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If the official slogan is to be believed, tax doesn’t have to be taxing. But with the UK possessing one of the longest tax codes in the world, this cheery catchphrase does not ring true for many.
There is nothing quite like the increasing complexity of the tax system to get experts hot under the collar. “It is a viciously complicated area,” says Nimesh Shah, a partner at Blick Rothenberg, an accountancy firm.
Tax complexity can itself be a kind of tax borne by the unwary. Philip Booth of the Institute of Economic Affairs says: “People who are more astute and use professionals pay less than others. It brings the tax system into disrepute.”
The reverse can also be true: ordinary taxpayers may not realise how complex the tax system can be . . . and find out the reality to their cost. When the Financial Times asked experts for their top gripes about complexity, it released a torrent of responses. From pensions to property, from expenses to employment status, here are the 10 top issues raised, along with an assessment of the prospects for reform.
1. National insurance contributions
People who sell their work through their own business can make particularly big tax savings, as they can be paid through dividends or capital gains rather than wages. But the self-employed also have a big tax advantage, averaging £1,240 a person a year, because of much lower rates of national insurance contributions.
The varying tax treatment of different ways of working is one of the top bugbears for Helen Miller, head of tax at the Institute for Fiscal Studies (IFS), a think-tank. “We have a lot of complexity at the heart of the tax system, where the personal and corporate tax systems collide, that creates all sorts of avoidance opportunities and inefficiencies,” she says.
Like many experts, Ms Miller also bemoans the separation of income tax and NICs, especially as it encourages people to believe, wrongly, that NICs are a payment for future benefits. She says: “Having NICs operate effectively like an income tax but having different thresholds and rate schedules is unnecessarily complex.”
One illustration of the complications caused by the separation of NICs and income tax is the plight of people living in Scotland with a taxable income between £43,430 and £45,000. They will pay a marginal tax rate of 52 per cent rather than the 32 per cent that applies to those earning an identical amount in the rest of the UK. That is because the Scottish government retained a lower threshold for the start of higher-rate tax (it went up in the rest of the UK) but has no power to make a corresponding adjustment for NICs.
2. High marginal tax rates
Forget the 45p rate of income tax on those earning more than £150,000 a year. The highest rates of tax are often levied on much lower incomes, as a result of the withdrawal of allowances and benefits. Abolishing these “disincentivising and punitive marginal income tax rates” is top of the wish list for simplification, says Stephen Herring, head of tax at the Institute of Directors.
High marginal rates are experienced by some of the several hundred thousand families in which the highest-income adult is on £50,000 to £60,000, as some of their child benefit is clawed back. The extra marginal tax rate is about 11 per cent of income and 7 per cent for each subsequent child.
Several hundred thousand people are also affected by a 60p rate on earnings of £100,000 to £123,000, caused by the withdrawal of the personal allowance.
The prospect of taking home just 38p in the pound (after tax and national insurance) on earnings in that band is a powerful disincentive, according to Dave Chaplin of ContractorCalculator, a website for freelancers. He says it is the reason why many surgeons are reluctant to work overtime for the National Health Service and instead do tax-efficient private work through a limited company. “The result is less operating time [for the NHS], waiting lists growing longer, and disillusionment,” says Mr Chaplin.
3. Digital dismay
One of the most striking illustrations of the growing complexity of the tax system is that HMRC’s software does not always provide taxpayers with the right answer. Robin Williamson of the Low Incomes Tax Reform Group says: “A good test of whether a policy is workable is whether the tax authority can program it.”
This year thousands of taxpayers will be required to file paper returns because of errors in the tax computation software for the 2016-17 tax year. The problems were caused by the interaction of the new tax-free allowances for dividends and savings and the zero per cent savings rate band.
Paradoxically, the reason for the problems is an attempt to simplify the tax code, according to Jonathan Riley of Grant Thornton. The government introduced allowances to remove many individuals from self-assessment. Those who remain, however, have to deal with a substantially more complex tax system, which, says Mr Riley, results “in relatively straightforward cases requiring detailed and complex analysis to identify the most tax efficient position”.
4. Capital gains tax
Working out the relevant rate of capital gains tax is now a lot more complicated. “Not only are there higher and standard income-tax levels but also two rates depending on the assets — residential property and chargeable assets,” says Justin Urquhart Stewart, co-founder of Seven Investment Management.
Calculating gains where income has been accumulated or reinvested can be particularly tricky, says Ian Dyall, estate planning expert at Tilney, a financial planner. “The data required is often long since lost and most providers can only provide a long list of past transactions, making it difficult to calculate the gain. Fund mergers and corporate actions can complicate things even further”.
A source of extra complexity is the frequent changes to rates, as chancellors oscillate between keeping them low to encourage investment and raising them to discourage avoidance. When chancellor George Osborne slashed capital gains tax rates in March 2016, it was greeted by the IFS as “the latest episode in an inglorious history of yo-yoing in CGT policy”.
The complexity of pensions rules has dramatically increased, as governments have scaled back annual and lifetime allowances in an effort to rebuild public finances.
There are particular problems for people earning more than £150,000 who are snared by a new annual allowance taper. If they inadvertently breach the limit, they face unexpected tax bills of up to £13,500.
There is also a lot of complexity for many pensioners on low incomes, partly because of confusion over which of their benefits are taxable. Mr Williamson of LITRG pins some of the blame on the refusal of the Department for Work and Pensions to operate pay-as-you-earn on the state pension. This has meant a lot of pensioners have been forced to complete self-assessment forms.
