Employees could have to pay National Insurance on company car and private fuel benefits if proposals from the Office of Tax Simplification (OTS) are adopted by the Government.

However, if ratified, the move could also trigger a rethink in the popularity of salary sacrifice schemes among employers.

The OTS has called for further work to be undertaken to examine the case for applying Class 1 National Insurance Contributions (NICs) to all employee remuneration – whether cash or benefits-in-kind – as part of an overhaul of the entire tax and National Insurance regime.

However, this is likely to be several years away, according to Jeff Whitcombe, tax specialist and director of business car consultancy BCF Wessex, and they would also require a realignment of rates so employees were not penalised financially.

The Review of Employee Benefits and Expenses report said that having a separate Class 1A NIC paid by employers on employees’ benefits-in-kind is seen by many people as “distorting, unfair and administratively complex”.

It adds that the unfairness of the current system has become “an incentive to pay employees through benefits rather than salary, possibly through salary sacrifice, which does not seem appropriate”.

Whitcombe said the NIC change to company cars funded via salary sacrifice as outlined by the OTS would change the dynamics of such schemes.

He said: “Salary sacrifice could still be a valuable benefit, but it may not be as valuable and so schemes might not prove to be as popular.”

The OTS acknowledges any change would have an impact on the amount of NICs some employees pay, but added: “Work needs to be done on determining the real impact and how the basis for compensating adjustments could be made; the simplest possibly being a pragmatic cut to NIC rates.”

Including a cash equivalent value of benefits would also increase the earnings taken into account for NIC purposes and could push employees across the boundaries of the earnings limits and thresholds, says the report.

Currently, benefits are generally subject to Class 1A NIC, which is an employer-only charge paid at the rate of 13.8% after the year end, rather than Class 1, which is an employee and employer charge calculated for each earnings period, which tends to be monthly.

The employer Class 1 NIC rate is 13.8% with employees paying 12% between the primary threshold and the upper earning limit and 2% above the upper earning limit.

However, employees who are contracted out of the State Second Pension pay a reduced rate of Class 1 NIC between the primary threshold and the upper accruals point. Employers also pay reduced Class 1 NIC between these thresholds for contracted out employees.

As an alternative to the merger of Class 1 and Class 1A NICs, the OTS said it would be possible to abolish Class 1 and Class 1A NICs on employee benefits and have a new employer tax on cash and benefits similar to the Australian fringe benefits tax (FBT), a tax levied on most non-cash benefits.

But it acknowledges the feedback it has received suggests the present system is not broken and so does not need a major change; the preference, therefore, is to improve the current system, not replace it.

The OTS recommends that HMRC and the Treasury ‘reinvigorate’ the work previously undertaken to fully analyse the issues involved, with the aim of removing the distorting and complicating effect of Class 1A.

Whitcombe said: “I’m sure that many would argue that tax and NI rates would have to be realigned to compensate company car drivers who would be liable to NIC on their car and fuel benefits under the proposed regime.

“Simply adding NI to tax rates at current levels would appear to be far too penal, but the Government would need to ensure that any reduction in NI designed to compensate company car drivers did not benefit those who do not receive benefits.”

He believes there are huge issues to overcome if a complete overhaul of the current tax and NIC system, and an alignment of rates, is to be undertaken.

“It would therefore appear to be a difficult measure to introduce at a stroke and without very careful consideration of the practical effect,” added Whitcombe.

“The report goes some way to dealing with the issues, but the crux of the matter is that the UK effectively operates two income tax systems, albeit one is called National Insurance.

“If you were starting from scratch, it would be simpler to establish just one form of income tax and apply that to all forms of income, including salary and benefits.

“However, moving toward such a simplified approach from the current system is likely to prove very difficult, both practically and politically.”