Clarke puts PRP tax relief on trial

PAUL WALLACE

Economics Editor

Chancellor Kenneth Clarke, in hot water over executive share options, is understood to be examining the tax treatment of profit-related pay as part of an attempt to give himself elbow room for cuts in the next Budget.

Any such move would cause a furore, but removal of the relief could give him pounds 1bn to finance cuts in the standard rate of tax. According to the Treasury, the cost of cutting the basic rate of income tax by 1p would be pounds 1.6bn.

Tax relief on profit-related pay (PRP) currently stands at pounds 4,000 or 20 per cent of an employee's pay, whichever is lower. With 2.4 million people on PRP schemes, the cost to the Exchequer has escalated at an extraordinary rate in the Nineties. Five years ago, cost of the relief was no more than pounds 25m. The Treasury and Inland Revenuehave become increasinglyconcerned at its burgeoning cost.

Malcolm Gammie, a tax specialist at law firm, Linklaters & Paines, says of PRP that "as soon as you start using the tax system to create incentives, people pile in and then you find the tax benefit being given to people who shouldn't really benefit".

Another tax exemption that may stand in the firing line is the relief from income tax on the first pounds 30,000 of redundancy payments. The cost to the Treasury of this longstanding provision has risen by half in just two years and stands at pounds 1.5bn in the current tax year. One clear warning is that the Inland Revenue is toughening up its approach to such payments. "Are the Revenue pulling the plug?" asks accountancy firm Arthur Andersen in a recently published pamphlet on redundancy payments.

Arthur Andersen warns that "the Inland Revenue are adopting a more aggressive stance" when considering whether relief is applicable.

For example, payments made to employees on "gardening leave" are now treated as taxable. The Inland Revenue is also viewing payments made in lieu of notice as taxable.

According to Tony Atkinson, Warden of Nuffield College at Oxford University and a specialist on public finance: "There is no case for simply exempting redundancy payments; why should one form of remuneration be treated differently from another?"

When marginal rates of tax were so much higher, there was an argument for shielding individuals from high taxes on redundancy payments. That was no longer the case - and the effect could be cushioned by "averaging provisions" which are applied to actors and others with highly variable earnings.

A further exemption looking vulnerable is the income tax relief that the self-employed can claim against half their Class 4 National Insurance Contributions.

The cost to the Exchequer of this exemption in the current fiscal year stands at pounds 150m. Paul Johnson, a director of the personal tax programme at the Institute for Fiscal Studies, says "the well-off self-employed do pretty well out of the tax system". More bluntly, Tony Atkinson says "there is no justification for the relief".

Relief given on the first pounds 8,000 of relocation could also come under the axe. This was radically curbed by Norman Lamont in his spring 1993 budget, but the cost still stands at pounds 300m.

Attacking these reliefs would undoubtedly cause an outcry, although the Chancellor might gamble that was a price worth paying for worthwhile cuts in the basic rate of tax. But Malcolm Gammie at Linklaters warns that "such changes have to be made as a part of a coherent package. Picking at areas is a hopeless way to undertake tax reform".

The cost of tax reliefs

1995-96

Profit-related pay pounds 800m

Redundancy payments pounds 1.5bn

Half of class 4 National Insurance Contributions pounds 150m

Relocation packages pounds 300m

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