Inland Revenue: Simplifying National Insurance Contributions for Employers

A technical discussion paper.

Contents

• Introduction
• Context
• Employer compliance officer powers
• Helping employers get it right
• "Pay"
• Employees seconded abroad
• Earnings of employees seconded abroad
• Benefits provided by third parties
• Summary of proposals and areas for discussion
• Annexes

Chapter 1: Introduction

"Employers often suggest that differences in the detailed rules for pay as you earn (PAYE) income tax and national insurance contributions (NICs) and their application cause difficulties when dealing with payroll. By bringing policy responsibility for tax and NICs together in the Inland Revenue, the Government has provided a single focus for employers' representatives to discuss improvements in legislation and processes across both PAYE and National Insurance. The Inland Revenue will work with employers' representatives and others on options to reduce technical differences, while having due regard to individuals' benefit entitlement."

Pre- Budget Report November 1999

The Chancellor announced in his Pre Budget Report that the Inland Revenue would work with employers' representatives and others on reducing technical differences between tax and national insurance contributions (NICs). This consultation paper follows on from the Pre Budget Report commitment and sets out areas where there are difficulties around the tax and NICs rules.

The proposals in this paper are intended to address some priority areas of concern that have been made to us by employers, tax professionals and their representatives. Some of the proposals aim to provide a more common approach by Inland Revenue employer compliance officers, for example chapter 3 on powers and chapter 4 on dealing with arrears; others aim to reduce the costs of complying with current NICs rules, for example chapter 6 on an additional collection mechanism for NICs due in respect of seconded workers. It is our belief that the proposals in this paper will be broadly deregulatory and we would welcome comments on whether the proposals will reduce employers' costs of operating the NICs system. Employers, tax professionals and their advisors and representatives will no doubt have further suggestions for areas where the tax and NICs procedures can be made to work better. We would welcome those suggestions and, subject to the context set out in chapter 2, these will inform our ongoing work to improve the operation of the tax and NICs system.

A glossary of terms and abbreviations used in this paper is at annex 1.

Providing responses

If you would like to comment on the proposals contained in this paper, or suggest further areas where improvements can be made, please write to us by 30 August 2000 at the latest, to:

Personal Tax Division
Room 69,
New Wing,
Somerset House
London WC2R 1LB

Fax: 020 7438 6400

E Mail: Tax.NICs@ir.gsi.gov.uk

Under the principles of openness and access to Government information, responses to this paper may be made available to members of the public, unless confidentiality is specifically requested by the respondent. But please note that any list of those who have commented will identify those who have asked that their views be treated as confidential.

What happens after this consultation exercise

All comments received will be carefully considered. Inland Revenue will then publish the results of the consultation, outlining future action.

Most of the proposals in this paper require only secondary legislation or changes to guidance, so we would anticipate that if there is a positive response new procedures could be in place for April 2001. Indeed it might prove possible to issue new guidance on the treatment of arrears before then if that would be helpful. However some of the proposals in chapters 3 and 8 require Finance Bill and non-Finance Bill primary legislation and therefore will not be in place until a suitable legislative vehicle has been found. We also intend to publish a regulatory impact assessment that will assess the regulatory impact of the proposals in this paper.

No proposals in this paper take effect from the publication of the paper, nor will they be applied retrospectively.

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Chapter 2: Context

Background

The Government is committed to doing as much as possible to keep the regulatory requirements on small business to a minimum and, where possible, to reduce them. Within this framework the Inland Revenue's regulatory reform strategy seeks to:

• reduce the requirements placed on business and individuals wherever possible;
• improve the support offered to businesses and individuals to help them manage their payroll responsibilities effectively.

Simplifying the operation of NICs for employers forms a key part of that strategy.

Tax/ NICs alignment

Employers and their representatives note the similarities - intentional and increasing - between tax and NICs. Some suggest going much further, to a full merger of tax and NICs.

Such a merger would raise important policy questions, such as

• How would primary NICs be replaced ? If by a social security surcharge on the income tax base, would this surcharge extend to savings income and pensioners ? Would tax reliefs for savings and pension contributions apply to the surcharge ? Would there be any attempt to replace the NICs Upper Earnings Limit ?
• How would secondary NICs be replaced ? By some form of payroll tax on cash pay, plus Class 1A on benefits in kind ? Would a payroll tax need a proxy for the NICs secondary threshold ? Without one, the employer NICs burden would shift from high to low-paid staff.
• What could be done to replace contracted-out rebates in respect of occupational pension contributions ?
• If entitlement to contributory state benefits became based on total annual income, would employers and savings institutions need to keep records, and make returns to the Inland Revenue, of many more small income sources ?

Against this background, the Report this March from the Payroll Sub-group of the Better Regulation Task Force said

"We understand that a full scale merger of tax and national insurance can only be a long-term goal as it involves major questions of both tax and social policy. In addition, there would be substantial systems implications for the Revenue and for employers."

A less radical form of integration would be to let NICs, as well as income tax, liability depend on the individual employee's PAYE code. At present, this would mean that both employer and employee NICs would turn on the employee's family and personal circumstances. For example, the code may reflect income tax reliefs, such as the children's tax credit from 2001-2. It may also reflect an underpayment of tax, perhaps relating to an employment with a different employer. Or it may reflect the fact that the taxpayer has another source of income on which the code at this employment is collecting the tax. So, substantial further simplification of PAYE codes would be needed before employers could use a single set of tax and NICs tables without facing capricious results.

Recent developments in simplifying NICs

Accordingly, the Government has followed the recommendations in Martin Taylor's 1998 report to bring "NICs operational and policy functions into the Inland Revenue". The transfer of the Contributions Agency and policy responsibility for National Insurance to the Inland Revenue from 1 April 1999 has meant business and other representative bodies can now deal with one organisation to discuss improvements to legislation, procedures and guidance for tax and NICs. On a local level employers will mainly deal with one office, for tax and national insurance as regional staff become co-located. By the end of March 2000, 33 official merger projects had been completed, covering nearly 30% of offices. Further co-locations are underway. We are planning for Employer Compliance Officers to be cross skilled by December 2000 which will enable them to undertake an integrated review covering both tax and NICs issues.

The merger of the two organisations has delivered for the first time a unified tax and NICs appeals procedure. Often the same issues, such as whether someone is employed or self-employed, will arise in both cases. Since April 1999 appeals on both tax and NICs have been heard by the General or Special Commissioners.

Further operational improvements are also in the pipeline. We are currently writing an "Employment Status Manual" to replace the separate guidance our tax and NICs staff have for dealing with employment status questions. This should be completed and available on the Inland Revenue internet site from July 2000. This will ensure that not only is there one set of guidance for Inland Revenue compliance and status officers but also that employers and their advisers are fully aware of the guidance given. We are also rewriting all other NICs internal guidance and aim to complete the task by Autumn 2001. The guidance will be available to the public under open Government.

Martin Taylor also recommended that the Government focus "directly on the disincentives in the NICs system - starting with alignment with the income tax system and the current entry fee and steps". Employers are already starting to see the benefits of greater alignment of the tax and NICs structures. From April 1999, a new earnings threshold was introduced as the point above which employers start to pay NICs. The threshold was set at the same level as the income tax personal allowance and removed the previous unfair entry fee. At the same time the multiple rates of contributions applicable to four bands of earnings were abolished in favour of a single rate of 12.2% on earnings above the new earnings threshold. From April 2001, the point at which employees start to pay NICs will be fully aligned with the income tax personal allowance. This will mean employers will no longer need to calculate NICs for 1 million employees whilst maintaining their entitlement to contributory benefits.

Next steps

This consultation document is the next step in this process. Over the last year - since the transfer of policy responsibility for NICs to the Inland Revenue - we have had a number of discussions with employers, their representatives and their advisors about areas that cause significant practical difficulties. Their concerns have been largely about the technical detail of the rules and their application.

So the Government is not persuaded that radical reform of the tax and NICs systems is the best way of delivering worthwhile simplifications for employers. Instead the Government believes that it is possible to achieve worthwhile simplification for employers by looking at the detailed technical tax and NICs rules and their application. This would deliver benefits for employers in the shorter term, without significant effects on employees or the National Insurance Fund, and positions the Government well to move further in the longer term, if it so decides. The November 1999 Pre-Budget Report noted that:

"Employers often suggest that the differences in the detailed rules for pay-as-you-earn (PAYE) income tax and national insurance contributions (NICs) and their application cause difficulties when dealing with payroll. By bringing policy responsibility for tax and NICs together in the Inland Revenue the Government has now provided a single focus for employers' representatives to discuss improvements in legislation and processes across both PAYE and national insurance. The Inland Revenue will work with employers' representatives and others on options to reduce technical differences, while having due regard to individuals' benefit entitlement." (paragraph 3.56)

This statement provides the terms of reference for this consultation.

