Income Tax was first introduced, in around 1805 by William Pitt the Younger, to finance the cost of the Napoleonic Wars. It was (stated to be) intended to be temporary, but of course it is still with us.
|William Pitt the Younger|
- the man we have to thank for income tax
Later in the 19th Century the tax law was restructured into substantially the same form as we see today, although since 2003 there has been some change in the terminology used – the old references to the Schedules and Cases, which provide the framework for taxing
· income from property (Schedule A),
· Woodlands (Schedule B),
· Gilt-edged securities (Schedule C),
· Trades, professions and vocations (Schedule D cases 1-2)
· Interest, royalties and similar receipts in the UK (Case 3) and overseas (Cases 4 & 5)
· and the bucket category for anything else that has got forgotten elsewhere (Case 6),
· and finally, income from employment and pensions (Schedule E)
are no longer in common use – unless like me you have been around too long to get used to the new way.
I shall concentrate here on Schedule E (employment income) and in particular the treatment of benefits-in-kind, particularly the provision of a company car.
Schedule E taxes the “emoluments” of an employment. Over many decades, case law expanded on and clarified what this term, defined in statute in good Victorian language as “salaries, wages, fees or perquisites of whatsoever nature”, is intended to mean. Broadly, payment in money or money’s worth is an emolument. If an employer offers to step in and settle an employee’s bill or reimburse an employee’s (non-business) expenses, the amount paid by the employer is an emolument. Finally, if the employer provides the employee with goods or services which the employee is capable of realising for cash, the emolument would be the amount of cash the employee might reasonably be expected to be able to realise. This particular point was much tested in case law – for example, when an employee was supplied by his employer with a bespoke Savile Row suit, the courts determined that the emolument was not the full cost of having the suit made, but the considerably lower value which the employee might be be expected to realise by selling it second-hand.
Where the employer provided something on loan to the employee, without transferring beneficial ownership and imposing restrictions on third party use so that the employee could not realise any cash value from the loaned item, there was nothing at all to tax. Housing and cars fell into this category.
Unsurprisingly, tax mitigation for owner-managers of businesses and for the Directors of public companies became a major industry in its own right, and finally the Labour Government of Jim Callaghan responded in 1976 with the introduction of taxation of benefits in kind (BIK) for directors and “higher-paid” employees. Back then, you were considered higher-paid if your taxable income, including the assessable value of your BIK, exceeded £7,500 pa, soon raised to £8,500 pa. As my first job after graduation from Oxford, in 1977, paid £3,000 pa, my younger readers will see that eight grand really was a fairly good whack in those days. The £8,500 threshold however has remained ever since so in effect captures almost everybody, down to minimum wage.
Directors were caught by the rules whatever they earned – in order to catch owner-managers who had become used to rewarding themselves primarily with BIK which they otherwise would have paid from their salaries. The term director also covered Shadow Directors – people whose names didn’t appear on the Companies House register for the company as directors, but who nevertheless practically determined what the directors-of-record could do with the company.
Alongside provisions for taxing any other type of BIK, such as accommodation, meals, gym membership, medical insurance etc, the 1976 Finance Act introduced a scale charge for taxing company cars. Believe it or not, until 6th April 1976 an employee or director could be supplied with use of a car, including fuel and even a chauffeur, entirely free from taxation!
I think we can assume – admittedly with “cognitive bias” – that this situation must have been highly instrumental in forming the Great Car Economy of present day Britain, and the greater dependence on cars – and deeper obsession with how big/fast/new/shiny our cars are – than we typically see in many European countries where the tax system was not quite so sympathetic to motorists.
We are now into our third phase of taxing the company car as employment benefit. In the first phase, which ran eighteen years from April 1976 to April 1994, we saw the taxable benefit of a car expressed as a fixed scale charge which bore no real resemblance to the cost of buying and operating that car. If we consider the far most common type of company car – the middle-market saloon with an engine between 1,401 cc and 2,000 cc – the scale charge in 1976 was £225 – this is what the car was deemed to be worth as income, per year. At this stage, provision of fuel (at the employer’s own pump or using an employer-provided fuel credit card) was still not taxed – that only came in five years later.
