Chapter 3 - Modernising the PAYE rules
Secondary tax codes
Tax treatment of extra pays
Tax treatment of holiday pay
Extra pay day in a tax year
Application of legislated rate changes
This chapter of the discussion document consulted on potential changes to the PAYE rules relating to secondary tax codes, extra pays, holiday pay, an extra pay day in a tax year, as well as how legislated rate changes should be dealt with.
Secondary tax codes
The discussion document set out the Government’s approach for reducing existing pressure points around secondary tax codes through improved administrative intervention during the year, as a result of Inland Revenue receiving more timely PAYE information.
Summary of comments
This approach was widely supported in written submissions, although many of the submitters emphasised that care must be taken to ensure that this does not increase compliance costs for employers. Some submitters considered that secondary tax codes were unfair and should be abolished.
“The setting of individual rates should be optional. Some taxpayers may wish to maintain their privacy if they have income from other sources such as a second job, investment or family trust distributions.” Suggestion for reducing secondary tax pressure points: “Allowing taxpayers to set own rates based on previous year’s marginal tax rate.”
“… supports the above vision for reducing existing pressure points by way of receiving more timely PAYE information. While we agree that IRD intervention during the year will help in reducing over and under payments of tax, this intervention should be managed and applied (by the IRD) in a way that does not increase compliance costs for employers, or result in special tax codes being applied incorrectly due to incomplete employment information being held regarding an employee.”
“…the employee must make the decision whether to apply for a special tax code to change the withholding rate. An employer has imperfect information regarding an employee’s overall income profile and as such, it is only the employee that is in a position to determine whether a special tax code is appropriate. Further we note that it is essential that the employee make this decision, as changes in withholding rates to correct for tax previously under-withheld or over-withheld without notifying the employee could cause issues in the employer-employee relationship.”
“I think there shouldn't be secondary tax. Why should someone who is happy or needs to work 2+ jobs be taxed more? We should be thanking them for getting out there and doing everything they can to be a part of the working world.”
Tax treatment of extra pays
The discussion document sought feedback on what was more important in relation to the tax treatment of extra pays – a simple calculation method or withholding accuracy. It also sought feedback on the idea of introducing two options that an employer could use to determine the amount of tax to withhold from an extra pay – a simple method (suitable for employers doing their payroll manually), and a more accurate, but more complex, method (suitable for employers with payroll software). Feedback was also sought on what the calculation method(s) should be.
Summary of comments
Consultation responses were mixed. Small employers running their payroll manually and the accounting profession generally thought simplicity was more important, while payroll software providers and large employers generally thought withholding accuracy was more important. There were also a number of suggestions to improve the calculation method for calculating tax on an extra pay.
“On balance, making the method simpler for employers is more important. A degree of inaccuracy should be tolerated.”
“… does not consider the current calculation of extra pay to be overly complex from an employer perspective (using payroll software), and is of the view that accuracy should be prioritised in this instance to reduce the occurrences of over withholding of tax from employees…we do not agree that the introduction of an annual 'square-up' would reduce the need for accuracy in the withholding of tax. Rather it would place a heightened importance on employers to get the tax "right" during the year, as the employee will be required to pay additional underpayments at year end (which does not necessarily occur now), which is likely to result in additional queries to the employer.”
“we do question whether this (greater accuracy) is consistent with the overall vision of “Making Tax Simpler” as noted in the title to this discussion document. In [our] view, a drive for greater accuracy will lead to more complexity in the PAYE rules, and this is not necessarily a desirable outcome. In addition, accuracy in the calculation of PAYE appears to be of less importance in a post- Business Transformation world where it is envisaged that all taxpayers will be required to complete an annual square-up of income tax.”
“We are supportive of proposals to modernise the existing PAYE rules, such as secondary tax, extra pay and holiday pay. On balance, we support greater simplicity over complexity, particularly for smaller employers. However, a more accurate option (for calculating tax on extra pays) for employers who have more sophisticated payroll systems should be available.”
“We consider trying to achieve tax positions that are "correct" on a comprehensive annual liability basis solely by source deductions requires too much administration and compliance by employers and other payers to be entirely successful in a progressive tax rate system…”
Tax treatment of holiday pay
This section of the discussion document consulted on clarifying the tax treatment of holiday pay through either legislation or an Inland Revenue publication. Submitters were also asked whether the tax treatment of holiday pay is unclear.
Summary of comments
The majority of large employers and tax advisors thought that the existing tax treatment of holiday pay is clear. The online forum comments suggested that there may be some lack of clarity amongst small employers. There were mixed views about whether legislative clarity should be provided, or whether clarification in an Inland Revenue publication would be sufficient. However, the majority of submitters thought clarification in an Inland Revenue publication is sufficient.
Several submitters thought that taxing holiday pay paid in advance as an extra pay is unfair as it results in over withholding. It is common in some industries for employees to work extra hours in the lead up to Christmas, which can exacerbate the over-withholding if the extra pay formula is used.
“…treating advance payments of holiday pay as extra pay can be seen as unfair to employees, and as such, more employers could be fielding more queries from potentially disgruntled employees.”
Extra pay day in a tax year
The idea of introducing a mechanism to withhold additional PAYE in tax years in which an extra pay day will occur was consulted on.
Summary of comments
Consultation responses were mixed. Some submitters supported introducing a mechanism, but amongst supporters there was division about whether it should be mandatory or optional at the employers’ discretion. Other submitters were against introducing a mechanism, on the basis that it would introduce additional complexity for little benefit. Several submitters favoured retaining the status quo for now and revisiting the question if, and when, it is decided to make all individuals undertake an annual square-up.
“… for the next few years the status quo should be preserved and the problem dealt with if and when there is a requirement for all individuals to undertake an annual income tax square-up. Any firm decision at this point would risk following a different path from that eventually taken by the business transformation process.”
Application of legislated rate changes
Different types of PAYE income payments and PAYE-related social policy products have different rules on what is to be done when there is a legislated rate (or threshold) change during a pay period, or if there is rate (or threshold) change between the date the payment is made and the pay period to which the payment relates. The discussion document consulted on aligning the rules about how legislated rate changes are applied across the different PAYE-related tax types/products.
Summary of comments
Consultation responses strongly supported alignment. The majority of submitters favoured a pay date-based approach for alignment.
“Yes this will help the simplification process”. “If the pay date approach is for pay periods starting after the rate change then it will be the best option.”
“…we support alignment based on a pay-date approach on the basis that this would minimise compliance costs for employers.”
“Apply rate changes from first pay after 1 April consistently. Better chance of everyone getting right then.”