This was followed up by a commitment in the Budget

"The Inland Revenue will be publishing for consultation this Spring proposals for simplifying some of the aspects of National Insurance Contributions (NICs) that create complexity and worry for employers and their payroll administrators. These will include giving employers more time to deal with particularly difficult payments and providing simplified arrangements for accounting for NICs paid on behalf of employees seconded abroad.

And the Inland Revenue will set out options for ensuring that its officers have common and appropriate powers for their examination of employers' tax and NICs records." (Inland Revenue news release REV10/2000, 21 March 2000)

This paper takes forward that commitment.

Scope

The proposals in this paper are intended to respond to some priority areas of concern that have been made known to us by employers, tax professionals and their representatives. These are not all the areas of concern and we would welcome your suggestions for further areas where improvements can be made in the future. But we are concerned with identifying areas of burdensome technical misalignment and complexity across tax and NICs - within the current tax and NICs structures.

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Chapter 3: Revenue Powers To Check Employers' Records

Introduction

1. The scope of the Inland Revenue's responsibilities has increased significantly over the last two years. The department has new work areas: administering tax credits for working families and disabled people; controlling the operation of the national minimum wage and overseeing the collection by employers of student loans. The transfer of the Contributions Agency to the Inland Revenue brought with it responsibility not only for the routine control of all classes of NICs, but also for the security of National Insurance numbers and for the proper recording of earnings to safeguard contributory benefit entitlement. Employers have responsibilities in each of these areas.

2. The former CA carried out compliance checks on employers' payroll records in much the same way as the Inland Revenue. But CA officers acted under powers in the Social Security Administration Act 1992 that were, in some respects, more wide ranging than powers available to the Inland Revenue. At the time of the transfer of the CA to the Inland Revenue concerns were expressed by professional bodies that the Inland Revenue's own powers would be levelled up to the powers available to the CA.

3. So during the passage of the legislation to transfer the CA to the Inland Revenue (the Social Security Contributions (Transfer of Functions, etc) Act 1999) the Government made a commitment to review those powers and to make recommendations for their alignment. Baroness Hollis of Heigham (Parliamentary Under Secretary of State for Social Security) said

"This Bill is not the occasion for substantial change of powers since the aim of the Bill is the transfer the CA as a 'going concern'. We have been clear from the outset that professional advisers would be nervous that there might be a levelling up of powers. This we have very deliberately not done.

Nevertheless, we accept that the statutory powers of enforcement under NICs legislation that the Inland Revenue will inherit will not be fully consistent with the existing powers in relation to tax. It is in no one's interest to have any lack of clarity or certainty about the state's powers to ask questions and to enter premises…

So we see considerable merit in conducting a review of inspector's powers, taking into account the rights of individual contributors as well as the interests of employers and the need to block fraud.

Such a review needs to be done properly, running well beyond the timescale of this Bill. Moreover the review needs to look at the wider context. The Inland Revenue is being given other tasks such as policing the national minimum wage and student loan recovery, and handling the working families tax credit. All three involve employers, although we hope to burden them as little as possible.

It may be that, on close examination, different powers are needed for different purposes. But our starting point must be that a Revenue officer visiting an employer should have much the same powers, and limitations on those powers, whatever the purpose of the visit - in other words as much congruence as possible…

(House of Lords Hansard, 25 January 1999, vol 596, col 819)

Scope of the review

4. So on 15 October 1999 we announced through a news release the scope and terms of reference of a review of officers' compliance powers. The review is concerned with the various powers available to the Inland Revenue in checking employers' compliance with the rules governing:

• income tax subject to PAYE and, for contractors affected, the Construction Industry Scheme;
• tax credits paid to employees through the pay-packet (WFTC and DPTC) and the collection of student loan repayments;
• NICs, Statutory Sick Pay and Statutory Maternity Pay.

5. The Inland Revenue also check on employers' compliance with the National Minimum Wage rules on behalf of the Department of Trade and Industry. Within the Inland Revenue NMW inspectors are managed separately from staff engaged in employer compliance work. The National Minimum Wage Act 1998 confers powers on NMW inspectors which are applicable only to NMW inspections on behalf of the DTI. The Government has no proposals for changes to or the extension of those powers and we do not seek comment on those powers as part of this review.

First stage of the review

6. We started the review by setting out suggestions for key principles that should underpin employer compliance powers. We believe that the powers we have for employer compliance work should have the following features:

• They should be simple to understand.
• They should be adequate to obtain access to the records and information that we need.
• They should be able to be exercised with the minimum of intrusion and interference in the citizen's affairs.
• They should be certain and transparent so that employers clearly understand their rights and obligations.
• They should be consistent. Where there are variations for different purposes these should be justified objectively by a clear need and not by historical accident.
• They should be subject to effective safeguards against error or abuse.

Initial respondents to the review have not dissented from these underlying principles.

Are these attributes sufficient? Are there others that we should consider?

Second stage of the review

7. To take the review further we have looked in detail at the range of powers available to Inland Revenue officers to help support their duty to ensure employers comply with tax legislation, and at how those powers are used. We need to ensure that our officers have appropriate and proportionate powers to carry out their regulatory functions. The existing powers differ depending on the purpose to which the power is to be applied (obtaining information, asking questions etc.) and for which line of business the power is to be applied (PAYE, NICs etc.). Annex 2 compares and contrasts the various powers. The matrix at annex 3 sets out the legislative sources of the powers for each line of business, identifying which powers correspond to other powers. Annex 4 sets out the text of the principal legislation mentioned in the matrix.

8. The powers fall into two broad groups - powers to underpin our regular programme of routine visits to employers and powers to deal with cases of serious non-compliance, typically where employers deliberately fail to meet their legal obligations.

Routine powers

9. Inland Revenue employer compliance reviews have four elements:

• an examination of relevant records;
• obtaining explanations and any further information necessary to support the entries in the records;
• correction of any errors found including the calculation and recovery of any underpayments;
• identifying changes which the employer needs to make so as to comply fully in the future.

The process is explained more fully in our publication IR 109 "Employer Compliance Reviews & Negotiations" and in our code of practice 3 "Reviews of employers' and contractors' records".

10. Currently there are two sets of powers in use for employer compliance checks; annex 2 sets these out in detail. The routine powers permit the Inland Revenue to examine employers' records wherever the records are held or wherever the Inland Revenue and the employer agree the inspection should take place. For PAYE these powers are set out in regulation 55 of the Income Tax (Employments) Regulations 1993 and are mirrored in other regulations for CIS, WFTC and CSL. The parallel powers for NICs are in regulation 32 of Schedule 1 to the Social Security (Contributions) Regulations 1979.

11. Regulation 55 powers and their equivalents are generally adequate for routine employer compliance functions. Officers find that, in the majority of cases, it is not necessary to use further powers. Where officers meet resistance they will usually send a letter drawing the employer's attention to regulation 55. Only in a small minority of cases is it necessary to go beyond this and formal penalty proceedings are very rare. These powers seem to meet the criteria set out in paragraph 6 above and do not appear to cause any significant difficulties for employers. So we do not see a case for making any substantial changes in this area.

Minor defects in the routine powers

12. However, we have identified a couple of minor defects in the routine powers. First, there are presently no powers available to the Inland Revenue, apart from under section 110ZA Social Security Administration Act 1992, which allow the Revenue to examine employers' records for SSP and SMP. Regulation 55 and regulation 32 of Schedule 1 do not extend to SSP and SMP records in their entirety. We need to check that employers not only calculate and pay SSP/SMP correctly but also recover the right amount. We also need to check employee's entitlement and that the right documentation is in place. We have no routine power to carry out this work, and the use of section 110ZA for this purpose seems disproportionate. There appears to be a good case for extending the scope of regulation 55 and its equivalents to SSP and SMP.

13. Secondly, there is a discrepancy between regulation 55 and regulation 32 of Schedule 1 over the examination of computer records. Regulation 55(7) makes specific provision requiring the employer to provide facilities for the officer to obtain information from computer records. There is no similar provision in regulation 32 of Schedule 1. Although it is possible to read into that regulation the implication that computer records are open to examination it is inconsistent that there should be this difference between the two regulations. This appears best remedied by introducing a provision in regulation 32 of Schedule 1 to mirror the regulation 55 requirement on employers to provide facilities for the officer to obtain information from computer records. This is simply a clarification and will have little practical impact on employers, who are already required to provide such access under regulation 55(7).

Summary

14. The Inland Revenue needs to carry out effectively its responsibilities to ensure employer compliance in a range of tasks including operation of PAYE, NICs, SSP/SMP, tax credits, and collection of student loans. For the majority of cases the routine checks are adequately backed up by the powers in regulation 55 for PAYE and mirrored for most other tasks. Subject to some minor "tidying" such as described above we propose to leave these provisions unchanged.

We would be grateful for comment on the detail of this proposal.

