The Northern Ireland (“NI”) Tax Committee of Chartered Accountants Ireland is pleased to present this discussion paper examining the complexities of income tax legislation in the UK. Information about Chartered Accountants Ireland and the Northern Ireland Tax Committee is provided on the previous page.

This paper has been prepared in advance of the joint workshop with the Office of Tax Simplification (“OTS”) discussing UK tax complexity which is being held in November 2019. Income tax has been chosen by the Committee as one of its two topics of the four topics for discussion at the workshop.

Of the £622.88 billion in taxes collected by HMRC in 2018/19, income tax receipts totalled £190.76 billion or 30.6 per cent1. Of total income tax receipts, £161.91 billion related to PAYE income tax with the remaining £31.39 billion comprising self-assessment income tax.

In recent years, income tax legislation has become increasingly complex. As the largest contributor to UK tax receipts, the knock-on impact of this complexity is widely felt across the UK by both tax professionals, businesses and ultimately individual taxpayers.

The comments and recommendations made in this discussion paper are based both on feedback received from members of the NI Tax Committee and the wider membership of Chartered Accountants Ireland.

This paper does not examine the administrative complexities of UK income tax in detail. The administration of taxes in the UK, including filing and paying income tax for individuals, is examined in a separate discussion paper.

UK devolved regimes

It should be noted that this discussion paper also does not examine in detail the additional complexities which arise from the existence of the two devolved income tax regimes in the UK which apply in Scotland and Wales. In Scotland, the Scottish Parliament’s income tax regime for rates and bands took effect from 6 April 2016 whilst in Wales, that devolved regime took effect from 6 April 2019. As national insurance is not a devolved tax, any divergence in income tax rates and bands, within the devolved regimes, from the income tax rates and bands which apply in England and Northern Ireland adds another layer of complexity.

From 6 April 2018, the Scottish income tax regime, in particular, began to diverge significantly from the rest of the UK. In 2019/20, this regime has five different rates and bands in operation2 compared to the three in existence in the rest of the UK.

In May 2019, it came to light that, during April 2019, the very first month of Welsh income tax, an error occurred in the application of the new Welsh codes by a number of employers. In a letter to the Welsh Finance Committee on Welsh Taxpayers3, HMRC’s (then) Second Permanent Secretary wrote that this error occurred despite advance engagement with employers and payroll software providers.

HMRC had provided “technical specifications and test services to ensure employers and payroll software providers had all the information they needed”. This advance engagement was undertaken and designed around the lessons learned from the introduction of Scottish income tax when issues also occurred because some employers did not initially operate Scottish tax codes.

The existence of three different sets of rules for income tax in England and Northern Ireland, Scotland and Wales in itself results in a high level of complexity which is a major concern for tax advisers, taxpayers and software developers across the UK who are often required to understand and deal with transactions that have differing sets of rules depending on which of the three different UK regimes the taxpayer is resident in. This has a specific impact on taxpayers and businesses operating in two different jurisdictions in border areas and employers with employees subject to different income tax regimes.

Income tax – history

In the UK, income tax was introduced first in 1799 and the original Act of Parliament which implemented it was a complex document comprising 152 pages4. The initial rules were so complex that the Government also issued accompanying guidance “A Plain, Short and Easy Description of the Different Clauses of the Income Tax so as to render it Familiar to the Meanest Capacity”5.

Today, the Income Tax Act (“ITA”) 2007 is the primary Act of Parliament concerning income tax paid by individuals subject to the law of the UK. This Act mostly replaces and consolidates the Income and Corporation Taxes Act 1988 and completed the process of re-writing UK income tax legislation as part of the Tax Law Rewrite Project.

This project was intended to make the language of UK tax law simpler, while preserving the effect of the existing law, subject to some minor changes. It aimed to remove archaic language and terminology from UK tax law to replace it with modern language, terms and meaning.

