A Stealth Tax Too Far

MALCOLM GUNN FTII, TEP examines the principles underlying Class 1A National Insurance contributions.

I HAVE NEITHER the time, patience nor inclination for completing jigsaw puzzles, but I remember getting involved in one many years ago which was entitled 'The Sky at Night'. It was an enterprise which no-one should ever embark upon. All the pieces seemed to be approximately identical in both shape and colour – black background with pin pricks for stars – and it would be difficult to think of a more exasperating leisure activity. The puzzle, as it was completed at the time, clearly reorganised the entire constellations of our universe, interspersed with gaps apparently through to some other undiscovered universe where the mismatched pieces failed to fit together properly.

This unhappy episode was brought back to mind in my researches into the extension of Class 1A National Insurance contributions to nearly all benefits in kind. Those researches have taken some considerable time, and hence the belated publication of this article. My guess is that most readers will have relied on the brochures put out by the National Insurance Contributions Office for guidance on the matter; any attempt to follow the statutory provisions plummets the researcher into a mixture of amended statutes and amendments of amended regulations, all of which were rapidly superseded by consolidating provisions even before they reached the Yellow Book. Although I have no doubt that all the various provisions, in themselves, fit together much better than the erstwhile attempt at 'The Sky at Night', this is not the end of the story. The whole contributions edifice in this area is built upon the foundations of the various income tax benefits in kind provisions and the interaction with those provisions is certainly every bit as poor as the finished puzzle.

The reason for this is that the principal income tax provisions in sections 153 to 168F, Taxes Act 1988 do indeed treat the cash equivalent of a vast array of benefits as being chargeable to income tax under Schedule E, but they also leave the employee to make any claims for relief which may be available to him. Some of those claims are imported into the National Insurance legislation and some are not. Given that payroll is commonly dealt with in-house, it is difficult to imagine a tax structure which would be more likely to give scope for problems, misunderstandings, errors and ultimately interest and penalties. My prediction is that this whole area will prove to be a minefield of booby traps.

The legislation

The statutory provisions relating to Class 1A contributions are at section 10 and the following two sections of the Social Security Contributions and Benefits Act 1992. The amendments to that legislation in order to extend Class 1A contributions to all benefits in kind were made by the Child Support, Pensions and Social Security Act 2000. Regulations to modify or alleviate the charge to Class 1A contributions have been made and they are now in the consolidating provisions of the Social Security (Contributions) Regulations 2001 (SI 2001 No 1004).

Section 10 of the 1992 Act, as amended with effect for 2000-01 onwards, gives rise to Class 1A liability as follows:

Exceptions

The foregoing charging provision is of a sweeping nature and of course very often the prima facie charge to tax under Schedule E is relieved by claims made on the employee's self-assessment return. The Class 1A contributions legislation attempts to deal with this by allowing some of those claims to be taken into account, but not others and by providing for some reductions, a global disregard and also some specific disregards. Bearing in mind that the scope of Class 1 contributions already has its own interaction and discrepancies with the income tax provisions, one begins to see what a minefield this will all turn out to be when applied in practice. For example, a round sum expense allowance towards business travel technically gives rise to liability to Class 1 National Insurance contributions whereas there may be no income tax liability on the allowance, although clients often fail to appreciate any distinction between a specific allowance and a round sum allowance.

The global exception

If an amount is paid to an employee by way of reimbursement of expenses, then provided that the sum paid is fully covered by a claim for income tax relief by the employee under one of the following sections (but no others), then no Class 1A contributions liability arises in respect of that reimbursement. The relevant income tax relief provisions (in the Taxes Act 1988) are, for this purpose:

Note that the global disregard does not apply if the reimbursed expense is not fully deductible under any one of the four provisions set out above. In that case the whole amount is chargeable to Class 1A contributions.

This global disregard has a mirror provision in section 156(8), Taxes Act 1988 which allows for deductions from the cash equivalent of benefits under those sections if the cost of the benefits concerned had been incurred by the employee personally. The problem is of course that the deductions are often made on the employee's own return so that the employer does not necessarily know whether the employee is claiming wholly business use or is admitting to some private use.