Non-routine powers

15. The routine powers do not grant officers the right to:

• obtain access to supplementary information
• obtain access to the employer's premises if the records are kept elsewhere in the UK and
• interview employees regarding the circumstances of their employment

16. Some examples of situations where these limitations become significant particularly concerned Lord Grabiner in his review of the Informal Economy published in March:

• the hidden economy employer (an employer who was previously unknown to the Revenue). The employer may deduct tax and NICs but those deductions do not find their way to the Exchequer. By their very nature these employers do not respond to polite written requests for access to records. They may not trade from fixed premises and may be in one place for a short period of time;
• where the employer and employee collude and "cash in hand" wages are paid. This practice has a number of implications. By colluding to suppress true gross wages both tax and NIC may be evaded, false claims to benefits or tax credits may be enabled and the employer gains an unfair competitive advantage;
• where there is potential for fraud from abuses of the national insurance number system. The Government is committed to ensuring the integrity of the national insurance number system. To support this enquiries may need to be made in cases where it is suspected that a false or hijacked NINO has been used. It may be suspected that a person is working and claiming benefit using two NINOs, or even claiming personal tax allowances twice in two separate jobs. This is an area where there is liaison between Inland Revenue employer compliance officers and the Benefits Agency.

17. In circumstances such as these other powers need to be considered. Annex 2 describes the various powers available. For NIC, SSP and SMP the powers in section 110ZA of the Social Security Administration Act 1992 (based on the powers available to the Department of Social Security) give an explicit right of entry to premises, a power to call for any reasonably required documents and information and a power to interview anybody found on premises which officers can enter. For tax, there are in particular the rules in section 20 onwards of the Taxes Management Act that also provide a means of obtaining documents and information. There is a clear contrast of effect and ethos between the two approaches.

18. Our view is that since there is no intrinsic difference in the situations investigated for tax purposes and the situations investigated for NICs purposes it is unsatisfactory to have divergent powers for effectively the same purpose.

Comments are invited on this conclusion.

Proposals

19. The Government proposes to harmonise non-routine tax and NICs powers by repealing the existing powers in section 110ZA and providing for NICs and SSP/SMP a similar regime to that which already exists for tax. This will provide a common basis for tax and NICs, which should in itself reduce confusion for employers and meet the criteria for appropriate powers set out above. The effects of this on the various types of information that may be required will be as follows.

Supplementary documentary information (already in existence)

20. Where we are seeking records or information that are outside regulation 55, and an employer is unwilling to supply them voluntarily it is open to the Inland Revenue to take steps to issue a notice under section 20 of the Taxes Management Act. It is proposed to make this process available for all classes of NIC. The use of section 20 is a measured process that begins with an informal request for the records or information (a precursor letter). Then the issue of a formal notice by an inspector requires the consent of an Appeal Commissioner. There is a period for the delivery of the records or information (usually at least 30 days). A failure to comply with a section 20 notice is subject to a civil penalty under section 98 TMA. But from the moment the precursor request is made it is a criminal offence (under section 20BB) to conceal, destroy, falsify or otherwise destroy the documents.

Other supplementary information, including explanations

21. For tax the powers in section 20(1) extend to requiring an employer to supply 'particulars'. That may encompass written explanations, including for example the reconciliation of figures in the PAYE records with the wider business accounting records. The use of this power is governed by the rules described above.

Power to interview people

22. Section 110ZA enables officers to interview employees at the work place without interference from the employer. In practice, this falls short of giving employees complete security since it will often be clear to an employer after the event that an employee must have made some damaging statement.

23. Using the section 20 approach for NIC, instead of a power to interview, it would be possible, with the safeguards discussed earlier, to require an employee to supply documents (for example wage slips) or to provide written explanations of matters relevant to their own tax or NICs affairs.

Power of entry to premises

24. The right of entry (but not by force) to an employer's premises for NICs purposes in section 110ZA will only represent a significant additional power to that of access to payroll records in regulation 32 of Schedule 1 where they are kept elsewhere. Its merits in those circumstances appear to turn chiefly on the merit of the power to interview employees at the work place discussed above. Without the latter power the case for preserving the power of entry in section 110ZA looks problematical.

25. Where on the other hand a serious fraud is suspected, any power of entry needs to carry with it the element of surprise. That in turn requires the power to enter without notice, by force if necessary, to search for evidence. Under these proposals a search power equivalent to that in section 20C TMA (to be sparingly used and with the same stringent safeguards) would extend to NICs.

Estimated determinations of liability

26. In Annex 2 paragraph 37 we explain how the "regulation 49" procedure may be used to determine tax liability where, for example, an employer will not produce the required documentation. The NICs legislation allows for equivalent action i.e. an estimate of earnings followed by issue of an appealable decision on NICs liability made "to the best of his information and belief". We propose that - as part of the alignment of powers - we could issue guidance for officers to enable a NICs decision to be made, if appropriate, in the same circumstances as a regulation 49 determination. This would not require a change of legislation, but rather updates practice in line with the April 1999 changes in legislation. An employer who disagreed with the amount assessed for tax and/or NICs would be able to have the disputed tax and NICs dealt with at the same time and, if necessary, have his appeal against both listed for the same tribunal.

We would welcome comment on this approach in light of the attributes in paragraph 6

By getting rid of section 110ZA are we left with a sufficiently robust regime with which to deal with serious non-compliance?

Regulatory impact

27. We recognise that employers and others may incur costs in complying with regulations and in co-operating with the Inland Revenue as it checks records. In publicising this review we said that our aim was that any alignment should have a neutral or beneficial effect on employers' compliance costs. We believe that the approach we have described is broadly deregulatory and that it will have, as suggested, a neutral or beneficial effect on compliance costs.

We welcome comment on this view. In particular we would welcome information on specific ways in which compliance costs will either increase or decrease if this approach is adopted.

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Chapter 4: Helping Employers Get It Right

Introduction

1. Employers tell us that they find calculating individuals' NICs correctly harder than calculating their pay-as-you-earn (PAYE) income tax correctly; that they find correcting NICs errors harder than correcting PAYE errors and that they find our approach when we discover NICs errors on an employer compliance visit more burdensome.

2. This chapter explores ways of making it easier for employers to get the calculation of an individual's class 1 NICs right, and simpler procedures for dealing with arrears and errors when the class 1 NICs calculation is wrong and is identified in an employer compliance review. Nothing in this chapter changes the rules on liability for primary and secondary class 1 NICs, or the amount of NIC arrears that may be due following an underpayment.

Problem

3. The claim that getting the NICs calculation right is harder than getting the PAYE calculation right is surprising at first - there is no need to refer to earnings and tax paid earlier in the year, there are fewer rate bands, there are no tax codes. It appears that practical difficulties are less to do with the calculation process - which for many employers is automated - or indeed with the application of tax and NICs to the employee's wages or salary; but rather that employers find dealing with payments around the margins of an individual's remuneration package much harder for NICs than for tax.

4. An individual's earnings for NICs purposes are made up of a number of components - salary/ wages, overtime, bonuses, certain expenses, benefits (such as vouchers) etc. The core items - salary or wages - tend to be handled by the employer's payroll department and are recorded and deductions made accordingly. But marginal items of pay are often handled outside the payroll department - for example expenses and overtime might be paid by a local branch of a large company rather than the payroll department, relocation costs might be handled by a human resources branch and so on. Even in small businesses salary or wages might be handled very differently from expenses - expenses may be paid as they occur rather than at the end of the week or month with the main salary or wages. Evidence from employers - and indeed from our own employer compliance officers - indicates that, in mainstream employment rather than hidden economy or elaborate avoidance schemes, the main errors made by employers are in the recording of such incidental, high volume and low value payments.

5. There are two particular problems that arise with these payments, which go some way to explaining why employers find getting the NICs calculation right particularly difficult.

Earnings periods

6. Income tax is an annual charge. PAYE provides the mechanism for calculating and deducting payments on account of the annual income tax liability. It does not matter in which month the tax is paid because it is simply a payment on account of the annual tax liability. But the class 1 NICs liability is on earnings in the particular "earnings period" - the regular pay period for the employee. This is generally weekly or monthly, although directors have an annual earnings period. The "earnings period" provides the mechanism for apportioning the NICs limits and thresholds correctly and NICs should be assessed on all payments made to the employee in that earnings period, using those limits.

7. This puts a premium on employers getting the NICs calculation correct very quickly. Employers' payroll departments have to find out fast all the payments that have been made to the employee within that earnings period - so they need to know about all expenses payments, overtime, bonuses etc within the earnings period in which they are made. Employers complain that is unrealistic for, say, the London office to account for the NICs due on taxi bills or home telephone bills paid in a branch office in that month. So there is a problem of timing. Employers similarly say that they have difficulties identifying the business use of fuel bills, travel expenses and round sum allowances in order to deduct NICs correctly on the private use element.