The ITA 2007 completed the process of rewriting UK income tax legislation which began with the Income Tax (Earnings and Pensions) Act 2003 and continued with the Income Tax (Trading and Other Income) Act 2005. UK income tax legislation also comprises numerous Regulations, Statutory Instruments, Statements of Practice and Extra-Statutory Concessions. Legislation is also accompanied by published HMRC guidance, help sheets, policy papers, toolkits and manuals.

Although UK income tax legislation has always contained a layer of complexity, recent years has seen a further series of continued piecemeal patches, amendments and changes in addition to the introduction of additional rates, allowances and reliefs (and the curtailment of some reliefs) which has resulted in the unprecedented level of complexity we see today.

Income tax – sequence of major changes

In recent years, UK income tax legislation has developed into an extremely complex tax, particularly in respect of the taxation of investment income and the quantum of allowances (and their accompanying rules) available to individuals.

The sequence of some of the most significant changes can be summarised as follows:-

• From 6 April 2006, changes to pensions tax relief and savings followed by an extensive suite of restrictions and changes to pension investment rules up to and including 6 April 2019;
• From 6 April 2008, changes to the remittance basis of taxation and since that date various changes to the remittance basis;
• From 6 April 2010, the restriction of the UK personal allowance where an individual’s income is above £100,000;
• From 6 April 2012, the introduction of the Seed Enterprise Investment Scheme;
• From 7 January 2013, the introduction of the high-income child benefit tax charge;
• From 6 April 2013, the cap on certain income tax reliefs;
• From 6 April 2013, the statutory residence test;
• From 6 April 2013, flat rate expenses and the cash basis were introduced for unincorporated businesses;
• From 6 April 2015, the introduction of the zero per cent rate for savings income and the 10 per cent transferable marriage allowance;
• From 6 April 2016, the introduction of the dividend allowance and the personal savings allowance and tapering of pensions annual allowance;
• From 6 April 2017, the two new concepts of deemed domicile for income tax;
• From 6 April 2017, the application of the cash basis and the restriction of finance costs for unincorporated property businesses;
• From 6 April 2017, the introduction of the £1,000 trading income and £1,000 property income allowances;
• From 6 April 2018, the taxation of pay in lieu of notice compensation payments;
• From 6 April 2020, class 1A national insurance will be payable on termination payments in excess of £30,000;
• From 6 April 2020, the extension of the IR35 off-payroll working rules in the public sector to the private sector.

The above summary is just a flavour of some of the most complex major changes. Some specific changes are dealt with in more detail in the next section of this document where they have resulted in a high level of complexity for taxpayers and their advisers.

Pensions tax relief

The UK’s pension tax relief rules are, arguably, one of the most complex areas of UK income tax. This is not only in terms of how the rules themselves operate but also in the context of the interaction of pension savings with the rule which restricts the UK personal allowance and the extension of income tax bands by the making of pension contributions (and gift aid payments).

The main area of complexity arises from the constant level of changes to these rules over the last 13 years. Although the pensions annual allowance has not changed since the introduction of the restriction for certain taxpayers from 6 April 2016, this was preceded by a decade of change on an almost annual basis6. From 6 April 2018 and subsequent tax years, the standard lifetime allowance for pensions savings is also increasing, on an annual basis, in line with inflation.

From 6 April 2016, the annual allowance for certain taxpayer’s is reduced by £1 for every £2 of total or “adjusted” income above £150,000 until it reaches its minimum level of £10,000. Complexity arises because an individual’s annual allowance is determined by their total income within the same tax year. This means that unless an individual has a predictable income tax profile, it is often difficult for an additional rate taxpayer to determine the exact amount they are entitled to save tax free into their pension.

This becomes especially problematic as the taxpayer’s employer is also likely to be making contributions. A particular issue with the taper is that, when there are also employer contributions, the calculation of the allowance available operates with reference to sources of information which tend not exist in any one place. Employers do not have access to full details of private income of employees and tax advisers do not have details of employer contributions, unless provided separately.