Beneficial loans

This problem will be particularly acute in the case of beneficial loans. Following the Finance Act 2000, loans where the whole of the notional interest is tax deductible as regards the employee, whether under section 353, Taxes Act 1988 or in business accounts or the accounts for a property letting business, are now excluded from the beneficial loans provision in section 160 and therefore need not go on form P11D. As a result, they escape liability to Class 1A contributions. However, the employer will have no knowledge about the employee's own tax position, and in many cases neither will the employee who leaves such computational matters to an accountant. Or, if he is asked, he may give a wrong answer not realising that the whole of the loan is not eligible for relief, and the accountant may not be able to give a definitive answer by 6 July after the year-end.

The problems here are compounded by Revenue publication CWG5 which lists the National Insurance contributions treatment of numerous types of benefit and it states that qualifying loans are not liable to Class 1A contributions. This is clearly wrong; qualifying loans are defined in section 161A as loans where the whole or part of the interest is eligible for relief. To escape Class 1A liability, the loan does not need to be a qualifying loan; it needs to be one where every penny of notional interest is tax deductible by the employee, or else one of the other exemptions applies. Otherwise all the benefit is liable to Class 1A contributions even if nearly all the interest is allowable.

Insignificant private use

It should be remembered that assets provided to the employee outside the workplace with insignificant private use are now disregarded for the purposes of the benefit in kind provisions, following the Finance Act 2000. They are therefore also disregarded for Class 1A purposes. As with all tax these days, there are exclusions from this exclusion, these being cars, boats, aircraft and property alterations.

This general exclusion was no doubt introduced with the best of intentions but it will be a fertile area for dispute as to whether the nebulous phrasing is satisfied and part of the test is completely beyond the knowledge of the employer, who may therefore ignore the new section.

Specific exclusions

Regulation 40 of the Social Security (Contributions) Regulations 2001 sets out 'prescribed emoluments in respect of which Class 1A contributions are not payable'. Once one trawls through all the various provisions and cross-references, the list is quite lengthy, although it mostly follows what common sense would tell you the position to be. One odd feature is that seventeen Inland Revenue extra-statutory concessions are in the list so that presumably it would be possible to appeal to the courts over matters relating to these concessions insofar as they impact on Class 1A contributions, but one could not do so insofar as they relate to income tax matters. I will not trawl through every excluded item which can be identified from all the various references, but more important ones are as follows:

Childcare

The subject of employer contributions towards the cost of childcare as a benefit for employees merits separate and careful analysis. Readers will be well aware that there is a very limited exemption for income tax purposes where the employer organises childcare facilities for employees, but this exemption does not cover payments towards the cost of childcare facilities at home. As has been widely reported, there is a much wider exemption which applies for Class 1A National Insurance contributions purposes which does include care in the home including that by a relative or nanny. Although the regulations containing this exemption are drafted in modern plain English style, I do not find them any more comprehensible than the old-fashioned style.

Exemption is for childcare costs incurred by an employed earner in respect of a child not exceeding the age of 16 for whom the earner has parental responsibility, but excluding school fees. 'Childcare' is not a defined term, but the regulation states that it includes various aspects of childminding, some of which are exceedingly restrictive in scope, for example 'in the case of a child under 8, care provided by a childminder where that care does not exceed in total two hours in any day'. If what we have in the regulation is not a definition but simply various aspects included in the global term 'childcare', and which therefore must embrace other unidentified aspects, it does not seem appropriate to have such a restrictive provision. For children over 8, unrestricted care provided by a childminder is included in 'childcare' and there are other general matters included in this term such as 'care provided by a relative or nanny' and 'care provided during out of school hours and during school holidays'.

The interaction between all these provisions is something of a mystery, but perhaps a more important point is that the apparent wider scope of the Class 1A exemption, as compared with the income tax exemption, is highly misleading to the uninitiated. If the benefit is provided by way of cash, we are not even talking about Class 1A contributions at all, but rather Class 1 contributions which contain no exemption at all in relation to childcare. Why then does the Class 1A exemption apply only to costs 'incurred by the employed earner'?

It seems that in order to escape National Insurance contributions liability on the provision of childcare in the home for an employee, what is required is a contract direct between the employer and the relative, nanny or childminder and payments direct from the employer to that person. (But then those are not expenses incurred by the earner!)

Extra-statutory concessions

Numerous Inland Revenue extra-statutory concessions are listed as being applicable for Class 1A contributions purposes. The more important ones for these are:

• A11 (residence in the United Kingdom – split years);
• A22 (long service awards);
• A57 (suggestion schemes);
• A58 and A66 (travel allowances during strikes or for late night journeys);
• A70 (small gifts by third parties and staff parties);
• A74 (staff canteens);
• A91 (division of living accommodation charge between more than one applicable employee).

