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Which way for Scottish taxes?

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5th Sep 2014
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As the Scottish independence referendum of 18 September looms, individuals and businesses with interests north of the border face significant uncertainties about how they’ll be taxed in future, says Donald Drysdale.

Devolved taxes following a ‘No’ vote

A ‘No’ outcome in the referendum, rejecting independence, might offer few dramatic tax changes at the outset but would certainly not maintain the status quo.

Individuals who are Scottish taxpayers will become liable to the Scottish rate of income tax from April 2016. As a result they may find themselves paying tax at higher or lower rates than other UK tax residents. Higher seems the more probable, given the SNP’s commitment to maintain generous state handouts.

All the major political parties have voiced their support for greater devolution of tax powers from Westminster to Holyrood if the Union survives. There’s no telling what this might involve, but one specific possibility is removal of the lock-step on income tax rates. This could pave the way for proportionately higher top income tax rates in Scotland than elsewhere in the UK – again helping to fund Alex Salmond’s dream of a more strongly socialist society.

Complications may arise for some 110,000 individuals living on one side of the English-Scottish border and working on the other. They’ll need to know whether or not they are Scottish taxpayers, and the rules for determining their status from April 2016 are already known. Many of these individuals will be drawn into self assessment for the first time. Employers throughout the UK will face the added costs of operating Scottish PAYE codes (‘S’ codes) for employees who are Scottish taxpayers, and doubtless having to explain these to employees affected.

Taxes in an independent Scotland

A ‘Yes’ referendum result, in favour of Scottish independence, would pose far greater unknowns.

There’s little cause to believe that splitting up the UK would be an amicable separation, and plenty of reasons to expect an acrimonious divorce. As a first stage we could anticipate intense, early-stage negotiations between Westminster and the current SNP-led government at Holyrood, dealing with fundamental matters of principle. Then, after ‘independence day’, a new Scottish government – not necessarily SNP and perhaps not even committed to the ideals of separation – would have to pick up the pieces, trying to establish economic independence while embarking on years (perhaps even decades) of costly and painful manoeuvring to agree and implement a final settlement with the rest of the UK.

New Scottish taxes would be needed urgently to raise the substantial revenues a Holyrood government would require. With fiscal autonomy, it’s hard to guess what new fundraising ideas might emerge and how soon they could be introduced. In the meantime a variant of the Scottish rate of income tax might well be implemented as a pragmatic transitory measure.

Independence (for those who believe in it) ought to provide a unique opportunity for Scotland to adopt a simple, easily understood tax regime, but this is unlikely to happen. From the pattern of fiscal devolution to date (i.e. the development of Land and Buildings Transaction Tax and Scottish Landfill Tax), we can postulate that a Scottish government would be likely to create new taxes that largely replicate pre-existing UK taxes, and might then tweak these subsequently. Such a gradual process of evolution could lead to an excessively complex tax code, creating acute uncertainties for all Scottish taxpayers.

There has been a strong public focus on the difficulties an independent Scotland might face in applying to join the EU, but this is not the only international problem that needs to be resolved. The UK has a huge network of double tax treaties with most developed countries, and these have taken many years to negotiate. Nothing is known of any SNP plans for Scotland to develop an equivalent set of cross border tax treaties – to prevent income and gains from being taxed both in Scotland and in other countries.

There’s no telling at this early stage how new Scottish taxes might impact on those commuting across the English-Scottish border, or on any others with interests in both Scotland and other parts of the UK. It’s tempting to imagine that Scotland should find it easy to agree double tax treaties with England, Wales and Northern Ireland, but is this a reasonable assumption to make ahead of a messy divorce? Without such treaties, Scottish taxpayers with income arising in the rest of the UK might find themselves with limited or no relief from double taxation.

Whatever the outcome of the referendum, businesses and individuals with interests in Scotland and their accountants, lawyers and tax advisers need to understand current and forthcoming Scottish tax law and practice. They also need to follow new developments as they arise, and the next few months promise to be crucial in this respect.

Donald Drysdale is series editor of Bloomsbury Professional’s Scottish Tax Series, which aims to provide tax advisers and non-experts with practical and concise information on the Scottish and UK tax rules affecting taxpayers in Scotland.

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