8. In order to correct a mistake - for example where the employer was not aware of a payment in time to include that payment within earnings in the month in which it was actually paid - the employer has to go back, reopen the calculation for the earnings period in which the payment was made and recalculate NICs accordingly. For PAYE, the employer can simply include the payment within the next payment of earnings and assess the payment accordingly.

9. Of course the NICs liability arises at the point at which the payment is made, not at the point for which the payment is due. So if an employer pays a telephone bill covering four months of calls they do not have to allocate the sum paid by the month in which the call was made. The NICs liability is in the earnings period in which the bill is paid, not when the call was made.

Arrears

10. If an employer does not identify that a mistake has been made - for example the NICs liability on a number of payments made by a branch office has not been paid - the Inland Revenue may identify on a visit that an error has been made. The employer will be asked to pay the arrears.

11. However, there may be problems where the employer and employer compliance officer lack detailed information to establish what the arrears are. Here the processes differ for tax and for NICs - in the scope to estimate arrears and the need to allocate those arrears to individuals:

• for PAYE arrears, when records are not available, or obtaining detailed extracts from the employer's records would be very time consuming for the employer and the Inland Revenue, the employer compliance officer will consider estimating the amounts involved and agree this, and the basis of the estimate, with the employer. There is much less scope for estimating arrears for NICs;
• for PAYE, the employer will simply be asked to pay the arrears. For NICs, in addition to asking the employer to pay the arrears, the employer compliance officer may ask the employer to set out in detail which payments were made to which individuals. Where earnings on which NICs have been paid are reported on P14 end of year returns they are credited to individuals' NICs records. In the same way, arrears of primary class 1 NICs identified subsequently need to be credited to individuals' NICs records to ensure that full earnings on which NICs have been paid are taken into account in calculating individuals' benefit entitlement.

12. The decisions on whether to estimate and allocate or not will depend on factors such as accessibility of records, complexity of payroll arrangements, number of employees and whether the effort would be disproportionate for the arrears involved. But principally the employer compliance officer must have regard to the benefits position of the employee that is, where earnings are around the LEL or between the LEL and UEL - arrears should (where possible) be calculated precisely and allocated to individuals because their benefit entitlement could be affected.

13. Employers tell us that they find it extremely difficult and burdensome where we decide not to estimate arrears, or we need full employee details in order to allocate. It could involve matching records, getting information from around the company on taxi bills, restaurant bills and home telephone bills paid etc - and employers say that, if they had known which individuals were paid, they would probably have put the payment through the payroll in the first place. Employers claim that it is unreasonable and burdensome to expect them to provide detailed information on which payment was made to whom - for example dividing up restaurant bills paid by individual employees.

14. As a result there is a perception among employers that the Inland Revenue is interested in every last penny of NICs revenue and in unnecessary detail, while it takes a more pragmatic approach for tax.

Can employers recognise the problems described above ? What other sorts of payments do employers have problems with ? Are there other problems ?

Recent changes

15. The Inland Revenue, and previously the Department of Social Security and the Contributions Agency had taken a number of steps to help employers deal more effectively with miscellaneous payments:

• Since November 1994, dispensations agreed by employers with their local tax office for tax purposes will apply for NICs purposes too;
• since 1997, tax and NICs staff have been able to negotiate and estimate settlements of outstanding NICs liability under good administrative practice guidance;
• from April 1999, when employers agree with their local tax office to account for tax in respect of "minor and irregular" payments or benefits, or payments where it is impractical to operate PAYE, through a PAYE settlement agreement, they can pay class 1B NICs on the items in the PSA which would otherwise attract Class 1 or 1A NICs liability, and on the tax paid in respect of the PSA;
• from April 1999 with the transfer of the Contributions Agency to the Inland Revenue, NICs staff have been working alongside tax staff. From April 2000 this has led to one employer compliance review for both tax and NICs.

Why do different approaches remain between NICs and tax?

16. Negotiations on arrears of NICs are fettered by our duty to the contributor because of the benefit implications. For tax our administrative discretion (known as "care and management") means we can make a judgement not to spend £100 to collect £10. Although we have similar administrative discretion in relation to NICs - section 3 of the Social Security Contributions (Transfer of Functions, etc.) Act 1999 brings contributions under the care and management of the Board of Inland Revenue - in practice this simply reinforces the administrative discretion previously available to Contributions Agency staff. And Ministers explained in Parliament that this includes a duty to the contributor - so it might be worth spending £100 to collect £10 if that £10 would secure an individual's benefit entitlement:

"I know that many representative bodies are hoping that bringing national insurance contributions within this concept of care and management will give employers the opportunity to make simplifications in their record-keeping. However, payment of national insurance contributions builds entitlement to certain social security benefits. So, in exercising its duty of care and management over national insurance contributions the Inland Revenue will bear in mind its duty to the contributor. So the Inland Revenue will expect employers to keep accurate records of individuals' contributions in the same way as the Contributions Agency does now."

(Baroness Hollis of Heigham, House of Lords Hansard vol 595, col 1040

Links between NICs paid and benefit entitlement

17. But £10 extra NICs, or £10 extra earnings on which NICs are liable, does not correspond to £10 extra benefit entitlement. The precise relationship between additional NIC-able earnings and benefit entitlement depends on an individual's earnings at the point the additional sums are identified and at other times in the year, and on the type of pension scheme they are in. Benefit entitlement is based on the annual earnings on which contributions have been paid or deemed to have been paid - known as the "earnings factor". The test is whether this meets a "qualifying earnings factor" for benefit entitlement. Annex 5 describes the effect of discovering an additional £10 earnings on benefit entitlement for a range of earnings bands and a range of second pension schemes - all other things remaining equal. In summary:

• the most significant implications are where the contributor is earning just under the lower earnings limit (LEL). Here, any additional payment identified could bring the individual above the qualifying earnings factor and into contributory benefit entitlement. For example, if an individual is earning £64 wages a week but receives an expenses payment liable to NICs of £4 a week, their rights to a basic state pension for that year depend on employersor us if the employer does not - identifying and recording that expenses payment;
• for those earning between the annual LEL and the annual upper earnings limit (UEL) the effect depends on the type of earnings-related pension the employee is in:
  • If the employee is in SERPS, a single additional payment of earnings of £10 increases SERPS entitlement by around 12p a year and missed earnings of £10 a week for a year can reduce SERPS by 12p a week;
  • If the employee is in a salary-related pension, small additional sums will generally have no effect on the eventual pension paid. Where the pension is dependent on the final salary paid the precise salary in earlier years will not affect the final pension, and even precise earnings in the final year may not if the pension is based on final salary rather than final NIC-able earnings. Of course, slight variations might affect the rebate paid and therefore the funding of the pension scheme;
  • If the employee is in a money purchase scheme, small additional sums, and therefore small additional rebates, could, over time, have potentially significant effects depending on factors such as investment returns, annuity rates and the age of the contributor. Of course, other factors could also have significant effects;
• for those earning above the UEL, additional sums have no effect on benefit entitlement;
• all other things remaining equal, it should not matter at which point in year a payment is recorded. The annual earnings on which they have paid NICs will still be the same. There will only be a problem if earnings change between the point at which the payment was made and recorded so that the NICs paid is higher or lower. For example, if an employee is paid £64 one week plus £4 NIC-able expenses, but the expenses payment is put through the payroll in a week where the employee is only paid £32, correct application of the NICs rules means that the employee builds up a contribution week, delay means the employee does not.
• Nevertheless, the Inland Revenue has an obligation to ensure that an individual's potential to earn contributory benefit entitlement is protected. The employer is legally responsible for correctly assessing NICs liability, deducting it where appropriate from the individual contributor's gross earnings, and making payment and returning records to the Inland Revenue. The Inland Revenue has a matching responsibility to ensure that employers comply with their obligations and for accurately recording the information obtained from the employer on the contributor's personal national insurance account.

"Good administrative practice"

18. So, the Inland Revenue, and previously the Contributions Agency, have operated a number of "good administrative practices" within this framework. So for example:

• the Contributions Agency accepted that, although far from ideal, some employers might not be able to account for NICs in the same month as a payment is made to an employee, particular where that was a payment of expenses. In those circumstances the Contributions Agency would remind the employer of the correct application of the law but would not, generally, press employers to allocate payments to the precise earnings period;
• the Contributions Agency, when it had identified arrears, could estimate the amount attributable to each individual rather than requiring the employer to identify precise amounts where this was not practical, and could ignore for benefit purposes any insignificant sums.

19. We believe there is scope to take this sensible administrative practice slightly further to simplify further dealing with these payments for NICs purposes whilst taking reasonable steps to protect individuals' contributory benefit entitlement.

