Simplifying tax on key life events
By Donald Drysdale for ICAS
14 November 2019
Donald Drysdale studies the new OTS report on life events, and finds that Scottish taxpayers in ‘net pay’ pension schemes may be disadvantaged.
Life events
In October the Office of Tax Simplification (OTS) published a policy paper entitled OTS Life Events review: Simplifying tax for individuals. Its stated aim was to look at ways to improve people's experience of the tax system at key events in their lives.
The report makes 15 recommendations to help tackle complex tax issues that can arise in relation to events such as having children, entering work, saving for or drawing a pension, and helping others who need support.
While addressing a wide range of subjects, the report highlights three particular topics for special attention: pension reliefs and pension charges; the high income child benefit charge (HICBC); and tax education.
Pension contributions
The OTS recognises that the pensions savings landscape is complex, and regards it as inevitable that the tax issues arising will reflect this. However, the report identifies some specific tax rules which significantly add to the complexity.
Employers can choose between ‘net pay’ or ‘relief at source’ arrangements when providing pensions for their employees. This choice affects the operation of income tax but makes no difference in relation to national insurance contributions (NICs).
For employees with total income below the personal allowance, this choice makes a difference to their net pay packet, because ‘relief at source’ arrangements enable the pension savings to be topped up by ‘tax relief’ even where the individual doesn’t pay income tax.
By contrast, ‘net pay’ arrangements are administratively easier, allowing the full income tax relief to be allowed when deducting tax under PAYE, but they provide no ‘top up’ in cases where the employee has insufficient income to pay income tax.
The overall effect is that, when gross pay is at or below the personal allowance, people saving the same amount into their pension end up in different positions. Those in ‘net pay’ schemes have to fund it all, while those in ‘relief at source’ schemes gain from the relief from the exchequer.
The latest figures available, for 2016/17, show that this difference works to the detriment of 1.1 million individuals out of the 2.4 million workplace pension savers who have income less than the personal allowance.
Many employers choose ‘net pay’ schemes to simplify administration – they don’t have to claim tax relief from HMRC, and the employee automatically receives tax relief. However, it seems unfair that the employee’s relief can be lower in this instance.
The OTS suggests equalising the outcomes between ‘net pay’ and ‘relief at source’ schemes for people with income below the personal allowance. It also wants HMRC to improve their guidance on the tax consequences of particular pension arrangements, and review arrangements for the annual and lifetime allowances.
HMRC should also improve the explanatory notes they provide with tax coding notices when people first receive the state pension, or another pension, and when special ‘K-codes’ are applied to other sources of income within PAYE.
A Scottish dimension
Another difference between ‘net pay’ and ‘relief at source’ schemes affects Scottish taxpayers, who pay income tax on their non-savings, non-dividend income at rates set by the Scottish Parliament.
Employees whose marginal rate is the Scottish starter rate of 19% and who contribute to ‘net pay’ schemes receive tax relief at 19%; however, if they contribute to ‘relief at source’ schemes, they receive tax relief at the basic rate of 20% and HMRC don’t seek to recover the 1% difference.
Taxpayers liable to income tax at the Scottish intermediate, higher or top rates of 21%, 41% or 46% get tax relief on pensions contributions at 20% at source, and can claim the additional relief due through self assessment or by contacting HMRC.
Child benefit
While child benefit has existed since the 1970s and is fairly well understood, the high income child benefit charge (HICBC) has caused massive confusion ever since it was introduced in 2013.
Where an individual receives child benefit and either they or their partner have income of more than £50,000, HICBC claws back a tapered proportion of the child benefit received – up to 100% if that income is above £60,000.
Those affected have various options about what to do, and the consequences of these options are not obvious. The options are to:
- not claim the benefit at all;
- claim the benefit, but not to receive payment of it; or
- receive the benefit but pay some or all of it back through HICBC.
Registering a claim for child benefit, but then opting not to receive it, is the only way to avoid an HICBC charge and its associated administration, while preserving national insurance entitlements.
Child benefit has important links with the wider national insurance system. It provides the main way children are issued a national insurance numbers as they turn 16. It also provides the child benefit claimant with NIC credits until the child is 12.
If child benefit is not claimed, the child will eventually face an additional step to prove their identity to get their national insurance number. Furthermore, one of the parents (very often the mother) may lose out on state pension, to which a more complete NIC record would entitle them.
The OTS wants the government to simplify the arrangements surrounding child benefit and HICBC, and improve related guidance.
Other recommendations
It suggests that HMRC should focus on practical issues arising in connection with starting work, changing jobs, taking on additional jobs and claiming expenses in its ongoing work to improve the operation of the PAYE system.
The report recommends maintaining Basic PAYE Tools software and improving related guidance for non-commercial employers, particularly those who employ carers
HMRC should review the forms issued once a death has been notified through ‘Tell Us Once’, and consider how they could work more effectively, rapidly and sensitively with personal representatives to gain a complete view of the tax affairs of the deceased and the survivor.
The OTS wants HMRC to integrate and improve its various sources of guidance for those helping others, including agents and those with powers of attorney, to help make it easier for suitable people (whether paid or not) to take on such roles.
HMRC should collaborate with schools, other educational bodies and academic researchers in their efforts to improve the public’s understanding of tax and finance.
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