Scottish tax proposals for 2018/19

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Donald Drysdale dissects the proposals in the Scottish Budget, including increased rates and bands of income tax. Could this herald a slow increase in the tax rates north of the border?

Income tax

Scottish income tax is the only major revenue-raising tax power possessed by Scotland’s Parliament in Edinburgh.

The draft Scottish Budget for 2018/19 was unveiled on 14 December by Scottish Finance Secretary Derek Mackay. He proposes a significant reform of the income tax rates and bands which apply to the earnings and pensions of Scottish taxpayers – ie the non-savings non-dividend (NSND) income of individuals who have their main home in Scotland for most of the time.

Dividend and savings income will remain subject to the income tax rates which apply in the rest of the UK (rUK). 

Speculation had been rife ahead of the Budget, since the Scottish Government had already published a discussion paper identifying a number of alternatives for Scottish income tax for 2018/19.

We now know that from 6 April 2018, instead of the basic, higher and additional rate bands which apply in rUK, Scots are likely to face five distinct income tax bands as follows:

Band of NSND income in 2018/19 Name of rate/band) Income tax rated
Over £11,850* – £13,850 Starter rate 19%
Over £13,850 – £24,000 Basic rate 20%
Over £24,000 – £44,273 Intermediate rate 21%
Over £44,273 – £150,000** Higher rate 41%
Above £150,000** Top rate 46%

*   This assumes that individuals are entitled to the personal allowance of £11,850.

**  The personal allowance is reduced by £1 for every £2 of income over £100,000.

Who wins?

The Budget claims that, on an unchanged income, these changes will result in the majority of people paying less tax next year than they do this year. That is misleading, since the inflationary increase in the personal allowance alone will have that impact.

What is perhaps more predictable is that Scottish taxpayers will find it hard to understand their liabilities under two interconnected income tax regimes, one with three bands and the other with five; tax practitioners will find their Scottish clients’ income tax increasingly difficult to deal with; and HMRC will charge the Scottish Government handsomely for the increased administration.

For the majority of Scottish taxpayers, the immediate tax impact of the reform will be slight. The starter rate (not to be confused with the UK starting rate for savings) will be an added complication producing, for those with NSND income up to £24,000, a negligible saving of up to £20 a year compared with those in rUK. It is hard to see how the price of a litre of whisky or 50 cigarettes will “protect the lowest earners” as the Budget claims.

Above £24,000 the new intermediate rate will quickly reverse this saving. Those with NSND income of £26,000 will pay the same tax as those in rUK. Those with NSND income of £46,350 – the higher rate threshold south of the border – will pay income tax of £639 more than those in rUK. This step change is largely due to the higher rate threshold being held down at £44,273 for Scottish income tax.

National insurance

By contrast, national insurance contributions (NICs) are not devolved. The upper earnings level for NICs will be £46,350 throughout the UK, but the differing income tax thresholds add further confusion. Between £44,273 and £46,350, Scots will pay tax and NICs at a combined marginal rate of 53% compared with 32% in rUK.

At higher NSND income levels, Scots will pay more tax than in rUK. The differences are not astronomical compared with the incomes involved, but may be resented by many high earners. For example, at income levels of (say) £60,000 and £90,000, the extra tax comes to £755 and £1,055 respectively.

Help for low earners?

The revised structure proposed for tax rates and bands will undoubtedly make Scottish income tax more progressive, and the changes in 2018/19 are forecast to provide an additional £164m to be “invested in” (ie spent on) public services.

In summary, the differences taking effect in 2018/19 provide little help for lower earners. The extra tax liabilities on higher earners are significant, but have been pitched at levels unlikely to trigger large scale behavioural avoidance measures such as incorporation or emigration.

Higher earners simmer

Just like the proverbial frog, a high earner plunged into the boiling water of a sharp tax rise might take swift avoiding action – perhaps moving their home and their business out of Scotland.

On the other hand, if heat was applied gradually, with (say) annual reductions of 1% in the starter rate and annual increases of similar amount in the higher and top rates, the same taxpayers might be willing to listen to arguments about greater fairness and equality and therefore less inclined to take precipitate action.