Proposal (1) - Earnings period flexibility

20. As noted earlier, employers argue that requiring the NICs to be accounted for in the earnings period in which the payment is made is not practical, for example where a branch office pays expenses and the payroll department doesn't find out for a few months. But, as noted above, the effect on benefit entitlement is generally minimal and therefore our employer compliance offices will often not press for certain payments to be attributable to the correct earnings period. We therefore propose to extend and publicise this guidance further to make clear that:

• we will allow employers to account for the NICs on payments when the payment is identified to the payroll department rather than when the payment is actually made;
• this will apply not only to expenses payments but also to other payments where employers have genuine difficulties in establishing that a payment has been made until some time after it has been made;
• in order to safeguard individuals' benefit entitlement we would expect that most payments should be put through the payroll by the end of the year and that employers should take particular care with employees with fluctuating earnings;
• we do not charge interest or penalties where an employer has allocated a payment to the incorrect earnings period;
• publish this statement of approach in, say, the "Employer's Further Guide to PAYE and NICs" (CWG2).

21. Annex 6 suggests a possible form of words for this guidance. For many employers, this would simply confirm to them that their current practices are acceptable to the Inland Revenue, and so the effect may be no more than to reassure them that such problems should not create difficulties on a visit.

Would employers find more time to process these payments helpful ? If so, would a statement along the lines of annex 6 be helpful ? How might the statement be improved ? What other payments might be covered ?

Are the safeguards on benefit entitlement reasonable ?

What might be the effect of this additional flexibility on compliance costs ?

Proposal (2) - estimation and non-allocation of some arrears

22. As noted earlier, employers have said they would like tax and NICs underpayments to be assessed and collected in the same way. Because of the benefit entitlement effects it is not possible to apply exactly the same procedures when underpayments have been identified. But we think it is possible to introduce additional flexibility which will:

• reduce the amount of information employers are required to provide following identification of tax and/or NICs underpayments during a review
  • thus reducing their time spent and cost;
• reduce the time spent and costs to the Inland Revenue of calculating NICs underpayments on an individual basis and allocating them to individual national insurance accounts;
• protect the individual contributor's ability to build entitlement to contributory benefits.

23. We propose to issue new guidance to employer compliance officers on the calculation and allocation of underpayments of tax and NICs during a review. This would take the following steps (illustrated by a flow chart at annex 7):

(i) Did the errors relate only to the current year? If so the employer would be advised to make good any incorrect recording of NICable pay and make appropriate payments. Follow up checks would, as now, be made to ensure the corrective action had been taken.

(ii) Would the number of employees or the nature of the NICable payment make it difficult to calculate and allocate to individuals the exact NICs due? Clearly there would be no need for special arrangements where a simple calculation was possible.

(iii) Were all employees affected above the UEL? If no primary NICs would be due because all affected employees had already paid maximum contributions, amounts due could be estimated globally - as now.

(iv) Were all the employees affected above the LEL? ie. based on a reasonable assumption agreed between the employer compliance officer and the employer, would the employees' NI records show a qualifying year for the relevant year. (As a guide for 2000/2001 this would mean minimum annual earnings of £3432 with no payments in excess of £535 per week or equivalent.) Any employees who were just below the LEL would be excluded from a global estimation. Precise calculation and, if appropriate, allocation of primary NICs would be required.

(v) What pension scheme was operated in respect of the relevant employees? In particular was there a contracted-out money purchase scheme. If so, Inland Revenue officers would bear this in mind when dealing with arrears of NICs and could ask for more detailed allocation information.

(vi) Were the under-recorded earnings "one off" payments? If so would they amount to more than £100 per employee? Where the additional earnings on which arrears of primary national insurance were due amounted to more than £ 100 recording these earnings on the NI account could have a significant impact on future benefit entitlement and precise calculation and allocation to individual accounts would be carried out if at all possible.

(vii) Were the under-recorded NICable pay ongoing additions to regular earnings? If so, were they equivalent to more than £5 per week if taken over the whole year for any employee? Where the additional earnings on which arrears of primary national insurance were due amounted to more than £5 per week recording these earnings on the NI account could have a significant impact on future benefit entitlement and precise calculation and allocation to individual accounts would be carried out if at all possible.

24. The employer compliance officer would work through these considerations with the employer - and, just as for tax - the agreement of the employer for any estimation and the basis of the estimate would be obtained. If the criteria were satisfied and the earnings on which NIC arrears were due were within the limits the employer compliance officer undertaking the review would estimate the additional NICs using the best available information without requiring the employer to provide details of the individual employees to whom the arrears applied. A note that the criteria were satisfied would be made in the computation - again in the same way as they are for tax.

25. In recognition of the importance of establishing benefit entitlement for those earning between the lower earnings limit (currently £67 per week) and the primary threshold (currently £76 per week) where no NICs or tax would normally be deducted - employer compliance officers would ask employers to identify and would examine the records - or a sample of records depending on the numbers involved - of any such employees to ensure accurate records are being kept. Similarly, employer compliance officers would want to be sure that those earning below the LEL were actually doing so - and that their earnings were not actually above the LEL, to ensure that these people could build up their benefit entitlement.

26. Where payments of Statutory Maternity Pay and Statutory Sick Pay had been made in the relevant period the employer would be advised that they were required to check individual records to calculate whether, had the additional earnings been recorded on the payroll at the time the SMP/SSP was paid, the payment would have been greater, and make any consequent adjustments.

27. The arrangements would be monitored closely and we would review the criteria if there were any changes, for example in contributions tests for benefits; or any indication that they were being mis-used to avoid or reduce NICs.

Comments are invited on:

• the use of global estimation where normal earnings fall between the LEL and the UEL but the amount of under-recorded NICable pay is below a set amount - set according to our estimation of minimal benefit impact.
• From recent experience roughly what proportion of under recorded earnings for NICs would fall below the one off cut off point of £100 per employee.
• From recent experience roughly what proportion of under recorded earnings for NICs would fall below the on going cut off point of £5 per week earnings per employee.
• The safeguard for those on lower wages requires identification of those earning between the LEL and the primary threshold (current year) - or a sample if the numbers are large. Are there any particular circumstances where this would not be feasible ?
• The compliance cost of savings of the revised approach

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Chapter 5: Pay

Introduction

1. Employers tell us that a common figure for "pay" across tax and NICs is high priority step towards simplification. At the moment the definitions of "pay" differ in a number of ways which means that employers have to decide the correct tax/ NICs treatment for different items that make up each employee's "pay". Clearly things would be simpler if employers could key in a figure for "pay" into their payroll software rather than needing to enter separate tax and NICs figures for different items.

Current Position

2. The differences in the definition of "pay" for tax and NICs stem from the different history and nature of the charges and, indeed, from the changes over time in the way people are paid. Income tax is a broad-based charge that covers savings and pensions as well as "pay" in all its various forms. Those taxable items that are subject to PAYE go through the payroll, others being subject by the employer to an annual procedure, such as the P11D and the remainder being for the employee to account through the self-assessment process. By contrast NICs are a much narrower charge, historically based much more closely on cash earnings and are specifically designed to fund certain social security benefits with all payments subject to Class 1 NICs having to be put through the payroll.

Legislative basis

4. Directors, office holders and employees are normally liable for Schedule E income tax and Class 1 NICs on their employment income. Schedule E and National Insurance legislation uses different definitions of "pay" to determine basic liability - "earnings" are used for NICs purposes and "emoluments" for Schedule E purposes.

5. "Earnings" are defined for NICs purposes as:

'earnings' includes any remuneration or profit derived from an employment (s.3(1)(a) SSCBA;

For Schedule E purposes emoluments are defined as:

the expression "emoluments" shall include all salaries, fees, wages, perquisites and profits whatsoever. (s.131 ICTA).

6. Both ICTA and SSCBA rules then include specific provisions removing and adding items to the charges that have been added over time. This, inevitably, leads to different treatment for some types of payment. However, we think that developing an agreed understanding of what we mean by "pay" for employers to use will mean they can assume common treatment for tax and NICs unless the particular type of payment falls into a small group of listed payments where differences exist.

7. Although our proposal will not change the current tax or NICs charging base it will mean that employers can operate on the basis that the tax and NICs treatment of payments will be the same unless we have clearly stated otherwise. It will also allow us to target guidance to employers and our own staff on those areas where there are particular difficulties. It will, for example, enable us to rewrite our guidance in the Employer's Further Guide to PAYE and NICs (CWG2) so that it is focussed on those payments where there is different treatment.

8. Notwithstanding the move towards a common definition of "pay" for tax and NICs purposes there will continue to be a number of payments where there is still different treatment for tax and NICs. These are summarised at annex 8. The key area of misalignment is in relation to employees occupational pension contributions which receive tax relief but are treated as earnings for NICs purposes. Other than this there are few remaining areas where there is a difference. These include childcare vouchers, payroll giving and redundancy payments.