Anecdotal evidence7 suggests that some employers are simply unable to deal with the administrative complexity this presents as employer contributions also count towards establishing if the relevant annual allowance limit has been breached. Other employers have decided to err on the side of caution and have imposed a £10,000 limit on all pension contributions to avoid both the complexity of these rules and the possibility of the annual allowance charge applying.

In a more recent development, the restriction of pensions tax relief for high earners has been cited as leading to a resourcing crisis in the NHS with many doctors, since the introduction of the restriction, looking more closely at whether it is in their financial interest to do extra work for the NHS. As a result, a consultation8 was launched on 11^th September 2019 examining proposals to introduce increased flexibility to the NHS pension scheme.

The trading and property income allowances

These allowances were introduced to “provide simplicity and certainty regarding Income Tax obligations”9 on small amounts of trading income and property income. In certain cases, if a taxpayer’s gross annual income per tax year from sources which qualify for these allowances is £1,000 or less, the taxpayer does not have to complete a self-assessment or pay any income tax. However, record keeping in respect of these income sources is unaffected and remains a compliance burden for all taxpayers.

The rules are, however, more complex than just providing a £1,000 tax free allowance. They only apply to certain trading and property income types and there are restrictions if the income is received from certain connected parties which includes the individual’s (and their spouse/civil partners) employer. The rules also provide for the individual to be taxed on the basis of either partial relief (taxable income from qualifying sources is gross total income less the £1,000 allowance) or alternatively the taxpayer can choose to forego the relevant allowance and calculate taxable income in the usual way. This means that the taxpayer must decide each tax year which method is most tax efficient for them, based on their circumstances.

Investment income allowances

In May 2018, the OTS published its paper “Savings income: routes to simplification”10. The executive summary of this paper sets out that “the tax complexity in savings and investment income is mainly caused by the interactions between the many reliefs and allowances”.

In its recommendations for further work, the OTS commented that “the interactions between the rates and allowances is sufficiently complex at the margins that HMRC’s self-assessment computer software has sometimes failed to get it right. It is proving to be very difficult to create an algorithm that calculates the tax correctly in all circumstances and HMRC does not expect to bring the complete calculation online until 2018–19.”

The NI Tax Committee supports the recommendations set out in the OTS paper in relation to the complexities of the investment income allowances. However, it is disappointing that in 2018/19, HMRC has not been able to implement a fix for all the online filing exclusions which specifically result from investment income. The existence of online filing exclusions is dealt with in more detail later in this paper.

The high income child benefit tax charge

In its October 2019 paper “Taxation and Life Events: Simplifying tax for individuals”11, the OTS sets out the complex implications of the high income child benefit tax charge. In summary, the OTS paper states that “the difficulty is that those affected have various options about what to do, and the consequences of these options are not obvious.” The NI Tax Committee agrees with this comment.

Flat-rate expenses and the cash basis for unincorporated businesses

Both measures were introduced as simplification mechanisms12. However, the rules for both the cash basis and flat-rate expenses each contain a hidden level of complexity and additional considerations for businesses which belies their intended purposes.

Flat-rate expenses

Once a flat-rate deduction has been claimed in respect of a motor vehicle, this approach must be used each year the vehicle is used by the business. The business cannot switch to claiming relief for actual expenditure, if this is higher, or claim capital allowances in respect of the vehicle. Similarly, if capital allowances have already been claimed in respect of a vehicle, flat-rate expenses cannot be claimed for the costs associated with that vehicle. Instead the business proportion of actual expenditure must be calculated.

When buying a new vehicle, the business must therefore decide to either:-

• claim capital allowances on the capital cost and claim relief for expenses on an actual usage basis; or
• keep records of mileage and claim the flat rate each year.

It is important that this decision is considered at the outset as once a claim has been made, the approach taken on a particular vehicle cannot be changed. To make things straightforward from an administrative perspective, a business may decide to adopt a consistent approach with all vehicles. However, this may not necessarily result in the most tax efficient result for the business.