Thus by proposing a five-tier structure of rate bands, the minority SNP administration has designed an income tax regime that may be more easily manipulated in future to make it more progressive. This deliberate design feature may also prove important in securing the necessary political support to get the 2018/19 Budget approved in February 2018.

LBTT relief

It was unclear whether Mackay would follow Philip Hammond’s first-time buyers SDLT relief, effective from 22 November 2017. Some commentators questioned whether such a relief was needed, given that the normal starting point for the similar Scottish land and buildings transaction tax (LBTT) (£145,000) is already higher than that for SDLT (£125,000), while average property prices in many parts of Scotland are lower than in rUK. However, subject to consultation, a new relief for first-time buyers will be introduced in 2018/19, increasing their nil rate band from £145,000 to £175,000.

Business rates

In a change to the system of business rates, the September 2017 measure of inflation, CPI (3.0%), will be used instead of RPI (3.9%), to calculate the annual inflationary uplift in rates poundage (the Scottish equivalent of rates multiplier) for 2018/19.

The Budget also announced that the Scottish Government will protect the small business bonus scheme, lifting 100,000 properties out of business rates and thus continuing to support SMEs.

Air departure tax

The introduction of air departure tax (ADT) to replace air passenger duty (APD) in Scotland is being deferred until issues have been resolved relating to EU state aid approval for the exemption of flights departing from the Highlands and Islands.

Conclusion

Mackay’s Budget has promised extra money for the NHS, police, fire services, education, childcare, economic development, infrastructure, local government services and the lifting of the public sector pay gap. The Scottish Government claims that it has only been able to do so because of the decisions it has taken to use Scotland’s tax powers.

The Budget seeks to increase employment, revolutionise productivity and encourage economic growth. If it fails in these objectives, Scottish income tax rates seem likely to rise further. Scottish frogs beware!

About Donald Drysdale

Image of Donald Drysdale, Author

Donald Drysdale of Taxing Words Ltd is a freelance author and winner of Tax Commentator of the Year in Tolley's Taxation Awards 2017. He also writes for ICAS, Bloomsbury Professional and other publishers, having previously held senior positions in tax and technology at KPMG, PwC and ICAS.

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18th Dec 2017 14:18

I've just put in the new Scottish Rates into my 2018-2022 tax/benefits model and into a beta of our pensionForward advice system.

Two things are apparent.

1) The small gains for low earners are reduced even more by the means testing of state benefits. Lower tax means higher net incomes, which means lower benefits. A person getting Universal Credit will find that 63p of each extra £1 they get from the 19p rate will be clawed back. On JSA it can be 100% of any gain.

2) There is a real hit for those taking out taxable sums from their pension savings. For those, typically poorer people with smaller pots, who are taking all their savings in one sum under the pension freedoms, they can easily hit higher rate tax in that tax year. In this case the poorest get hit by the change meant to benefit them.

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By raycad
18th Dec 2017 16:33

How is all this going to work under the PAYE system? There must be hundreds of thousands of Scottish-resident taxpayers who work for a non-Scottish HQ'd employer. (I have a couple.) Does this mean that all UK payroll software has to be configured to incorporate the various different Scottish rates and bands in addition to all the UK rates and bands? Ye Gods!

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to raycad
18th Dec 2017 21:05

and vice versa, there will be non-Scottish resident employees working for Scottish employers. An of course all new starter employees are currently not Scottish (at least to HMRC initially).

The Scottish Rate of Income Tax is already a requirement of PAYE across the UK, hence the 'S' prefix.

Yes UK software operating PAYE will require inclusion of the calcuations to handle S tax codes.

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18th Dec 2017 21:10

Look forward to receiving further clarification from HMRC on proposals of the implementation. The calculation is one aspect. However, there are currently a number of anomalies evident with SRIT:
- All school leavers are Rest of UK even if they were born, and never left Scotland. Currently HMRC does not allow an individual to declare themselves Scottish!
-Will there be additional tax codes for the Starter Rate and the Intermediate Rate - how about B0 and B1, or even better BS and BI! We already have BR.
-Presume that Relief At Source with pension AE issue is resolved (at least for the time being) with the Basic Rate in Scotland remaining the same as the Rest of the UK.

And into the future, role on Welsh taxation.

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