It must be remembered that these are Class 1A exclusions and not general National Insurance contributions exclusions, and therefore they largely relate to benefits in kind. However, there is an equivalent exclusion for Class 1 purposes for the strike or late night travel allowances.

Mind-boggling

As readers will by now appreciate, what employers and payroll bureaux face here is a labyrinth of different rules applying for income tax, Class 1 and Class 1A with some crossovers, some similarities and some distinctions, all tossed in together without any particularly comprehensible game plan to the layman. We tax people will see how the whole thing got in this mess, but I pity the payroll department for the small family business. It is all very well for the Contributions Office to put out publication CWG5 with its massive list, but one still needs to know one's way round the list and to know what some of the particular items are really driving at. I think I would rather attempt 'The Sky at Night' jigsaw than try and operate this list in practice.

For example, the first item in the list instructs Class 1A contributions to be levied where an asset is placed at the employee's disposal for mixed business and private use so long as private use is not small(!). How many will know to look further down the list to find a special item for computers, 'annual value and running expenses of £500 or less – no liability'. And what is annual value? Only those studying section 156, Taxes Act 1988 will understand this. Furthermore, the list says that in the case of assets transferred to the employee which are not readily convertible assets (what are they, I hear the office clerk asking), there is Class 1A liability and not Class 1 liability. But further down the list goods such as furniture transferred to the employee have differing treatment identified according to whether or not the employer contracts or the employee contracts; the former gives rise to Class 1A liability and the latter Class 1 liability.

There is an item for telephones with a vast array of different consequences according to who contracts to provide the line, but employers will need to be alive to the separate item for mobile phones with yet another set of varying outcomes. And in both cases the positions will be different yet again if the expenses are debited to director's loan account.

Even more inscrutable are the items for entertainment expenses, where reimbursement of staff entertainment is listed as having Class 1 liability, although staff would dispute this, saying that it is a specific business expense; employer contracts for staff entertainment are listed as having Class 1A liability, but I would have thought that it depends what the function was all about.

I have to say that, even with my knowledge of tax legislation, many items in this list take some fathoming out as to the reasoning behind them and I am still struggling with some of them (childcare, for example). Much of the problem arises from the fact that although form P11D is in theory the starting point for Class 1A contributions, items on that form have to be adjusted for those already considered to have fallen within Class 1 contributions and then once again for those items which have been given special Class 1A treatment, distinct from the income tax treatment. Many items have differing treatment for contributions purposes only according to whether the employer is considered to contract or whether the employee contracts. That in itself is a hotly disputed topic because in the case of a company it can only contract through the operations of its staff. The Contributions Agency has taken the view that for it to be an employer contract, the staff must notify the supplier of the capacity in which the supply is made before placing an order, and this is supposed to lead to laughable operations in local shops and garage forecourts with young shop assistants listening to gibberish in which they have absolutely no interest.

The list in publication CWG5 shows only the profit element in a round sum expense allowance to be liable to Class 1 contributions, which came as a surprise to me as the received wisdom in the past was that the whole allowance was liable. Has the Revenue confused itself by applying section 198 to Class 1 contributions, when it can only have relevance to Class 1A contributions?

Also has the Parliamentary draftsman confused himself by referring to section 332(3), Taxes Act 1988 (clergymen's tax allowances)? The items listed in that subsection relate to claims on the clergyman's self-assessment return for various expenses which he may have incurred personally and it is hard to see how they could ever have relevance to National Insurance contributions.

A quagmire

All in all, I am confident that it would take the average person several months of study to get even a basic understanding of this latest charge on the employer. It is a stealth tax too far. The whole business is a quagmire and it is very unfair indeed of the legislature to expect a layperson to work it all out for himself and send the right amount of tax off at the right time, under threat of penalty for getting it wrong.

My guess is that even major employers with expert payroll staff are proceeding on the basis that they are bound to get some things wrong and it will be easier to take it on the chin when they are caught out, rather than struggle with all the details of the now incredibly technical benefit in kind provisions. If this is our modern enterprise friendly tax system, I dread to think what the system would be like without the so-called encouragement for enterprise.

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