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Tony Wickenden: Pension tax relief debate has not been solved by NIC U-turn

Last week I considered the now famous U-turn on an increase in National Insurance contributions for the self-employed proposed at the Budget.

This week, I want to look at what the implications of that move might be for any other plans the Government has to reduce tax inequality between the employed and the self-employed and/or make up the lost income the NIC change would have generated.

It seems the U-turn will cause a hole in the Government’s financial plans and some commentators believe this will prompt the Chancellor to turn his attention to reviewing pension tax relief.

Before going on to consider the likelihood of this happening, it is worth noting – as a colleague recently pointed out – that in the grand scheme of things, the average £500m a year attributable to the Class 4 NIC increase is somewhere between small beer and a rounding error.

So, while some kind of retribution-based response cannot be entirely ruled out, there is no obvious connection between a non-implemented NIC increase, which will not have a major financial impact on government finances, and a change to pensions taxation.

That said, the amount at stake when it comes to pension tax relief – over £30bn – means it is always going to be under the microscope.

Of course, saving on the cost of tax relief is not the only factor that could drive change to pension taxation. Changing savings behaviour more fundamentally is also a key objective.

Arguably, the Lifetime Isa is a market research project to test the attraction of incentivising saving in a different way: that is, through a monetary incentive as opposed to tax relief, which people do not really understand. If you do not understand something, how are you going to be motivated by it to change your behaviour?

Anyway, what I am saying is that pension tax relief reform is a big enough issue on its own not to be substantially affected by the NIC U-turn.

Expect change

But there are clearly many moving parts to this debate and, especially given the Taylor review on modern employment practices, it seems unlikely we will not see any further changes to taxation or NI on earnings from work (though maybe not to the rates specifically; at least in this Parliament).

Indeed, the change to NICs was not the only one proposed in relation to the Government’s disquiet over the differences in taxation on earnings of the employed, self-employed and owner/managers of private limited companies.

Just as it was identified the earnings of the self-employed generate less NI than equivalent earnings of the employed, it has long been recognised that generating income from work through a limited company and removing those earnings by way of a dividend results in substantial savings in NI. After all, dividends are not earnings.

Over the years, the Government has taken successful action to assess earnings based on the substance, rather than purely the form, of how they are generated.

The IR35 provisions and the attack on “one person companies” are aimed at looking through corporate structures established to invoice for whom the work is done, receive the money into a low-tax environment and pay out any funds required for which the client pays by way of salary to the extent it falls below the thresholds for tax and NI and the rest by way of dividend.

Implying an employer/employee relationship between the client and the person doing the work prevents this beneficial outcome. But where there is a substantial legitimacy to the corporate structure, the fact remains that dividends are not subject to NI.

To increase the yield from legitimate businesses, the Government increased the rates of tax payable on dividends above its introduced £5,000 per annum allowance by an additional 7.5 per cent. So, on dividends above the allowance in a tax year, basic rate taxpayers pay tax at 7.5 per cent, higher rate taxpayers at 32.5 per cent and additional rate taxpayers at 38.1 per cent.

Given that most SME owners will draw more than £5,000, that move was quite a smart one from the Treasury. And now the Chancellor has announced that, from the 2018/19 tax year, this tax free allowance – and thus the threshold above which these higher tax rates will be paid – will fall to £2,000.

Tony Wickenden is joint managing director of Technical Connection. You can find him Tweeting @tecconn

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