9. As well as the difference in liability there are also more subtle legislative differences that have led to process misalignments. Here some payments made to employees are included on the in year deductions working sheet (P11) for Class 1 NICs purposes but on the end of year P11D for tax purposes. These process differences include expenses and non-cash vouchers. We are also aware that employers have been experiencing difficulties with accounting for the NICs due on employer contributions to funded unapproved retirement benefit schemes (FURBS). Where such contributions are taxable they are generally reported on the P11D at the end of the year, but where they are liable to NICs they are included in the gross pay figure reported on the P11. One solution would be to move the NICs charge from class 1 to class 1A. This would align the process with that for tax, and may assist pension schemes that have not yet secured tax approval. 3. Over recent years much has been done to bring the definitions closer together. In particular, the extension - from April 2000 - of class 1A NICs to most taxable benefits in kind not already subject to NICs brings the tax and NICs treatment in this area much more closely into line. We want to continue to explore how far other differences can be levelled out, always taking account of the potential effects this may have on individuals and the Exchequer. Past experience suggests that not all measures which help to align the treatment of tax and NICs are necessarily welcome. Against that background we have been looking at the underlying legislation to see what further technical alignments might be made.

Would employers be interested in moving the NICs charge on employer contributions to FURBS from class 1 to 1A in the longer term ? If so, in what specific ways might it be helpful ? What would the effect on compliance costs be ?

Conclusion

10. The box below sets out a draft statement on common understanding of "pay" which could be included in the CWG2. It sets out our technical interpretation of earnings and emoluments. However, we will need to use a more user friendly form of words to communicate the position to employers. In practice this could help employers by making the tax/NICs position on pay more transparent and allow guidance to be simpler and shorter by focussing on differences in liability or on the collection process (P11D/ PAYE). A table similar to annex 8 would alert employers to differences in treatment.

Common Treatment Of "Pay" For Tax And National Insurance Working Draft Of Statement Aimed At Practitioners

Class 1, 1A and 1B national insurance contributions (NICs) and income tax under Schedule E are both charged on income from employment. There is a substantial degree of commonality between the charges - class 1A NICs will from April 2000 be charged on all taxable benefits in kind where there is no other NICs charge and class 1B NICs are charged on any emoluments included in a PAYE settlement agreement. But there remain underlying differences because the two charges use different underlying definitions of pay. Class 1 NICs are charged on "earnings or profit derived from employment" and Schedule E income tax is charged on "emoluments" or where there is a specific charge in the Taxes Acts.

In practice, these different definitions work in similar ways and bring into liability similar types of payments. So, for the avoidance of doubt, and wherever possible, the Inland Revenue will interpret both "earnings" and "emoluments" in the same way. This means that in deciding whether a payment or benefit is liable to Class 1, 1A or 1B NICs, the Inland Revenue will apply the criteria which exist for deciding if the item in question is an emolument or deemed as an emolument for Schedule E. To avoid any doubt the Inland Revenue will now interpret them in the same way.

This is not to say that every payment that is treated as earnings for NICs will be treated as an emolument for tax or vice versa. But, where income tax under Schedule E is charged on the basis that a payment is an emolument or is deemed to be an emolument (or under a specific charge in the Taxes Acts) and that payment is NOT subject to Class 1A or 1B NICs, it should generally be subject to Class 1 NICs, unless there are current differences in treatment based on specific statutory provisions or case law.

Would a statement along the lines of the above be helpful to employers and their advisors ? If so, how ?

Is the specific wording above helpful ? How could it be improved ?

Would the table at annex 8 be helpful ? Have we covered the principal types of payments where you understand there to be different treatment? If not, what else should be included ?

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Chapter 6: Employees Seconded Abroad: An Additional Collection Mechanism For National Insurance Contributions

Introduction

1. Employers and their advisors have suggested to us that they find assessing NICs on the earnings of UK employees seconded abroad particularly difficult. They have noted that there are mechanisms available to help employers account for the tax paid on the earnings of employees seconded to the UK and have asked us to explore whether similar arrangements could be introduced for NICs. This chapter explores the problem in more detail and sets out proposals for a simplified collection method for NICs on the earnings of employees seconded abroad. It focuses on the UK employees seconded outside the UK rather than on overseas employees seconded to the UK.

Background

2. UK employees seconded abroad for more than a year generally remain liable to UK NICs for at least the first 52 weeks of the secondment period, and for longer if the secondment is to a country with whom the UK has a reciprocal agreement. But seconded employees tend to fall out of PAYE almost immediately. This disparity stems from the fact that for NICs purposes, under regulation 120 of the Contributions Regulations, liability depends on factors such as whether the employer has a place of business in the UK and whether the employee is ordinarily resident for NICs purposes. For Schedule E purposes the sole consideration is whether the employee is classed as resident.

3. Alignment of these residency rules would be a long-term change with potentially significant implications, not least because the UK has at least sixteen reciprocal agreements with other countries concerning social security which would need to be amended if there were any changes to the NICs definition of ordinary residence. There would be questions about the way alignment of these definitions would interact with social security definitions of residence elsewhere in the EU. But employers primary concerns seem to be with the practical problem of assessing the NICs on earnings paid abroad, so we have focused our efforts on dealing with this problem.

4. The proposals are concerned only with providing information about NICs and accounting for sums due. They do not affect the payment of tax in any way and relate to NICs only where the secondment abroad is likely to be for more than a year. Nor do they change the underlying liability to NICs. Chapter 7 deals with the related issue of providing better guidance on the tax and NICs treatment of payments to employees seconded abroad.

Current problem

5. There are a variety of secondment packages provided to employees seconded abroad. They typically involve some of the package being paid from the UK and some from the overseas company. During the period of NICs liability, the UK employer is required to track these additional payments, add them to other earnings paid in the same pay period and deduct NICs. The employer must ensure he has tracked all these payments by the 19 April following the end of the tax year in which they are paid in order to avoid interest on outstanding amounts. The employer must also ensure that the payments are returned on form P35 by 19 May following the end of the tax year in order to avoid penalties for late filing of returns. The difficulty of obtaining this information by the end of the tax year is compounded by the fact that other countries' tax years do not run in line with the UK one.

6. Employers and their advisors tell us that it is almost impossible to obtain earnings information (for example, local expenses payments and payments of local foreign taxes) and that the lack of an annual settlement for NICs means there is no way of settling the liability on these payments. Employers have asked if we could permit the relevant information to be provided later than 19 May without attracting penalties for late filing, and if the relevant NICs could be paid later than 19 April without attracting interest.

7. Employers have asked us whether it would be possible to pay NICs in-year on estimates of earnings of employees seconded abroad and to settle the remaining NICs due after the year end, without facing interest and penalties for late payment and filing. We have been happy to investigate possible models for enabling this, on the basis that this provides a means of ensuring that the correct liability is paid whilst reducing the burdens on employers and their advisors.

• Have we understood the NICs problems associated with employees seconded abroad?
• Are there other problems?

Proposed collection system

8. To protect individuals' benefit entitlement, the employer would be required to put best estimates of salary through the UK payroll for tax and NICs purposes, at amounts of at least the weekly or monthly UEL. If the UK employer pays most of the seconded workers earnings, then this will be straightforward. If the overseas company pays the seconded worker, then it would be up to the UK employer to estimate the earnings and process these through the UK payroll on a weekly or monthly basis. These estimates must be amounts of at least the weekly or monthly UEL. Primary and secondary NICs would be assessed on these estimated amounts and paid over to the Collector of Taxes in accordance with normal PAYE procedures.

9. In order to avoid any effect on benefit entitlement, the proposed collection system could only be used in respect of those workers whose earnings are above the Upper Earnings Limit (UEL). This would avoid any impact on individuals' benefit entitlement. We understand that almost all employees seconded abroad will be earning above the UEL and therefore that this condition is unlikely to impose any significant practical constraints on the operation of the scheme.

End of Year

10. We propose to allow employers to settle their outstanding class 1 NICs liability after the year end. We want to provide the most straightforward mechanism for doing so and have looked at three possible models for delivering the extended payment and filing dates:

I. adaptation of the current modified PAYE scheme (which applies to workers seconded into the UK). Under these arrangements, annual earnings are estimated at the beginning of the year and PAYE is operated on this estimate. A substitute P11D is submitted with the individual's tax return as soon as all relevant information is available, and at the latest by 31 January following the end of the tax year. Any additional tax found to be due following the submission of the individual's tax return will be paid by 31 January following the year of assessment.

II. using the PAYE Settlement Agreement (PSA) accounting mechanism and so pay Class 1B NICs on the outstanding liability.

III. a P35 end of year return submitted under a separate PAYE scheme reference from that of the employer's "main" PAYE scheme.

11. We do not think adaptation of the modified PAYE scheme for NICs will work. This is because the reconciliation process which applies for the current scheme can not be adapted for NICs. Under the scheme, employers are permitted to file the P11D by 31 January following the year of assessment, along with the individual's self assessment return. But, even with the extended Class 1A charge from 6 April 2000, a P11D may not be completed if the employee is not resident for tax purposes. So this does not appear to be viable.