Overall, flat-rate expenses may reduce the complexity of preparing tax returns for some (but not all) small businesses, but they may not always be beneficial and could lead to higher levels of taxation. For many businesses, the reality is that it will always be worth estimating what the deduction would be based on actual expenditure and comparing this with the deduction calculated using the flat rates. If the actual basis provides a higher deduction, business will simply continue to claim relief under the actual basis supported by the attendant detailed records this requires.

Cash basis

Using the cash basis of accounting may be appealing to a sole trader who is struggling to apply the accruals concept of accounting. However, before changing to the cash basis, a sole trader must consider the full tax implications and commercial cost of this decision. Specific adjustments are required in the year of the change to the cash basis which could distort trading profits in the year of change. Similar adjustments are required when leaving the cash basis.

Furthermore, under the cash basis, trading losses cannot be carried back or set-off ‘sideways’ against other sources of income, they can only be carried forward. This more restrictive use of losses could lead to loss relief at a lower rate than would otherwise be available.

The cash basis also is not suitable if a business is more highly geared as relief for interest on finance is restricted to a maximum of £500. It may also prove unsuitable if a business is more complex. In addition, where a business is seeking finance, the cash basis is likely to prove unsuitable as banks are likely to require accounts drawn up under UK GAAP before agreeing to provide finance. As set out above, there is also an important interaction between the flat-rate deduction for cars and the cash basis of accounting which must be considered.

Again, ultimately, a business is likely to use the basis which results in the lowest level of taxation, irrespective of administrative cost. In some cases, this may mean two sets of records are maintained as the business can switch between these methods each tax year. Maintaining two sets of records may ultimately outweigh any tax saving available.

The transferable married couple’s allowance

This allowance initially must be claimed and is only available if certain conditions are met. Once it has been claimed, in future tax years 10% of the personal allowance transfers automatically until one of the parties cancels it or advises HMRC that a change in circumstances means they are no longer entitled to it.

When it was first announced, the number of married couples and civil partners eligible for marriage allowance was estimated at four million13. However, in 2018/19, the estimated number of claimants of marriage allowance (subject to self-assessment returns for this year being finalised) is 1.78 million14.

It is not clear why this gap is so significant. However, the requirement to initially apply for this relief and the need to keep HMRC informed of life changes which impact on its availability means that those who are entitled are not often not aware of it, or are put off by having to claim it and keep HMRC informed.

A worrying aspect to this is that an online industry has now sprung up around the marriage allowance and several high-volume repayment agents are now in existence who often charge for marriage allowance applications. This is, perhaps, because the allowance must be claimed at the outset. There is therefore a concern that taxpayers could be exploited into wrongly claiming the allowance. This could lead to taxpayers having to make tax repayments and be exposed to interest and penalties.

Extension of IR35 off-payroll working to private sector

From April 2020, businesses in the private sector (who do not meet the definition of small) will be required to consider the applicability of these rules to any contractor they engage. This represents another significant change for businesses.

Businesses in the private sector will be required to:-

• decide on the status of each person contracted through a Personal Service Company or an intermediary;
• pass the decision made and the reasons for it to the worker and the person or organisation contracted with;
• keep records of those decisions and fees paid;
• have processes in place to deal with any disputes; and
• respond to any disagreements received from the contractor within 45 days

The rules are complex and impose significant additional obligations on any party in a relevant labour supply chain. It is important, therefore, that HMRC provides the necessary information and support to those potentially affected to help them deal with these complex rules. Whilst guidance has been published, this does not go far enough to help businesses prepare for this change.

In its response to the consultation Off payroll working rules from April 2020, the NI Tax Committee recommended HMRC hold a national campaign to raise awareness of these changes and signpost where advice and support can be obtained. To date, this had not happened. The enhancement of the Check Employment Status for Tax (“CEST”) tool is also a critical element of this. The Committee is disappointed that the improvements to CEST will now not be up and running until December 2019, just over three months from this legislation takes effect.

