Mirrlees review proposes wide ranging changes to UK tax system - how will contractors be affected?

A new report on how to simplify the UK's tax system, published by the Institute of Fiscal Studies, contains radical proposals which may affect how all individuals and corporations are taxed.

The Mirrlees Review is highly critical of the state of the current tax system, and makes far reaching proposals on how to make the system work more efficiently.

The key principles outlined in the report are the the tax system should:

• be designed as a whole, in conjunction with the benefits system. The system as a whole needs to be green and to be progressive. But not every tax needs to be green or progressive. Indeed, not all should be. The way taxes (and the benefit system) fit together matters very much.
• seek neutrality. Tax systems that distort people's behaviour by treating similar activities differently without very good reason - as the UK system currently does - create inefficiency, complexity and opportunities for avoidance. Exceptions, to deal with the costs of smoking or pollution for example, should be limited and carefully designed.
• achieve progressivity as efficiently as possible. That means relying on the rate schedule of personal taxes and benefits - rather than inefficiently distorting the tax base - to achieve redistribution. It also means designing that rate schedule carefully to minimise the extent to which the tax system reduces employment and earnings.

How might contractors be affected?

Limited company contractors, in particular, are most likely to be affected if any of the report's recommendations are carried through by the Coalition - as they cross the divide between corporate and personal taxation.

The report is highly critical of the recent introduction of the marginal rate of income tax between £100,000 and £112,900 - where marginal income tax rates rises from 40% to 60% in this tax bracket, before falling back to 40%, then up to 50% for incomes over £150,000!

The report suggests that there is no need to have two separate taxes on earnings, and that National Insurance and income tax should be merged.

Significantly for IT contractors, the IFS review suggests that the tax treatment of employment, self employment and corporate-source income should be aligned.

Corporate tax on company profits are also taxed at different rates according to profit levels, and is not integrated with the personal tax system... creating opportunities for 'avoidance'.

You can view a summary of the IFS review report here (PDF download).