Written evidence submitted by David Kirk (Director at David Kirk & Co. Ltd)

 

Tax after Coronavirus

 

 

  1. This submission is made in response to the Treasury Committee’s call for evidence on Tax after Coronavirus, for which I thank the Committee for the opportunity.  It is principally directed at the question: ‘Which areas of the tax system are most in need of reform, and which are best left alone.’  Most of it considers tax considerations that affect individual taxpayers but are too complicated for many of them to understand.

 

Who I am

 

  1. David Kirk is a Chartered Accountant and Chartered Tax Adviser who specialises in employment taxes and in particular in employment status.  Employment taxes (PAYE, National Insurance and the Construction Industry Scheme) constitute about three-quarters of my business, and Revenue inquiry work about half of it.  My published works include a book on employment status which is now in its fourth edition and a guide to the High Income Child Benefit Charge.  Although I have a corporate structure I am, in economic terms, a sole practitioner.

Summary

  1. My representations are made with employment taxes in mind, although some of them have a more general application.  They can be summarised as follows:
    1. I note that the Office of Tax Simplification has published an Evaluation Update on various matters including personal service companies.  These make a very good starting point for this and I comment on these in paragraph 4.
    2. Cliff-edges distort behaviour and encourage both avoidance and evasion, in particular where there is uncertainty as to which side of the cliff one is on, and certainty cannot be provided in all cases.  A particular example of this is the employer’s National Insurance charge, in effect a 13.8% payroll tax, which is levied on businesses where the people that work for them are employed but not where they are self-employed.  (See paragraphs 5 to 7.)
    3. Taxes levied on individuals need to be capable of simple and coherent explanation so that people know what taxes they have to pay without needing experts and commentators to tell them.  Examples of where this is not done are in employment status, where the criteria for determining status are different as between tax law and employment law (see paragraph 8); and the Higher Income Child Benefit Charge, which is levied on household income where tax is levied on individuals’ income (paragraphs 9 to 11).
    4. The tax system is far too complicated, with our having the longest tax code in the world, and possibly to the point of being unreformable.  This in itself inhibits understanding and makes people feel that it is capricious and hostile.  An example, which could be substantially tidied up at little cost to the Exchequer, is the off-payroll rules (paragraphs 12 to 15).
    5. Tax provisions frequently encourage people to take up certain forms of behaviour that might be considered undesirable on policy grounds, but these changes in behaviour are rarely looked at when considering the tax change, even where they are predictable.  An example of this is the British habit of trading through companies, which has now got to the stage that people are forced to trade through companies even when they do not wish to.  It is this that has caused the rise of umbrella companies (paragraphs 16 to 18).
    6. The Taxes Management Act was passed in 1970, before self-assessment and before the digital era, and needs a thorough overhaul.  An example of where it is deficient is that there is no inquiry procedure for PAYE cases, and so it relies on provisions that are intended as a back-up; also with a tax system as complicated as this one there ought to be a binding procedure whereby HMRC can be asked to give clearance to a transaction, be obliged to give reasons why not if they decline to, and be held to their decisions in all cases.

Office of Tax Simplification Report

  1. The Office of Tax Simplification make the following recommendations in its July 2020 report referred to in paragraph 3a:
    1. Allowing small personal service style businesses to operate through a UK limited company while being treated as transparent for tax.  I endorse this idea whole-heartedly but believe that it ought to go further and be made compulsory for all close companies (those under the control of five or fewer people or of their directors), otherwise it will not take off.  It will raise more National Insurance without these companies having to pay employer contributions on their owners’ remuneration, and thus level the playing field with the self-employed.  Accountants otherwise have too much to gain from promoting the existing companies regime which, because of the tax complications, provides a ready source of largely useless work for them, whilst at the same time leaving their clients better off operating a system that they frequently do not understand.  The difficulties presented by the OTS are in my view not serious barriers to doing this.
    2. Statutory definition of employment for tax purposes.  This should be resisted unless it is also brought in for employment law.  Employment status is a feature of both tax and employment law and should wherever possible be aligned, otherwise those on the boundary (of whom there are probably over a million) will never understand their rights and responsibilities.  We now have a situation where large number of agency workers and IR35 contactors are in ‘zero-rights employment’ – paying employment taxes without receiving any of the corresponding employment rights.  Furthermore, there is a grave danger of a statutory definition ossifying the rules, opening it up to unscrupulous operators to game the system and leaving the courts powerless to move the boundaries when circumstances warrant it.
    3. Aligning National Insurance Contributions with Income Tax.  Although this would be a major exercise and would tax some years to bring into effect, it would have some important benefits, not only in terms of being understood by taxpayers but in bringing in a fairer pensions system.  For example, at present someone earning £8,000 a year from a single job (presumably part-time, perhaps two days a week) would pay no National Insurance but would be entitled to a full state pension, whereas someone who earns the same money from two jobs worth £4,000 a year each would not.  Further up the scale, someone earning £16,000 a year from one job would pay £780 in National Insurance contributions, whereas someone earning the same from two £8,000-a-year jobs would pay none yet get the same benefits.  As noted in paragraph 2.46 of the OTS report, these anomalies affect over 13 million people – an astonishing number.