HMRC is testing a system of “simple assessment” that will calculate the extra tax they owe, allowing about 400,000 taxpayers to avoid the chore of form-filling. Mr Williamson says this will “probably alleviate some of the complexity but it will depend on the ability of the taxpayers to check the data used”.
Pension freedoms have brought a further complaint over complexity: HMRC typically applies an emergency tax code to those withdrawing a lump sum from their pension, resulting in substantial overpayment, according to mutual pension provider Royal London. It said this week that in April-June this year, HMRC had to pay about 10,000 refunds worth more than £26m.
6. Inheritance tax
Much of the complexity around this tax comes from reliefs for agricultural land and business property. While many people who seek to avoid IHT will know the rules, other aspects of the tax can trap the unwary. One example is the anti-avoidance rules that can hit people who reorganise their affairs so they can share a home with elderly parents.
Another source of complexity are the new rules aimed at allowing a couple to leave a £1m property to their descendants without paying IHT. The provisions even require users to have an understanding of algebra.
Other than IHT, no tax is less popular than stamp duty land tax. Critics are particularly unenthusiastic about the surcharge introduced in 2016 for buy-to-let and second homes.
The TaxPayers' Alliance says the new tax has unintended consequences. House-buying chains may break because temporary ownership of two properties triggers a charge. This can be reclaimed but buyers still need to have cash to hand. “One virtue of this tax was simplicity: now people are asking if they should get divorced to save,” the alliance says.
Cuts to tax relief on mortgage interest, being phased in over four years from last April, are hitting buy-to-let landlords. Tim Stovold of Kingston Smith, an accountancy firm, says very few people are aware of the actual mechanism in the tax calculation that will apply when tax returns for 2016/17 onwards are completed. The way it is calculated is likely to surprise some people by pushing them into the 60p income tax bracket, removing their eligibility for child benefit or by reducing their ability to make pensions contributions.
The Lifetime Isa, a savings account for the under-40s, left many young people confused about how best to save for retirement when it was introduced last April. A lot of savers are bemused by the sheer variety of Isas. Mr Stovold says: “The continued reinvention of the Isa is baffling people.”
Complexity is also getting in the way of attempts to encourage business investment, says Andrew Hubbard of RSM, an accountancy firm. He says the enterprise investment scheme is “notoriously complicated”.
Investment bonds also contain traps. Paul Aplin, a partner at accountancy firm AC Mole & Sons, says: “Taxation of bonds is a good example: they are sold in their thousands but the tax consequences of partial surrender or death of the bondholder sometimes come as a shock”. Policymakers who withdraw funds early can face high tax bills but may be unaware they can apply for relief from HMRC.
Trusts are a particularly complex area of the tax system, in part because of the Treasury’s efforts to stop them being used to avoid tax. Mr Dyall, of Tilney, says many trustees are amateurs who are often unaware of their responsibilities. Most trusts created since April 2006 are subject to inheritance tax on every tenth anniversary. The calculation is “the stuff of nightmares”, he says.
Arabella Murphy, head of private wealth at Maurice Turnor Gardner, a law firm, says if she could wave a magic wand, she would abolish most niche reliefs and allowances. Instead she would either apply more generous limits to simple reliefs or reduce the headline rates of tax.
She says that judging by the height of a stack of tax-law guides, this would probably halve the amount of tax legislation, which has, roughly speaking, quadrupled since she qualified in 1996.
Even the fiercest critics of the tax system accept that simplifying it is easier said than done. That is vividly illustrated by the struggles of the Office of Tax Simplification, set up in 2010 with the task of simplifying the “spaghetti bowl” of tax rules for the Treasury. Over the past seven years it has conducted 14 big projects, produced about 40 reports and put forward 450 recommendations, of which more than half were accepted.
It has had to run to keep still. John Whiting, the first tax director of the OTS, liked to quote the late chancellor Sir Geoffrey Howe (later Lord Howe of Aberavon). He said simplification was like painting Brighton pier while someone else was extending it to France.
Take reliefs, for instance. The OTS successfully recommended the abolition of more than 40 reliefs, such that for the first 15p of Luncheon Vouchers, which dates to the time of rationing, yet the number of reliefs has increased. Lobbying is one reason why more were not abolished: one example is the relief on the benefit of late-night taxis: employers whose employees used such taxis argued for it to be kept.
Looking ahead, the OTS has a full programme but tax director Paul Morton wants to hear more suggestions (email firstname.lastname@example.org). Some areas will remain complicated but the focus is on making the tax system easier to use, just as it is easy to send a text on a smartphone, which is in itself a complex piece of engineering,
Is complexity so bad anyway? Some suggest it may be necessary to achieve fairness. Chris Sanger, global head of tax policy at EY professional services group and a former Treasury official, says: “The focus on simplicity is a false one — this should not be an end in itself but instead the policies [ …] should be no more complex than necessary to achieve their aims.”
Technology may usher in big changes, he says. For example, HMRC may be able to capture details for capital gains calculations from information provided by online trading platforms. More broadly, some experts think artificial intelligence could be the answer to complexity.
Paul Aplin, a partner at accountancy firm AC Mole & Sons, says this may be an alternative to putting the brakes on tax legislation, which otherwise seems unstoppable: “The creation of large volumes of complex tax legislation now feels like a self-perpetuating process. It would take considerable political will to halt or even significantly slow it.”