The April 2020 deadline is now just over five months away and organisations need time to properly understand, assess and prepare for these changes. This is in addition to the uncertainty businesses are still facing in respect of their preparations for the UK’s departure from the European Union.

In addition, recent Tribunal cases on the subject of IR35 are complicating the picture with several decisions in 2019 not in HMRC’s favour. This pattern of losing IR35 cases on appeal to Tribunal seems to suggest that HMRC itself has difficulty in understanding this complex legislation. In the interests of fairness, however, it should be noted that HMRC have also been successful in a number of recent IR35 cases.

Self-assessment online filing exclusions

The UK income tax regime is so complex that HMRC now maintains a list of cases15 where a self-assessment return cannot be filed online because neither HMRC’s own self-assessment filing software nor the filing software of software providers can be configured to correctly calculate the relevant income tax liability or where a fix is required to enable either of these filing methods to do so.

Where a self-assessment return cannot be filed online for one of the reasons listed as an exclusion from online filing, the taxpayer or their agent is required to file a paper return on or before 31st January following the end of the tax year to which the return relates. In these cases, HMRC rightly accepts that the taxpayer had a reasonable excuse for failing to file a paper return by the normal 31st October deadline.

Taxpayers and their agents are required to regularly check the online filing exclusions document published by HMRC as more cases of exclusions can come to light after the tax year end and before the relevant filing deadline or a fix may be developed in time for online filing.

For example, in 2018/19, at the time of writing, a second version of the online filing exclusions has already been published. In 2018/19 alone, nine new exclusions were initially added, though 18 previous exclusions were removed due to a fix. In 2017/18, there were three versions of this document.

These online exclusion cases mean that the taxpayer ultimately will suffer additional costs in meeting their compliance obligations either by completing a paper tax return which, if not correct, leads to underpaid tax, interest and penalties or by engaging a tax adviser to do so on their behalf.

This also leads to additional costs for HMRC in processing and checking paper returns and the accompanying calculations for online exclusion cases.

Alignment of income tax and NIC

The merger of income tax and NIC was first mentioned by former Chancellor George Osborne in Budget 201116. Five years later, the OTS published its report on “The closer alignment of income tax and national insurance”17. That report set out several main recommendations, framed as key steps to closer alignment, rather than merger.

It is not clear to us that much progress has been made since the March 2016 report was published in reaching closer alignment. However, we recognise that the issue is not a simple one and is inter-connected with the ongoing review of modern working practices/the gig economy.

Making Tax Digital for income tax

This topic is dealt with in more detail in our paper examining administration of the UK tax system. However, it is worthy of mention that when Making Tax Digital (“MTD”) for income tax is introduced, this will add another layer of complexity to income tax in the UK. Taxpayers will be required to make five submissions to HMRC in respect of their accounting period and digital recording keeping will also feature.

The trial for MTD for income tax has been scaled back in recent months and, at the time of writing, there are just four software providers with MTD for income tax compatible products.

In the context of MTD for VAT, it is worth noting that HMRC has had to scale back its expectations, particularly in relation to the digital record keeping requirement, on several occasions before MTD for VAT first began in April 2019. In October 2018, HMRC announced that MTD for VAT was being deferred for some businesses to 1 October 2019. Just last month, HMRC announced a new deferral application process which will allow some businesses, subject to strict conditions, longer to meet the digital links requirement once the relevant one-year soft landing period has passed.

This suggests that HMRC did not understand the concerns expressed regarding the complexity that MTD presents for some businesses until very late in the process.

Prior to the implementation of MTD for income tax, useful lessons can be learned from the recent implementation of Real Time Information (“RTI”) for PAYE. The post implementation review of RTI18 found an overwhelming consensus that the migration of more than 1.5 million employers into RTI through a staggered implementation was the right approach. The review also found that many welcomed the programme’s willingness to adapt, for example by deferring the implementation of in-year penalties.

However, there is no doubt that the deferred implementation of penalties and many of the exemptions announced for smaller business which only took effect after RTI commenced should have been considered before the regime’s start date. HMRC should learn from this in advance of the introduction of MTD for income tax.