Employer’s National Insurance

  1. Employer’s National Insurance has frequently been described as ‘the elephant in the room’, the ghost lurking behind all employment status problems.  It is a 13.8% levy on all payments to employees earnings above £169 a week that is not paid on self-employed contractors and nor (currently) on payments to companies.  For companies with large payrolls this can represent the difference between profit and loss.  I can speak from my experience as finance director some years ago of a group that had two companies: one where the payroll costs came to 10% of the company’s turnover and the other where it came to 53%.  In the former we were not all that bothered about extra payroll costs if they meant that we were able to get the right people under the right conditions – something like this was never going to threaten the company’s existence.  The latter company was a very different matter: having to pay National Insurance on all those working for us would have reduced our profits by two-thirds.  It was not surprising that we looked for legitimate ways of avoiding this.
  2. It is not easy to see what the solution to this is, when the levy raises approximately £70 billion annually.  Levelling things out so that the self-employed pay the same rate as the employed would lead to employer contributions going down to (say) 11.5% and asking the self-employed to pay the same: it is fairly easy to predict the uproar that this would cause.  However failure to do anything about it will mean that problems surrounding employment status will be with us for as far ahead as the eye can see.
  3. I recommend consideration of a gradual replacement of this levy with an alternative, and note that Canada does perfectly well without it and is considered to have a very competitive economy.  The only alternative that springs to mind is another tax on business profits, i.e. Corporation Tax.  The drawback of this would be that the U.K. has long advertised a low rate of Corporation Tax in order to attract investment, but consider the following:
    1. Which is actually more likely to attract investment: ‘low Corporation Tax’ or ‘no payroll taxes here’?
    2. It would only be levied on profitable companies and so would not act as a disincentive for hiring or as an incentive for firing people.
    3. In most of the public sector this would simply involve taking money out of one pot and putting it into another.  Departmental budgets and local authority grants could be adjusted accordingly.  Much the same could be said of charities that rely on Government money, which is many of them.
    4. Large limited liability partnerships would gain, but even there I should be noted that most of their partners will be additional rate taxpayers and so 47% of the money saved would come straight back to HMRC in Income Tax and class 4 National Insurance receipts.

Employment status

  1. Most people are clearly employed; some are clearly self-employed; but those in the grey area in the middle are left with considerable uncertainty.  Many people have their own views on what constitutes employment: something that the lack of clarity encourages.  As noted above, I think that a statutory definition of employment would not help, but aligning the core definition of employment so that it is common to tax and employment law would greatly assist, and the best way to do this would be to work out what is needed for employment law and let that apply to tax as well.