12. Using the PAYE settlement agreement accounting method to pay Class 1B NICs on the outstanding liability is potentially an attractive option because it would enable employers to settle the liability alongside other liabilities. But this would require primary legislation. As section 10A of the Social Security Contributions and Benefits Act 1992 currently stands, the Class 1B charge only arises if a PSA is entered into for tax (10A(1)). The liability arises only in respect of those items included in the PSA which attract a liability for Class 1 or Class 1A NICs and on the tax paid under the PSA. To provide for a NICs only PSA, section 10A would need to be amended. We have therefore looked for an option which could be achieved more easily and quickly.

13. This leaves option III - filing a P35 under a separate PAYE scheme reference from that of the employer's "main" PAYE scheme in respect of NICs due on earnings paid by the overseas employer. The details of how this could work are set out below.

Extended filing date for a separate P35 - how it would work

14. Currently, an employer is liable for interest on payments made late included in a normal P35, and for penalties if the P35 is filed late. We propose to impose a final date for payment of the NICs and return of the separate P35 in respect of earnings paid by the overseas company and not charge interest and penalties in line with that date. If an employer pays NICs in respect of items included in the separate P35 after that extended date, interest would be charged, and if an employer files the separate P35 return after that extended date, penalties would be due for late filing. Normal interest and penalty provisions will apply in respect of the "main" return.

15. The earnings of the seconded worker will therefore be split between two of the employer's returns. Estimates of earnings (or actual earnings if the worker is paid primarily by the UK company) of amounts of at least the UEL would be accounted for on the main return. P14s would be completed at the end of the year showing the estimated amounts of salary and included on the employer's "main" end of year return. This will ensure that the contributions are posted to individuals' National Insurance accounts on time. Residual earnings paid by the overseas company will have NICs assessed on them and paid through the separate P35 system.

16. In order to set up a separate PAYE scheme to return and account for the NICs in respect of earnings paid by the overseas employer, the employer will need to make a written, signed, and dated election to the PAYE tax office they deal with normally. The election will need to specify the following:

(a) The tax year from which the election to make a separate End of Year return for each group of employees is to apply, which will be the tax year that begins after the date of the election

(b) The total number of end of year returns (forms P35) that the employer will be making from the year specified in (a) onwards

(c) The names of the separate group of employees, for example, "Employer name, main payroll" and "Employer name seconded workers NI only"

(d) That the employer understands that for all PAYE purposes that he/she/the company will be treated as a different employer for each group of employees

(e) That the employer certifies that there are no employees other than those within the groups shown at (c) above

Alternatively, the employer can ask the tax office for a form that incorporates a form of election to complete. This will be a form similar to a current P350 election to make more than one End of Year Return. The form P35 in respect of the seconded workers PAYE scheme would be issued to the employer before the extended filing date, for completion and return by the extended filing date. With the P35, the employer would be required to submit two copies of a schedule detailing each worker's name and National Insurance number, and the amount of NICs in respect of each worker.

17. The latest date for filing the separate return and accounting for the relevant NICs would be 31 January following the year of assessment, which would allow an extra nine months to obtain the information and pay over the monies due. As most other countries' tax years run from January to January, this will allow the UK employer optimal time to obtain the information required. The overseas company would be collating the same information for their tax returns. So for example, for earnings paid by the overseas company to a seconded worker for 2001/02 year, the separate P35 and the NICs would be due by 31 January 2003. An example of how the proposed scheme would work is shown overleaf.

Example 1:

Jack is seconded to the USA on 1 October 2001 for a period of three years. During his secondment, his UK employer will pay most of his salary, although some expenses will be paid from the US company. Jack is non resident for tax purposes and has been issued with a "NT" code. His employer knows that his basic annual earnings to be paid by the UK company will be £42,000, plus a cost of living allowance of £10,000.

As Jack is non resident for tax purposes and his earnings are above the UEL, his UK employer can use the separate P35 to account for the NICs due in respect of additional earnings paid by the US company.

The UK employer would account for NICs in the following way:

The basic salary and other allowances paid each month by the UK employer remains within PAYE liability. So in this example:

52,000 divided by 2 = £4,333 per month which will be put through the UK payroll with primary and secondary NICs paid in line with PAYE provisions. Paid over on the 19th of the following month.

At the end of the year, the UK employer will complete a P14 for Jack in respect of his earnings from 6/4/2001 - 5/4/2002 and include him on the main PAYE scheme P35 return.

If this return is not in by 19 May 2002, normal penalty provisions will apply.

During the year, Jack has received expenses payments from the US company which are liable to NICs. The UK employer has until 31 January 2003 to find out about these payments, account for the NICs due on them and to file a separate P35 return relating to the expenses payments. If the NICs are not accounted for or the separate P35 is not in by 31 January 2003, interest and penalties will apply from 1 February 2003 until payment is received and the P35 is filed.

Would the proposed mechanism be helpful? If not, what might be done to improve it?

Are the timescales for sending the separate return reasonable?

Are we right to build on existing processes for agreeing a separate P35 scheme? If not, what alternative arrangements would you like to see?

What might be the effect on the compliance costs of dealing with employees seconded abroad ?

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Chapter 7: Earnings Of Employees Seconded Abroad

1. As discussed in Chapter 6 there are substantial differences in the underlying tax and NICs treatment of employees seconded abroad. Employees seconded abroad will often receive a secondment package that will typically include a number of different types of payment along with the basic salary. Employers and advisors have suggested to us that it is not always perfectly clear what the liability is on the various categories of payment that make up the package. They have suggested that it would be useful if we provided better guidance on the tax/ NICs liability of such payments to help reduce confusion and errors.

• Would more detailed guidance on the tax and NICs treatment on payments made to employees seconded abroad be helpful ?

2. The table we have produced below provides details of the common types of payment and their tax/ NICs position. However, it is difficult to produce definitive guidance in this area because:

• there are a wide variety of secondment packages;
• the payments are known by different names in different circumstances;
• and tax/ NICs liability depends on residence conditions which are different. Example of a table on Tax/ NICs treatment of common payments made to seconded employees

Type of Payment	Tax Position *	NICs Position **
Salary including bonus	Taxable apply PAYE	Apply Class 1
Cost of Living Allowances- general allowance to compensate for the higher cost of living abroad	Taxable apply PAYE	Apply Class 1
Qualifying Relocation Expenses up to £8,000***	Tax relief	No NICs liability
Qualifying Relocation Expenses over £8,000***	Taxable report on P11D	Class 1A from 6 April 2000
Tax equalisation packages/ net pay agreements	Taxable report on P11D	Apply Class 1
School Fees - contract between employee and school - cash payment direct by employer to school/ payment to employee	Taxable report on P11D/ Taxable apply PAYE	Apply Class 1/ Apply Class 1
Occupational Pension Contributions	Tax relief	Apply Class 1
Foreign Travel Expenses	Tax relief	See para 3.

*This table sets out the tax treatment if the employee remains resident in the UK. This depends on the employee satisfying the resident conditions for UK tax liability (leaflet IR20). If the worker remains resident in the UK there may be treaty exemption in respect of UK tax liability and a liability in the other state.

**There are separate rules for establishing whether a NICs liability exists (leaflets NI38 and NI132).

***Appendix 7 of Expenses and Benefit leaflet IR 480 includes a breakdown of what are qualifying expenses.

• We would welcome your views on other items in secondment packages that are causing difficulty, which could benefit from inclusion in the table above.

Foreign Travel Expenses

3. In the course of our work we noted that NICs and tax are not due on certain travel expenses paid to employees seconded to work overseas. Regulation 19(1)(q) of the Social Security (Contributions) Regulations 1979 disregards certain foreign travel expenses referred to under section 193(3), (4) or (6) or section 194 of ICTA. Someone sent to work overseas is likely to cease to be chargeable to UK tax at a different point in time - generally much earlier - than for NICs. However, because of the way the NICs rules have been framed, if there is no longer a UK tax liability, the employee seconded abroad does not have, according to regulations, the benefit of two NICs free trips home a year. We plan to put this right so that allowable travel expenses for seconded workers are excluded from NICs.

• Subject to comments we may receive - for seconded workers we will amend the legislation to exclude from NICs all travel expenses that are allowable for tax. Changes will be made in a suitable package of regulations.

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Chapter 8: Benefits Provided By Third Parties

Introduction

1. Since April 1999 non-cash vouchers have attracted a class 1 NICs charge. Employers have identified practical problems with accounting for the NICs due on payments of vouchers made by third parties to their employees. The Inland Revenue has worked with employers, third parties (in particular incentive providers) and their advisors to provide a short term practical solution. This chapter seeks views on a potential longer term solution with slightly wider application.

