possible to be compliant

Equitable

 

  • Where possible, aim to treat taxpayers in similar situations comparably
  • Avoid injustices and traps for the unwary

Just

 

  • A careful balance between the powers of tax collectors and the rights of taxpayers
  • Appropriate safeguards and oversight
  • Availability of justice to all, irrespective of financial means and vulnerability

Accessible and responsive

 

  • Capitalise on technological advances appropriately, but ensure no-one is disadvantaged
  • Ensure resources are available to allow for flexibility and to be responsive to individuals with particular needs

Joined-up

 

  • Different government departments and devolved administrations work closely together, so that no-one falls into gaps between different arms of government
  • Data is shared appropriately, and taxpayers are not caught between different arms of government and third parties as regards inaccurate or incomplete data
  • The tax and benefits systems interact effectively and coherently

Inclusive

 

  • Policy and legislation are consulted on in a wide and meaningful way
  • Everyone has a voice
  • The full impact of proposed changes is considered, including the interaction with non-tax systems such as welfare benefits

 

                                         

              - 19 -             


[1] Our main website for the public being www.litrg.org.uk

[2] Where individuals are treated as self-employed but the facts indicate that they are actually employed.

[3] We explain the issues with the tax treatment of Access to Work on our website: https://www.litrg.org.uk/tax-guides/disabled-people-and-carers/help-employees-and-self-employed#report-tax-purpose

[4] For relief at source schemes, 19% taxpayers get a ‘bonus’ 1% tax relief for administrative convenience which is not afforded to individuals in net pay arrangements. Similar issues arise with Gift Aid contributions.

[5] https://www.litrg.org.uk/latest-news/news/200722-press-release-tomorrows-world-plan-tax-administration-must-not-leave-anyone

[6] https://www.gov.uk/government/publications/ots-suggests-paye-equivalent-for-online-platform-workers

[7] https://www.litrg.org.uk/latest-news/submissions/190529-payroll-working-private-sector

[8] https://www.ifs.org.uk/publications/13079

[9] Good Work: The Taylor Review of Modern Working Practices (page 66):
https://www.gov.uk/government/publications/good-work-the-taylor-review-of-modern-working-practices

[10] The government was forced to abandon its attempt to raise rates of self-employed National Insurance as announced in Budget 2017. However, the current Chancellor has recently made it clear that parity of support offered to self-employed individuals through the Self-Employment Income Support Scheme indicates that the lower rates of National Insurance for the self-employed are difficult to still justify.

[11] Similarly, self-employed individuals start to pay Class 4 National Insurance contributions on profits above the Lower Profits Limit of £9,500 (in 2020/21). However, the self-employed are required to pay Class 2 National Insurance contributions once profits exceed the Small Profits Threshold, which is lower (£6,475 for 2020/21).

[12] https://www.gov.uk/government/publications/closer-alignment-of-income-tax-and-national-insurance-contributions

[13] See https://www.ifs.org.uk/publications/13791

[14] See previous consultation: https://www.gov.uk/government/consultations/the-of-taxation-of-trusts-a-review

[15] https://www.gov.uk/government/publications/making-tax-digital/overview-of-making-tax-digital

[16] https://www.gov.uk/government/publications/tax-reliefs-review

[17] The Public Accounts Committee in its recent report Management of Tax Reliefs recently estimated that £117bn is spent annually on the ten largest tax reliefs, £38bn on pensions tax relief alone, and observed that “the Government has not made any assessment of whether that huge cost encourages saving for retirement or reduces dependence on state retirement benefits, or whether it just enables those already saving comfortably to save more.”
https://publications.parliament.uk/pa/cm5801/cmselect/cmpubacc/379/37902.htm

[18] Not all High Volume Repayment Agents are unscrupulous. Some offer a legitimate service to people who may otherwise not claim any tax relief.

[19] We discussed these issues in our recent submission on Raising standards in the tax advice market call for evidence:
https://www.litrg.org.uk/latest-news/submissions/200826-raising-standards-tax-advice-market-call-evidence

[20] https://www.gov.uk/government/consultations/pensions-tax-relief-administration-call-for-evidence

[21] For further detail, see https://www.litrg.org.uk/latest-news/submissions/200204-budget-representation-2020-net-pay-action-group.

[22] HMRC / HM Treasury corporate report, 21 July 2020: https://www.gov.uk/government/publications/tax-administration-strategy/building-a-trusted-modern-tax-administration-system

[23] One taxpayer was even successful: see https://www.litrg.org.uk/latest-news/news/200714-hmrc-told-high-income-child-benefit-charge-assessments-not-valid.

[24] See https://www.litrg.org.uk/latest-news/news/191213-press-release-review-high-income-child-benefit-charge-say-campaigners

[25] Pre-6 April 2016 state pension lump sums are taxed in a unique way – applying the highest rate of income tax applicable to other income (Sections 7 to 10, Finance (No. 2) Act 2005). See also our article, November 2019: https://www.litrg.org.uk/latest-news/news/191114-claiming-state-pension-lump-sum-check-your-tax-you-act

[26] In the case of tax credits, after LITRG highlighted the issue HMRC have agreed that rental profits can be calculated under the ‘old’ rules for tax credits purposes.

[27] Guidance for taxpayers: a vision for the future (October 2018):
https://www.gov.uk/government/publications/guidance-for-taxpayers

[28] See https://www.litrg.org.uk/latest-news/submissions/200826-raising-standards-tax-advice-market-call-evidence for further discussion.