When is a tax not a tax?

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Share schemes expert, Philip Fisher of Chantrey
Vellacott DFK
provides a provocative view on Gordon Brown’s recent changes to National Insurance Contributions.

We all think that we know what a stealth bomber is. This is an aeroplane that approaches its target unseen and unheard and then unleashes carnage. A stealth tax follows some of the same principles. This is a tax that approaches in the guise of a supplier of hospital beds and comfort in old age, but turns out to be a way of emptying pockets politely.

National Health Insurance
The game is slightly given away by a mature generation that still refers to National Insurance Contributions as NHI which apparently stands for National Health Insurance. They fondly (well perhaps not) remember the days when you purchased your weekly stamp. The term hypothecation may not have been known but the stamps were intended to pay for the National Health Service and other generally good and worthy things.
In fact, David Lloyd George was the Prime Minister when the scheme was introduced which gives an idea of its age. It started before the First World War and even though it was initially introduced as a short-term measure, it is enjoying more popularity and success with the Government of 2002 than at any stage in living memory. The yield to the Exchequer from this levy dwarfs those from many recognised taxes. In the last set of published figures, it represented over 15% of all taxes and brought in twice as much money as Corporation Tax .

NI reform
For many years, political and tax commentators have been suggesting that in the spirit of honesty the Government (of whichever colour) should abolish National Insurance Contributions and increase income tax rates to appropriate levels. The claim that there is any connection, however tenuous between contributions paid by employers and employees and the quality of the health service or the availability of State Retirement Pensions has become increasingly hollow.

In his 2002 Budget speech, Chancellor Brown has gone a considerable way towards the concept of adding extra nuclear warheads to his stealth tax. First, against all precedents, he actually referred to National Insurance Contributions as “”a tax””. He seems to have forgotten the charade by which successive Governments had denied any suggestion that this is the case. Whether he has been blessed with a new gift of honesty or whether he just forgot to play the game is uncertain.

Recent NI history of changes
In view of the latest changes that are proposed, this seems a good time to take stock of the changes in the nature of National Insurance Contributions over the last few years with particular reference to the “”taxation”” of employers and employees.

For many years, National Insurance Contributions were broadly deducted from payroll based remuneration but not from any other benefits. Contributions were payable, at different rates, by both the employer and the employee on this remuneration.

As avoidance measures became more sophisticated, the Government with the assistance of what was then a separate Contributions Agency of the Department of Social Security began to expand the legislation. Before long, they were taken over by the Inland Revenue and now form its National Insurance Contributions Office.

NI on benefits
The widening of legislative scope meant that higher value benefits such as fine wines, gold bars, and platinum sponges all became subject to separate National Insurance charges under Class 1 which applied for both employers and employees. Many cases were taken to court as wily taxpayers (or non-payers) and their advisers sought ways of escaping charges of around about 10% each for employers and employees.

At around the same time, there was also the case of a private nursing home in the Midlands that chose to pay its employees about 75% of their salary in vouchers for high street stores because these were also exempt from National Insurance Contributions. Much as one may love Marks & Spencer‘s or Sainsburys, the prospect of buying all of the necessities of life from these suppliers as a means of saving your employer National Insurance Contributions is not particularly palatable.

Class 1A
Class 1A Contributions had originally been introduced in 1991 to provide a means of applying National Insurance Contributions to company cars and private fuel. Only primary contributions were charged i.e. the employee did not face an NIC charge. While this may seem to be a generous measure on the part of the government, there was no great compulsion to extend this liability to employees, there was a cap at a salary of about £18,000 (now increased to about £30,000) above which secondary contributions were not payable.

From 6 April 2002, Class 1A contributions have been extended to apply to the vast majority of benefits that are not already caught by specific Class 1 legislation. However, the advantage of Class 1A remains that these contributions are only payable by the employer and not by the employee.

As the legislation has developed in recent years, the only items that generally remain outside the NIC net are those that are exempt from Income Tax. These include such things as shares provided under Inland Revenue approved arrangements and mobile phones.
It seemed that after the enactment of the legislation that introduced the wider scope of Class 1A there was little left for any Chancellor to do except abolish the upper earnings limit for employees. This had been mooted in the weeks leading up to each Budget and interim report since the days of the last Government. While this may have been an attractive prospect from an economic perspective, the political ramifications of taking such action could have been drastic.

While the current government may enjoy a massive majority, if every employee in the country earning more than about £30,000 had faced this extra financial burden, William Hague might have found himself as Prime Minister in 2001.

Removing the upper limit
While this measure was not deemed to be stealthy enough, Chancellor Brown had been beavering away behind the scenes in an attempt to find a new invisible way of bolstering his finances. The conclusion that he came to was that while removing the employee‘s upper limit was political suicide, the introduction of a new levy still entitled National Insurance Contributions and using similar principles was an ideal solution.

To charge a mere 1% to employers and 1% to employees sounds totally inconsequential. It is not. This is because the extra 1% applies without any upper earnings cap for employees and unlike an increase in the top rate of income tax it will apply to everyone earning over £75 a week, subject to inflationary increases. It could be argued that the Chancellor also showed remarkable shrewdness in delaying implementation for a year. This is now an unpleasant measure of which everyone is aware but it is not yet costing him or her anything. When it finally applies, some of the sting will have been taken from it.

Future NI avoidance
The good news is that the NIC avoidance industry will almost certainly be cranking itself back into existence in the near future. While the extra 1% each for employers and employees may not sound a very large amount, pundits are confidently predicting that this is only phase one. Having invented such a super wheeze, the Chancellor or his successors will almost be certainly be looking to increase the extra levy gradually from 1% to perhaps 2% or even 5% over the next few years.

If it reaches the latter level then unless the legislation relating to class 1A contributions changes to extend these to employees as well as employers, there is plenty of scope for minimising liability by providing benefits to employees rather than cash payments.
It is therefore easy for the cynical to make two confident predictions with regard to the use of National Insurance Contributions in the near future. The first is that the 1% figure is unlikely to stay the same for any great length of time. The second is that an overall review of the scheme might well take place, the consequence of which might be the extension of Class 1A contributions to employees as well as employers.

The world and the country may have come a long way since the days of Lloyd George, but his successors must be very grateful to him for providing the mechanism whereby taxes could be raised without the temperature of the nation following suit.

Philip Fisher

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