Problem

2. The Social Security Contributions (Amendment) Regulations 1999 (SI 1999/561) brought a number of non-cash vouchers into class 1 NICs liability. Employers and accountants explained that in practice it was common for vouchers to be paid to employees not by the employer but by third parties - for example manufacturers giving shop assistants vouchers for selling their make of camera, car manufacturers giving employees of dealerships vouchers for selling more cars, incentive providers providing vouchers to staff under contract with the employer. However, the regulations left the employer responsible for accounting for the class 1 NICs due on these payments made by third parties and for paying the secondary NICs due on those payments. Employers explained that this created considerable practical problems, both in terms of finding out about payments made to their employees by the third party and in terms of the secondary NICs due on that voucher.

3. Employers and accountants also explained that this problem would become greater from April 2000 as the extension of class 1A to all taxable benefits would see employers taking on responsibility for accounting for the NICs paid on all benefits provided to their employees by third parties.

4. The problem did not arise for tax - non-cash vouchers were already subject to tax - because there was a mechanism for settling the tax liability on payments by third parties. The non-statutory taxed award scheme enables the third party to account for the tax due, and the tax due on the tax paid, by agreement with the local tax office. However, the taxed award scheme was not available for NICs and therefore there was no corresponding mechanism for dealing with third parties' NICs liabilities.

Current solution

5. The Government accepted that this was a practical problem for employers and worked with employers, their advisors and the incentive industry to develop a workable solution. The effect of the Social Security (Contributions) (Amendment No. 4) Regulations 2000 (SI 761/2000), together with the class 1A legislation in the Child Support, Pensions and Social Security Bill, is to move the charge on the third party from class 1 to 1A NICs.

Longer term solution

6. Some employers and advisers have suggested that the ideal solution would be to enable third parties to enter into PAYE settlement agreements (PSAs) with tax offices. A PSA is a mechanism for enabling the employer to settle by way of lump sum payment the tax otherwise payable by his employees on minor and incidental items, in particular minor and incidental benefits and expenses payments, and on items for which it is impractical to operate PAYE. The employer can then pay class 1B NICs on items attracting a class 1 or 1A NICs liability included in a PSA, and on the tax paid on items in the PSA.

7. Currently only employers can account for tax through a PSA (and therefore pay class 1B NICs on items included in the PSA). Section 206A(1) of the Income and Corporation Taxes Act 1988 - which provides the statutory basis for PSAs - makes it clear that "PAYE regulations may make provision….about the sums which, as sums in respect of income tax under Schedule E on emoluments of a person's employees, are to be the sums for which the employer is to be accountable to the Board from time to time." And section 10A(1) of the Social Security Contributions and Benefits Act 1992 - which introduces the class 1B charge on items in a PSA - provides that "where for any tax year a person is accountable to the Inland Revenue in respect of income tax on emoluments of his employees in accordance with a PAYE settlement agreement, a Class 1B contribution shall be payable by him for that tax year in accordance with this section."

8. Extending the scope of PAYE settlement agreements to cover third parties would - like the taxed award scheme and proposed class 1A mechanism - enable third parties to account for and pay the tax and NICs due on payments they make directly. But it would provide a common mechanism across tax and NICs - which could be more straightforward to operate than two separate mechanisms - and bring the accounting mechanism for tax into a statutory framework.

• Are employers, third parties and their advisors interested in this as a longer term solution? What would the benefits be?
• What would be the effect on compliance costs ?
• In what circumstances might it be useful?
• Would the PSA mechanism need to be adapted in any way to extend it to third parties, or is it solely necessary to extend the definition of who can use a PSA to include a third party?

9. Extending PSAs to third parties would require Finance Bill and social security legislation, as well as supporting regulations. So if employers, third parties and their advisors are interested in developing this further we shall need to pursue this over the coming years.

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Chapter 9: Summary Of Proposals And Areas For Discussion

This is a summary of the key chapters covering our proposals and the main areas where we have asked for comments.

Chapter 3: Employer compliance officer powers

The powers used by the former CA to check employers' records for NICs were different (and generally wider) in scope and application from the powers used by the Inland Revenue for tax. The CA powers came to the Revenue at the transfer but a commitment was given to review those powers and to make proposals for alignment. This paper takes that commitment forward.

We recognise that the majority of employers comply fully and voluntarily with the requirements of tax law. We need to ensure that a correct balance is struck between the burden of regulation on employers and the duty of the Revenue to properly check compliance with regulations and to prevent leakage of revenue through fraud.

The proposals in this paper are to adopt/adapt the Revenue's existing regime for tax to SSP/SMP and all classes of NIC.

We have set out what we believe to be the appropriate attributes of our powers to check employer records. Are these attributes sufficient? Are there others that we should consider?

We have concluded that it is unsatisfactory to have divergent powers for effectively the same purpose. Comments are invited on this conclusion.

We recommend extending the existing regime for tax to all classes on NIC's and SSP/SMP. We would welcome comment on this approach in light of the attributes in paragraph 6.

We recommend repeal of the powers contained in S110ZA of the Social Security Administration Act. By getting rid of section 110ZA are we left with a sufficiently robust regime with which to deal with serious non-compliance?

We believe that our suggestions will have a broadly neutral cost effect of employers. We welcome comment on this view. In particular we would welcome information on specific ways in which compliance costs will either increase or decrease if our recommended approach is adopted.

Chapter 4: Helping employers get it right

This chapter explores ways of making it easier for employers to get the calculation of an individual's Class 1 NICs right in relation to marginal items of pay e.g. expenses.

• What other sorts of payments do employers have problems with ?
• Would employers find more time to process payments helpful ?
• Would a statement along the lines of Annex 6 be helpful ?
• What might be the effect of this additional flexibility on compliance costs ?

The chapter also looks at simpler procedures for dealing with arrears and errors involving Class 1 NICs identified during an employer compliance review. While still taking reasonable steps to protect individuals' contributory benefit entitlement. Comments are invited on:-

• The use of global estimation of the arrears due where normal earnings fall between the LEL and the UEL but the amount of under recorded pay is below a set amount:
  • One off payments up to £100 NICable earnings per employee.
  • On going payments up to £5 per week extra NICable earnings per employee.
• The safeguard for those on lower wages requires identification of those earning between the LEL and the primary threshold (current year) - or a sample if the numbers are large. Are there any particular circumstances where this would not be feasible ?
• The compliance cost of savings of the revised approach.

Chapter 5: "Pay"

The definition of "pay" for tax and NICs purposes are different. Schedule E uses the term "emoluments" and NICs uses "earnings". However, we think there is sufficient similarity between "pay" for tax and NICs purposes to develop an agreed understanding of "pay", so that employers can assume common treatment (unless the payment falls into a small group of listed payments where differences exist). We have set out a draft statement on a common understanding of "pay" which could be included in the CWG2.

• Would a statement on "pay" along the lines that we have produced be considered helpful to employers and their advisors? If so how?
• Is the specific wording of the statement helpful? How can it be improved?
• Would a table which covers the principal types of payment where there are differences in treatment be helpful? Have we covered the main ones? If not, what else should be included?

Employers have been experiencing difficulties with accounting for NICs due on employers contributions to funded unapproved retirement benefit schemes (FURBS). One solution would be to move the NICs charge from Class 1 to Class 1A to align with the need to report on the P11D for tax.

• Would employers be interested in moving the NICs charge on employer contributions to FURBS from Class 1 to 1A in the longer term?

Chapter 6: Employees seconded abroad:an additional collection mechanism for National Insurance contributions

Employers and their advisors have suggested to us that they find assessing NICs on the earnings of UK employees seconded abroad particularly difficult. Chapter 6 contains a proposal to deliver an extended date for payment of the NICs due and return of a separate P35 End of Year Return, in respect of earnings paid to seconded workers by the overseas company. Interest and penalties would not be charged in line with that date. We would particularly welcome comments on the following:

• Would the proposed mechanism be helpful? If not, what might be done to improve it?
• Are the timescales for sending the separate return reasonable?
• Are we right to build on existing processes for agreeing a separate P35 scheme? If not, what alternative arrangements would you like to see?
• What might be the effect on the compliance costs of dealing with employees seconded abroad?

Chapter 7: Earnings of employees seconded abroad

Employers and their advisors have suggested that it would be useful if we provided better guidance on the tax/ NICs liability of secondment packages that seconded employees may receive.

• Would more detailed guidance on the tax and NICs treatment on payments made to employees seconded abroad be helpful?
• We would welcome your views on other items in secondment packages that are causing difficulty, which could be included in a summary table?

Chapter 8: Benefits provided by third parties

Employers have identified practical problems with accounting for NICs due on payments of vouchers made by third parties to their employees. Employers have suggested that the ideal solution was to extend the scope of PAYE settlement agreements to cover third parties to enable third parties to account for and pay tax and NICs due on these payments directly.

• Are employers, third parties and their advisors interested in this as a longer term solution ?
• What would be the effect on compliance costs ?
• Would the PSA mechanism need to be adapted in anyway to extend it to third parties, or is it solely necessary to extend the definition of who can use a PSA to include a third party ?

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