The impact of complexity

Ultimately, it is the taxpayer who bears the cost of this increased complexity where they either engage a tax professional to navigate the rules for them or, for those that don’t, the cost of errors made.

As a consequence of these complexities, tax professionals now need to ask a myriad of questions of a client in order to be able to calculate their income tax liability. There are several potential rates, allowances, and interactions of bands which must be considered. This is before the adviser even considers the possibility of exemptions, reliefs and anti-avoidance rules which may apply.

Taxpayers, who are not tax experts, often need to take advice from a tax professional to navigate this complex legislation. This complexity is often disproportionate to the amount of tax at stake, and unfair outcomes can arise for both the taxpayer and HMRC. This complexity comes at a cost for all parties involved.

If tax professionals make errors when advising and calculating income tax liabilities, this could, in future, give insurers cause to review the provision of professional indemnity insurance for income tax compliance and advise work due to its increasingly specialist nature.

Income tax – the Irish experience

In contrast to UK income tax legislation, Irish income tax legislation doesn’t contain the same level of complexity. Firstly, there are two rates of Irish income tax. Instead of a system of allowances, Irish legislation contains a series of tax credits and reliefs which simply reduce the taxpayer’s income tax liability or the taxable income amount. There is no restriction of these tax credits for incomes over a certain level nor is there a separate set of tax credits for investment income. Ireland also does not have any property income or trading allowances like the UK.

Although Ireland does have legislation which restricts the use of certain tax reliefs and exemptions by high income individuals, this legislation applies to a much more limited set of reliefs and exemptions compared to the UK. It does not, for example, apply to a scenario where an individual is seeking to use a loss from their sole trade against other income sources.

Ireland’s rules for tax relief on pension contributions have also not been subject to the save level of fluctuation as those in the UK which have changed to some extent, on almost an annual basis, since 6 April 2006.

Executive summary and recommendation

The analysis in this paper clearly signposts the unworkable level of complexity of the UK income tax regime. We therefore recommend that the UK Government tasks the OTS with carrying out a review of the complexities of UK income tax legislation. Any options presented by the OTS, by way of reform, must then be given serious consideration by Government. We look forward to engaging in further discussion on this matter.

Freedom of Information

We note the scope of the Freedom of Information Act with regards to this position paper. We have no difficulty with this position paper being published or disclosed in accordance with the access to information regimes. This position paper will be published on our own website in due course and will be available to all our members and the general public.

Source: Chartered Accountants Ireland www.charteredaccountants.ie

1 HMRC Tax and NIC Receipts, 22 May 2019

2 Scottish Income Tax 2019–2020, 12 December 2018

3 HMRC letter on Welsh taxpayers, 15 May 2019

4 The Complexity of Tax Simplification: The UK Experience, Simon James, 2016

5 Addington, Author of the Modern Income Tax, A. Farnsworth 1951

6 Pension tax relief cuts – a brief history, Professional Pensions

7 High earners snared by the pension taper, The Financial Times, March 2017

8 NHS pension scheme: increased flexibility, Department of Health & Social Care, September 2019

9 Policy paper: Income Tax: new tax allowance for property and trading income, HMRC

10 Savings income: routes to simplification, The Office of Tax Simplification, May 2018

11 Taxation and Life Events: Simplifying tax for individuals, The Office of Tax Simplification, October 2019

12 Making Tax easier, quicker and simpler for small business, HMRC, March 2012

13 Issue Briefing: marriage allowance, HMRC, February 2015

14 Estimated costs of tax reliefs, HMRC, October 2019

15 Self Assessment Individual Exclusions for online filing – 2018/19, HMRC

16 Budget 2011 speech, www.parliament.uk, March 2011

17 The closer alignment of income tax and national insurance, The Office of Tax Simplification, March 2016

18 https://www.gov.uk/government/publications/real-time-information-programme-post-implementation-review