It was announced at the Scottish Budget on 14 December 2017 that Scotland would for the first time have both different income tax thresholds and two additional income tax bands when compared to the rest of the UK.
The Scottish Government on 20 February 2018 then set the following income tax rates and bands for Scottish resident taxpayers for the 2018/19 tax year:
The Scottish Government have estimated that the introduction of these measures will raise an additional £164 million in income tax receipts and result in 70% of Scottish income taxpayers paying less tax in the 2018/19 tax year.
We will look at who will be affected by these changes, what it means in practice and the interaction of the Scottish rate of income tax with other UK wide taxes.
The following table demonstrates how these changes will impact on a higher rate Scottish taxpayer with taxable earnings of £50,000 when compared to a taxpayer resident in another part of the UK in the 2018/19 tax year.
A Scottish taxpayer with earnings of £50,000 will therefore pay £823 more income tax than their counterparts in the rest of the UK. This tax gap will only widen for Scottish higher rate taxpayers as their earnings increase.
What is the Scottish rate of income tax (SRIT)?
The SRIT is a power which the Scottish Parliament has to set the thresholds and rates of income tax for Scottish taxpayers and therefore the amount that the Scottish Government has to spend. It is estimated that income tax receipts in Scotland amounted to over £12.75 billion in the 2016/17 tax year.
The SRIT applies to the earnings of Scottish taxpayers arising from employment (e.g. salaries, bonuses, etc.), self-employment (e.g. sole-trader and partnership profits), pension income and income from property (e.g. rent). The UK thresholds and rates of income tax continue to apply to savings income (e.g. interest, dividends, etc.).
The UK Parliament retains control of all other aspects of the income tax regime, including setting the level of the personal income tax allowance and introducing and altering available income tax reliefs, such as those applicable to gift aid donations to charity and pension contributions. Scottish taxpayers will therefore benefit from the increase in the income tax personal allowance by £350 (3%) to £11,850 from 6 April 2018 announced at last November’s UK Budget.
How does the Scottish rate of income tax work?
The Scotland Act 2016 gave unrestricted powers to the Scottish Parliament to set income tax rates and thresholds for Scottish taxpayers (excluding savings income) with effect from 6 April 2017. The Scottish Parliament will set the thresholds and rates of the SRIT on an annual basis in the Scottish Budget. This further devolution of taxation powers was first proposed in the Smith Commission’s report published in November 2014 following the independence referendum.
The 2017/18 tax year had been the first time the Scottish Parliament had varied the income tax thresholds that are applied to Scottish taxpayers by freezing the higher rate threshold at £43,000. Up until 6 April 2017, the Scottish Parliament had chosen to retain the status quo with the rest of the UK by not exercising any of its devolved income tax powers to vary Scottish income tax rates.
To whom does the Scottish rate of income tax apply?
The question of whether or not you will be treated as a Scottish taxpayer should be relatively clear in the vast majority of cases. The basic rule of thumb is that you will be a Scottish taxpayer if you are UK resident for tax purposes and your main residence for most of the tax year has a Scottish post code. HMRC have stated in their guidance that the test is not based upon location of work, location of income source, travelling in Scotland or even your national identity. What is important is where you live, rather than where you work.
There will, of course, be certain instances where during the course of a tax year UK resident taxpayers have interests both north and south of the border and their tax status will not be so simple to establish. Where a taxpayer has more than one residence in the UK they will have to establish to which residence they have the “closest connection”. This will be a question of fact (e.g. where family live, where registered to vote, where registered for doctor, etc.). If this does not provide a clear answer, then it will be a question of counting the number of days the taxpayer spends in Scotland compared to the rest of the UK. Where the taxpayer spends at least as many days in Scotland as elsewhere in the UK he or she will be treated as a Scottish taxpayer.
How is the Scottish rate of income tax administered?
HMRC have estimated that approximately 70% of the top 2,100 businesses in the UK will have been affected by the introduction of the SRIT. HMRC have previously advised employers and pension providers if they require to treat any of their employees and members as Scottish taxpayers. PAYE codes with a suffix “S” letter have been introduced to enable employers and pension providers to identify Scottish taxpayers and apply the correct rate of PAYE. There has been no other change to how employers and pension providers UK-wide report or make payments for income tax to HMRC. It is the taxpayer’s responsibility (not their employer’s) to notify HMRC of any change in his or her residential address or other circumstances that may impact on residence status for the SRIT.
Scottish taxpayers with self-employment and/or property income will also have to apply the SRIT when reporting their taxable income on their self-assessment tax returns.
In the 2016/17 tax year the Scottish Government paid £6.2 million of implementation costs on the SRIT. The Scottish Government have advised that it could cost up to an additional £5 million to put today’s changes to the SRIT in place as a result of increased compliance and enforcement activity.
Does the Scottish rate of income tax have other implications?
It is important that Scottish taxpayers are aware of the potential implications for them of different rates and thresholds of income tax being applied in Scotland.
Scottish taxpayers have been from 6 April 2017 subject to two different sets of income tax rates where they have both earned and/or property related income (SRIT) and savings income (UK rates and thresholds). The introduction of two new tax bands from 6 April 2018 undoubtedly further complicates income tax calculations as a result of income being taxed on a stack basis (i.e. earned income is taxed first, followed by savings income and finally dividend income).
Income tax relief on, for example, pension contributions and gift aid payments, will be brought in by secondary legislation. Scottish taxpayers receive income tax relief at the appropriate Scottish rate based on whether they are a basic rate, higher rate or additional higher rate taxpayer.
Pension providers had until April 2018 to introduce changes to their IT systems that will enable them to claim the appropriate rate of income tax relief at source on behalf of Scottish taxpayers. HMRC had the same timescales to identify Scottish taxpayers and make adjustments, if any, to the rate of relief through PAYE or self-assessment.
Income tax marriage allowance may be forfeited in certain circumstances where an individual is treated as a higher rate taxpayer in Scotland even though he or she would have been treated as a basic rate taxpayer in the rest of the UK.
CGT has not been devolved to the Scottish Government and therefore a taxpayer’s CGT position should be the same no matter where they reside in the UK. Scottish resident higher rate taxpayers with capital gains will require to apply the income tax thresholds applicable in the rest of the UK to establish the CGT rate to be applied to their taxable gains.
What should you do?
The continued divergence of Scottish income tax thresholds from the rest of the UK combined with the introduction of two new income tax bands adds yet more layers of complexity to an already cumbersome tax regime.
Perhaps even greater differences in the income tax rates applied in Scotland compared to the rest of the UK in the future could well have important political and economic implications, as well as issues for business to address where employees are mobile or there is the need to address equality for employees working north or south of the border.
To establish the impact, if any, that these changes in the Scottish income tax thresholds and bands will have on you will depend on reviewing a number of factors: primarily whether or not you will be treated as being a Scottish resident taxpayer, together with the sources and level of your taxable income. You may also wish to consider any measures that may be taken in the light of that review.
We will continue to keep you informed on any future developments in the SRIT.
Our Private Client team offer a full portfolio of advisory services in wealth management, private property and family advice. It is a full-service solution that is always tailored to meet individual and family needs.