High Income Child Benefit Charge (‘HICBC’)

  1. As reported in a number of press articles, women are missing out on pension entitlements because they do not register for Child Benefit even though they would have to forfeit their claim to it if they did.  Earlier this month we were treated to Lady Altmann, a former pensions minister, explaining to people on national radio that they should claim Child Benefit even if they knew that they were not entitled to it – this is technically wrong but one can understand why she did it this way, as it is very difficult in a live broadcast to explain the difference between registering for something and claiming it, a distinction that would probably be lost on many listeners even if it was attempted.
  2. The fundamental problem here is that Income Tax is based on individuals’ earnings, whereas benefits are usually (as now here) based on household income.  This charge is perceived as very unfair anyway, for a number of reasons:
    1. A couple with earnings of £50,000 each (net income after tax and National Insurance £75,280) will not have to pay any HICBC, whereas one with a single income of £60,000 (net £42,540) will have to pay a Child Benefit back in full (£1,820 for two children).
    2. The higher earner has to pay the HICBC, in respect of children that are not necessarily his.
    3. People may become liable for the charge without knowing it, as many couples think it right and proper to keep their finances secret, even from spouses.  Separate taxation of husbands and wives was brought in as recently as 1990 so as to allow for this.
  3. The best solution would be to have Income Tax based on household assessment not individual assessment, as is done (on a voluntary basis) by a number of our major competitors, including the United States, Germany and France.

Off-payroll rules

  1. The ‘IR35’ rules, as they are colloquially known, purport to be an add-on to the status division between the employed and self-employed, but are unbelievably complicated, and so an area where any business that might find itself affected prefers to use models of engagement that transfer responsibility for this to other parties.  It is this above all that has fuelled the rise of umbrella companies.  The PAYE system simply is not designed to collect tax off payments to companies, and there are all sorts of anomalies which would take too long to explain here, but they include mothers getting less maternity pay, and the inability of HMRC to explain coherently how they get it at all.  Whereas the section in the Income Tax (Earnings and Pensions) Act that sets the main employment status boundary is six lines long, those setting the off-payroll rules go on for fourteen pages.
  2. It is too early to tell what the result of the 2021 changes will be, but the decision to make them was made without changes in behaviour – such as changes of models of business engagement, or moving business abroad – in mind, and they are likely to be substantial.  A House of Lords report entitled Off-payroll working: treating people fairly, which made some very pertinent observations on this, has had its warnings in effect unanswered.
  3. It is often forgotten in all this that over 80% of the extra revenue that the off-payroll rules seeks to collect consists of employer’s National Insurance contributions, and looked at in this light it is big business and (until 2017) various public sector bodies that have been largely responsible for avoiding tax in this area. This is because on the employee side tax is largely paid, in the form of Corporation Tax and self-assessment Income Tax (as opposed to the IR35 requirements to pay National Insurance and Income tax by PAYE). From reading both press reports and Government publications one could be forgiven for thinking that it is the contractors who have been driving the tax gap.
  4. What this means is that the problem could have been – and still could be very effectively dealt with by raising a National Insurance levy on the employers, and leaving the employee side well alone.  It would leave HMRC with the vast bulk of the revenue that they seek, with hardly any of the side effects.

Trading through companies

  1. Almost all commentators regard it as legitimate for those who want to trade through companies to do so, but there is no reason why this should be particularly encouraged.  There are a number of reasons why this has become easier and easier to do, not all of which are tax-related; it is however perhaps worth pointing out that back in 1978 the small profits rate of Corporation Tax was 42%, considerably higher than the basic rate of Income Tax at the time, and so nobody in those days would have incorporated in order to save tax.  Nowadays the tables are turned: the owner of an incorporated business that earned £40,000 a year would typically pay £7,245 in tax and NICs, whereas a self-employed individual would pay £8,402.  Most of the benefit of that will probably go to the person’s accountant, as there is substantially more work involved in producing company accounts and doing company tax than there is in a sole trader’s.  Added to that, many of the individuals concerned will not truly understand what managing a company involves and so will be less in control of their affairs as a result.
  2. Were we starting from here, I doubt that many people would be setting up companies in order to trade, but the tax differences were much greater in the past and so a ‘company culture’ has taken over the smaller end of British enterprise, probably uniquely in the worldThis has indeed gone a stage further, whereby people are now required by their customers to trade through companies in order to trade at all, including in some parts of the public sector.  In the context of the BBC the Commons Committee on Digital, Culture, Media and Sport branded this a disgrace (see paragraph 77), but my understanding is that this practice is by no means confined to the BBC.
  3. I recommend therefore that steps be taken to demonstrate that there is no advantage to this.  Treating companies as transparent as suggested in paragraph 4a above would do this.

 

July 2020