In the first five or so years of the scheme, the scale charge hardly rose at all – and a 50% reduction was introduced for users with more than 18,000 miles of business use and a 50% surcharge for users with less than 2,500 business miles - and then the mid-eighties saw the scale charge start to rise more rapidly, so that by its final year, 1993/4, the scale charge for a 1,400-2,000cc car had reached £2,990 (again add 50% for less than 2,500 miles business use). Although much higher, it still represented nothing like the true cost of buying a brand new car and keeping and using it for three years before replacing with a new one. Also, the business mileage threshold caused great distortions in employees’ travel decisions. I remember for example driving to meetings in Manchester from Surrey in preference to taking the train, as a way of racking up the necessary 2,500 miles. I even recall a colleague travelling to a conference in Vienna in his company car, to get his mileage in with one trip having failed to do any business driving at all throughout the year until then.
It also distorted the new car market. Ever wondered why so many cars labelled as 2 litre actually have engines of about 1,995 cc? Or 1,395 cc? Now you know. I also recall my brother’s father in law, a director of a chemicals company, choosing a “Grand Luxe” version of the Ford Granada 2 litre in preference to the standard spec for the 2.4 litre version – he did a deal with the garage to stick a “2.4 L” badge on the boot in place of the proper “2.0 GLS” badge, so he wasn’t exposed to ribbing in the company car-park!
The 1993 Finance Act sounded the death knell for the old scale charge system, and introduced a system a little closer to what we have today. From April 1994, the BIK was 35% pa of the achievable retail price (slightly lower than the manufacturer’s advertised RRP) plus the cost of any optional extras. Do 2,500 business miles and this dropped by a third, more than 18,000 and it dropped by another third. There were some minor tweaks but in substance this regime continued until 2002. It still contained the distortion of pushing people to get across business mileage thresholds by hook or by crook, and being purely price-based, it contained no incentive to buy smaller-engined or more fuel-efficient cars.
However, the scheme had approached a balance with the actual cost of providing the car, such that when my company car came up for renewal my employer now offered me not a car as such, but a specified monthly sum to spend on a car lease, or to take as gross salary through the payroll. Like many of my colleagues, I decided to take the money and buy my own – second-hand – car. Working as I did in the City of London I only rarely needed to use my car for business, would normally prefer to take the train instead, and struggled to achieve the necessary 2,500 business miles to reduce the taxable benefit. Better to be taxed on salary representing about 25% of the capital cost of that car than on a notional 35%!
Finally, in 2002 the scheme changed to substantially what we have today. The annual charge was a percentage factor, starting at 15%, of the new retail price, for cars with the lowest standardised CO2 emissions, of 165gm/km or lower. For every 5gm/km above 165, the annual factor rose by 1%, until it reached 35. Today, the “threshold percentage” is 11% and the “threshold amount” is 100gms/km but otherwise much the same – 1% more for each 5gm/km until 35% is reached.
There is now no reduction in the benefit for business mileage thresholds, so the incentive to make unnecessary car journeys has been removed.
Meanwhile, the introduction and gradual escalation in car fuel scale charges has to some extent discouraged provision of free fuel for personal use, although probably not for the most committed petrol-heads.
If my own experience is anything to go by, the 1994 scheme probably deterred some purely-personal users of company cars from taking one, but the 2002 scheme has evidently resulted in a significant reduction in uptake of company cars by “non-essential users”. There is some reference to this as a factor in the assumed arrival of “peak car” which occurred prior to the current economic downturn, in the mid-noughties when the economy was still defying gravity. (The RAC Foundation, of course, would deny that car use has peaked, it has merely briefly interrupted its relentless onwards march. A Parliamentary briefing paper, which also refers to the company car effect as one of the fiscal and demographic changes affecting private car use, prefers not to come off the fence as to whether peak car has arrived).
A report by HM Revenue & Customs evaluating the impact of the 2002 changes on CO2 emissions – not of course at all the same thing as total road travel mileage, or its impact on traffic congestion or road danger for motorists or other road users) however suggests that the new scheme has been, and will be, fairly successful in delivering its primary aim.