Work and Pensions Committee - Universal Credit implementation: meeting the needs of vulnerable claimantsWritten evidence submitted by the Chartered Institute of Taxation (CIOT)
1 Introduction
1.1 Our response focuses on the consequences for self-employed claimants, irregularly paid employee claimants and employers and is based on our members’ experiences of small businesses and employers, and the problems they encounter with record-keeping, reporting and related administrative requirements.
1.2 We have responded to the Social Security Advisory Committee (SSAC) on the draft Universal Credit (UC) Regulations 2012.
1.3 We have restricted our comments to the following areas:
The proposed arrangements for claims, support and advice.
Progress with IT systems including Real-Time Information (RTI) system for PAYE.
The definition of earnings, which affects income entitlement.
The Minimum Income Floor (MIF).
Impact monitoring.
1.4 The proposals for the self-employed, around which we have deep concerns, are likely to affect a significant number of people. DWP have indicated that around 910,000 households on Tax Credits receive some income from self-employment. Analysis carried out by the Office of Tax Simplification (OTS) of HM Revenue & Customs (HMRC) administrative data indicates that in 2007
1.5 Our Low Incomes Tax Reform Group (LITRG) is also submitting comments.
2 Summary
2.1 There are a number of aspects of UC that need reconsideration, especially in respect of the self-employed and small businesses. We recommend that:
Assessment periods should be reconsidered—using calendar or tax months would better tie in with other requirements and ease the burden.
The calculation and definition of self-employed earnings should be identical for tax and UC (as recommended by the OTS in their report Simpler Income Tax for the smallest businesses), as should the criteria for self-employment.
The fundamental accounting principle of “matching” should be retained to even out significant cash surpluses and deficits over a year.
Methods of reporting self-employed earnings should be trialled and assessed before monthly reporting is imposed.
Agent authorisation and agent reporting processes should be established.
The “on or before” requirement in the RTI legislation should be relaxed to enable employers with irregular payrolls to meet their obligations without breaching the strict terms of the legislation.
The Minimum Income Floor (MIF) proposals be reconsidered.
3 Claims, Support and Advice
3.1 The proposed procedures for self-employed claimants will place an additional and onerous burden on them, which for many will be impossible to comply with.
3.2 Gainful self-employment
The UC regulations require a claimant to be in genuine self-employment, which is being carried out in the expectation of profit. It is unclear how Department for Work and Pensions (DWP) will equip its staff to make informed decisions in this difficult area.
3.3 The question of whether a trade exists and whether it is being carried on in the expectation of profit, is a complex area of law. Sometimes an individual will take the view that his or her activities are a hobby rather than a trade, eg buying and selling on eBay.
3.4 A single definition on what is self-employment must be used and apply for both UC and tax purposes. A decision by either HMRC or DWP on this should be binding on the other department.
3.5 Income reporting
It is proposed that a self-employed claimant will have to report earnings:
12 times a year—each one month “assessment period” runs from the anniversary of the date of the first claim; and
Online within seven days of the end of each assessment period—otherwise payments will be suspended (and terminated if the information is not received within four weeks); and
On a different basis to that which they will use for tax (potentially both direct and indirect) purposes (and which will not necessarily tie into their annual accounting period).
3.6 This will impose a significant additional burden on the self-employed, compared with the current requirement of a single set of accounts, prepared annually, which may be used for both tax and Tax Credit purposes.
3.7 Assessment periods
Assessment periods will not necessarily align with the businesses accounts year, VAT periods or even the PAYE tax month. Consequently, separate processes will be required for each. Summarising receipts and payments every month, rather than annually, will be a significant and difficult burden, reliant on information from others.
3.8 To ease this burden the assessment period for the self-employed should align with the business’ accounting period.
3.9 Reporting within seven days
The seven day deadline is likely to prove exceptionally onerous for many claimants, especially those with more complex affairs, where they are also VAT registered and/or where they usually need help compiling their accounts. The individual will need access to online banking to retrieve figures, as paper bank statements will not arrive in time (even if the issue of them is aligned with the assessment period).
3.10 Such a short reporting period is also more likely to be disrupted by temporary problems—eg urgent business appointments, illness or holidays of the claimant or agent, a computer or banking failure.
3.11 Agents
The assumption is that individuals will be able to report monthly without engaging an agent. However, reporting net cash flows is more complex than reporting wages payments to employees and the tight reporting deadline will make it extremely difficult to comply.
3.12 Many individuals engage advisers because they do not have the expertise to keep or interpret their records without assistance nor extract information from their records to produce accounts. Our members commonly correct errors such as an owner mistakenly declaring their drawings from the business as expenses or excluding income received by direct debit. The current reporting requirements seem designed to force many claimants to spend money on advisers to help ensure they make claims properly and on time.
