The Office of Tax Simplification wants to avoid piecemeal changes which risk adding further layers of complexity
The Office of Tax Simplification published a 50-page paper entitled Savings income: routes to simplification in May.Quite what prompted the work is unclear (it had not been mentioned by Chancellor Philip Hammond), but the topic is certainly a suitable case for treatment.
As the OTS notes (without naming previous chancellor George Osborne): “Many of the issues have arisen because of a series of changes, each working well enough taken by itself but which together create significant complexity that is not easily resolved.”
The paper, which looks across all investment income, including dividends and pension payments, points out that 95 per cent of people pay no tax on savings income thanks to the starting rate for savings, personal savings allowance, dividend allowance and Isas.
However, it adds: “The interactions between the rates and allowances is sufficiently complex at the margins that HM Revenue & Customs’ self-assessment computer software has sometimes failed to get it right. It is proving very difficult to create an algorithm that calculates the tax correctly in all circumstances.”
The OTS floats a range of proposals for further work, which suggests a more formal consultation may emerge in Hammond’s Autumn Budget. The main areas put forward for review are as follows:
Streamlining the interaction of income tax rates and allowances
The OTS suggests the order in which allowances are deducted should be specified (as the order of income is at present). The current law is that the allocation of personal allowances (and reliefs available against general income) should be made in a way which will result in the greatest reduction in the liability to tax. It is this optimisation which has triggered the HMRC self-assessment errors.
The OTS would also like to see the PSA and DA become genuine allowances rather than nil rate bands: a simplifying measure which it accepts would reduce Exchequer income. Going further, it floats the idea of merging the PSA and SRS (which benefits fewer than 300,000 people) or even exempting savings interest from tax completely, either for basic rate taxpayers only, for individuals with income below a certain threshold or for individuals over pension age.
It is proving difficult for HMRC to create an algorithm that always calculates tax correctly
On the dividend front, a more radical option would be to end differential rates (7.5 per cent, 32.5 per cent and 38.1 per cent). The OTS says this change “would have the effect of increasing the amount of tax due from those who receive amounts of dividend income above the dividend allowance. It would also impact the taxation of profit extracted as a salary or as a dividend from family-owned companies”.
Given the ongoing issues with National Insurance contribution increases, IR35 and personal service companies, the attraction of such an idea for the Treasury is in little doubt.
Introduce a personal tax roadmap
This is the OTS asking the Treasury to set out a long-term tax strategy, rather than make yearly tweaks that have created the current situation.
The OTS believes Isas have become too complicated, with a variety of traps for the unwary. It suggests enabling partial transfers of money invested in-year, (in line with transfers from previous tax years’ Isas), removing the “only one Isa of each type per tax year” rule and reinstating the rule, scrapped in April, allowing transfers from Help to Buy to Lifetime Isas without affecting the annual Lisa allowance.
On Lisas, the OTS rightly observes take-up has been slower than predicted, with just one provider offering a cash Lisa. It wants the 25 per cent early withdrawal charge re-examined. It shares the FCA’s view that the effect of the charge is poorly understood and has been a deterrent to firms entering the market.
Review guidance on pension withdrawals, and the use of emergency tax code for lump sum withdrawals
The OTS joins in the growing criticism of the way in which the PAYE system and pension flexibility have been forced together, resulting in an initial overpayment of tax in most instances when lump sums are withdrawn. One option mentioned is a flat 20 per cent tax deduction where it has not been possible to operate the correct code for an individual, with any balance collected via self-assessment.
Review rules on part surrenders of life assurance policies
The OTS wants to see a review of this area once the new system for handling wholly disproportionate gains has bedded down. Interestingly, it says HMRC has only received around 15 applications to date for consideration.
In conclusion, the OTS says it considers it important not to make piecemeal changes, which risk adding further layers of complexity. On past performance it looks unlikely its wish will be granted.
Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn