Contractors would no longer be able to benefit from lower taxes in exchange for choosing to be in business if a key recommendation of the Mirrlees Review is adopted – to harmonise tax rates on employed and self-employed income taxation. Not only that, but based on the review’s proposals the basic and higher rates of tax could increase to 34% and 66% respectively, as a result of rolling National Insurance Contributions into income tax.
The review suggests that HMRC implement “…equal treatment of income derived from employment, self employment and running a small company.” This would effectively ‘kill’ IR35, but also cause the tax bills of limited company contractors to soar. And a further blow to limited company contractors could come from the review’s suggestion that income tax and National Insurance Contributions (NICs) should be merged.
The Mirrlees Review was commissioned by independent think-tank, the Institute For Fiscal Studies, and funded by the Nuffield Foundation and the Economic and Social Research Council. Its report states: “…we need to move away from having separate systems of income tax and NICs, with different sets of rules and exemptions, pointlessly increasing administration and compliance costs and making the system less transparent. National Insurance is not a true social insurance scheme; it is just another tax on earnings.”
Without the ability to significantly reduce NICs that most limited company contractors enjoy, a single set of income tax rates on all income, regardless of how it is earned, would effectively remove the motivation behind legislation such as IR35.
Income tax currently collects around £150 billion annually, and NICs around £100 billion. If NICs were rolled into income tax we would need an increase in rates of income tax of around two thirds. This would result in a basic rate of approximately 34%, up from 20%, and a higher rate of income tax increasing from 40% to an estimated 66%.
Although the recommendations include measures to exclude savings from taxation and include incentives for retirement saving, contractors working through most common trading solutions are likely to end up with higher personal tax bills. However, limited company contractors may benefit from a streamlined corporation tax regime, while the proposed cuts in ‘transaction taxes’, such as stamp duty, could benefit contractors with property and equity investments.
The high-profile team of international experts behind the review was tasked with proposing ways to radically simplify the UK’s tax and benefits system. It is expected to be considered as part of the work being conducted by the Office of Tax Simplification and the Coalition government’s new stance on creating tax policy.