3.13 Agent authorisation
A system of agent authorisation, similar to HMRC’s, to allow the claimant to authorise the agent to communicate with the DWP on his behalf needs to be designed, tested and in place ready for the start of UC. The system needs to permit agents to make claims and report cash flow on behalf of clients, once the client has approved the figures. This also needs to be reflected in the regulations. No attention seems to have been given to agents so far.
3.14 Cash basis
The UC “cash basis” will require businesses to compute “profits” using up to three methods: UC cash basis; VAT’s cash accounting and annual accounting bases; and UK Generally Accepted Accounting Principles (GAAP) (for direct tax purposes). Even if HMRC’s proposals for a cash basis for tax purposes are adopted from April 2013 those proposals differ significantly from the DWP proposals.
3.15 Problems with the chosen cash basis
The regulations require allowable “cash out” to fall into specific categories and be reasonable and incurred wholly and exclusively for the purposes of the self-employed activity. Who is to decide what is reasonable? For example, if goods are purchased for resale but there was a cheaper option, would the expense be disallowed? Mixed-use expenditure might not be deductible for UC purposes even though the business element would be for tax purposes.
3.16 The current proposals assume that income arises for the self-employed in the same linear, regular way that it usually does for employees. The regulations prevent cash deficits from one assessment period being carried forward to the next. Equally, cash surpluses from one period are not carried forward—this could encourage manipulation of cash flows to the disadvantage of the Exchequer.
3.17 Many profitable businesses will have periods of negative cash flow. For example:
(a)
(b)
(c)
(d)
As drafted, the regulations ignore the fundamental matching rule in accountancy and deny relief for expenses incurred in one period where the income the expense relates to is received in another period. There must be recognition for this otherwise UC will assess an unrealistic annual amount of income.
3.18 Loan interest
The regulations illogically deny a deduction for loan interest paid. In many cases, the business will not be set up in the first place without the aid of a loan, such as one provided under the “Funding for Lending” scheme.
3.19 Flat-rate deductions for business, use of one’s home or motor vehicle and other issues were expanded upon in our response to the SSAC on the draft regulations.
3.20 Partnerships
The regulations seem to have little regard to partnerships. As partners are self-employed they will presumably be required to report monthly. However, this takes no account of how partnerships operate.
3.21 In a large partnership only some partners may be able to claim UC. Such partners will have to obtain, every month, from the partnership a set of cash accounts (produced on a different basis to that of the management or annual accounts), and allocate to the partner their share of the partnership cash transactions based on the partnership profit sharing agreement. A junior partner claiming UC will have little control over the finances. Reporting within seven days, with no requirement for the partnership to provide the figures, will be well-nigh impossible.
3.22 Online reporting
UC claimants will be required to report their income using a tool within their personal online account. While many claimants will benefit from online reporting, a significant minority will be disadvantaged. The response from LITRG expands on these issues.
3.23 Support and advice
Client centric advice must be provided for claimants, including advice on how UC works and how to navigate the new system. DWP may need assistance in designing that help from specialists used to dealing with businesses.
3.24 We understand that the DWP plan to train Job Centre staff to carry out Gateway interviews for all self-employed claimants to assess whether they are in “gainful self-employment”. Will Job Centre staff be equipped with the right training and experience to assist claimants and make judgements? What appeal process will be put in place on decisions?
3.25 It should not be underestimated how long it takes to set up such advice programmes with online information and tools, coupled with telephone and face-to-face support.
4 Progress With IT Systems
4.1 Real-Time Information (RTI)
4.2 Reporting by employee
UC is based on regular reporting by employers. If an employer has failed to report employment income under RTI, the UC Regulations expect the employee to report the income, but it is not clear how the employee will know to do this.
4.3 Timing of reporting—“on or before”
To support UC, RTI requires a submission to be made “on or before” each payment, potentially meaning frequent reporting for some employers when, in the past, they have been able to comply with their PAYE obligations by doing a monthly payroll.
4.4 A submission will need to be made every time an employee is paid, including those paid on an ad hoc basis and irrespective of the time (eg shift worker late at night in a nightclub) or the location (eg a harvest worker paid on piece work in a field). This seems to be an unrealistic obligation for many, particularly small, businesses. Larger businesses face significant reporting problems around employee share plans.
4.5 The “on or before” reporting issue for employers can be resolved. Running claimants’ assessment periods to the same common date in the month would allow employers’ reporting to be done on a monthly basis, significantly reducing burdens for many employers. We understand that HMRC are considering changing the on or before requirement, but it needs to go further and permit monthly reporting. This would enable RTI to be introduced far more smoothly with less impact on many employers.
4.6 The UC monthly assessment basis can also affect UC entitlement. For example, an employee paid four weekly will, once a year, receive two salary payments in one assessment period, potentially negating their UC entitlement even though, when averaged across a whole year their earnings give entitlement.
4.7 Online reporting
It is not just claimants that will have online reporting issues (see above). Some employers will be unable to file RTI returns online. Employees of such employers are at risk of being excluded from UC unless HMRC puts into place help and support for “disadvantaged” employers.
4.8 Universal credit
4.9 Unlike with the RTI system, the professional bodies that act for many self-employed have not been consulted to date on the design of the IT systems. However, it recently transpired that the design is well advanced and systems changes, such as allowing for automatic carry forward of cash deficits between periods, may not be possible in time.
4.10 An agent authorisation and agent reporting process must be established and tested before the system goes live.
4.11 It is unclear how the deduction for tax deductible expenses is to be reported for employees. The employer will not necessarily have this information and it is not reported to HMRC. (See 5.1 below.)
4.12 Such an important system should be developed with adequate and timely consultation; we trust that time will be made to ensure it is fit for purpose.
5 Definition of Employment Earnings
5.1 Expenses
The draft Regulations refer to expenses which are wholly, exclusively and necessarily incurred as part of employment duties (“employment expenses”). This deals with those employment expenses which have been reimbursed by the employer by not including them in employed income, but makes no allowance for a deduction for employment expenses which have not been reimbursed by the employer. As queried at 4.11, how will these be identified and reported?
5.2 An amendment could be made to section 51 of the UC Regulations 2012 to expressly provide that expenses as defined under chapter 2 of Part 5 of the Income Tax (Earnings and Pensions) Act (ITEPA) 2003 are not included in the definition of “employed earnings”, either through a deduction or exclusion mechanism. This would partly resolve the issue.
5.3 Benefit-in-kind
The regulations require that benefits-in-kind, not otherwise included as PAYE employment income, are to be included as employment income. There seem to be many uncertainties in this area and we think more discussion is required with employment experts to provide a level playing field with the minimum of administrative burdens.
5.4 Miscellaneous income
It is unclear whether taxable miscellaneous income would be regarded as earned income for UC purposes—eg a payment for writing a single article, paid to an individual who may be neither employed nor self-employed.
6 Minimum Income Floor (MIF)
6.1 Those in “gainful self-employment” will be deemed to have earnings of a minimum amount in each assessment period, even if their actual earnings are lower.
6.2 The MIF presents an obstacle to those in business who, for example, wish to develop or expand their business, or who are going through a short-term cash crises (eg because a major customer is slow in paying an invoice).
6.3 As noted above, a business with negative cash flow in an assessment period cannot carry that loss forward. But the claimant is further penalised for this negative cash flow as the MIF will artificially increase the net amount for the assessment period. So the business paying an annual insurance premium in a month in which there is little income will have a loss turned into an artificial profit by virtue of the MIF.
6.4 12-month start up period
The draft regulations provide for a 12-month start-up period, in which the MIF is disregarded. 12-months is too short for many businesses. Businesses often take longer than 12-months to become profitable; for example, after 12-months a “new” business will be disincentivised from taking on its first employee as the MIF may restrict “relief” for the employee costs.
6.5 It is proposed that the MIF can only be claimed once. While it would be unreasonable for someone to have a new “start-up period” every year, limiting it to one period in a lifetime is a barrier to encouraging entrepreneurship. For example, an individual who was successfully self-employed, but is then employed for, say, five years, and then made redundant, would be denied a further start-up period if they wanted to start a new business.
7 Impact Monitoring
7.1 DWP’s priorities for monitoring the impact of the transition to Universal Credit should include monitoring of:
The proportion of the self-employed who fail to meet the monthly submission dates, investigating a sample to determine common reasons for failure.
The claimant employees of employers not reporting to determine whether they have been able to report their own income direct and if not why not.
The effectiveness of Gateway Interviews and whether the right people are being rejected as not having “gainful self-employment”.
The quality of advice given to self-employed claimants.
Those self-employed whose income falls beneath the MIF to ensure they have sufficient funds to live on without resorting to crime.
We also think DWP should liaise with:
Those who act for the self-employed, such as members of the professional and tax bodies, to see how the system is working from their and their clients’ perspective.
HMRC to monitor the number of employers who fail to meet RTI reporting requirements, determining common reasons for failure.
APPENDIX 1
THE CHARTERED INSTITUTE OF TAXATION
The Chartered Institute of Taxation (CIOT) is a charity and the leading professional body in the United Kingdom concerned solely with taxation. The CIOT’s primary purpose is to promote education and study of the administration and practice of taxation. One of the key aims is to achieve a better, more efficient, tax system for all affected by it—taxpayers, advisers and the authorities.
The CIOT’s comments and recommendations on tax issues are made solely in order to achieve its primary purpose: it is politically neutral in its work. The CIOT will seek to draw on its members’ experience in private practice, Government, commerce and industry and academia to argue and explain how public policy objectives (to the extent that these are clearly stated or can be discerned) can most effectively be achieved.
The CIOT’s 16,500 members have the practising title of “Chartered Tax Adviser” and the designatory letters “CTA”.
16 August 2012