Alternatives for Scottish income tax

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Donald Drysdale analyses income tax strategies under consideration by the Scottish Government, which would apply to Scottish taxpayers from 6 April 2018.

Open discussion

The Scottish Government has published a discussion paper: The role of income tax in Scotland’s Budget. It provides useful background material that helps inform the debate on the future use of the income tax powers devolved to the Scottish Parliament. It also offers an interesting summary of the income tax aspirations of the various political parties at Holyrood.

Subject to as-yet-unknown factors in the forthcoming UK and Scottish Budgets on 22 November and 14 December 2017 respectively, around 30% of devolved Scottish public expenditure for 2018/19 is likely to be funded by Scottish income tax, with a further 7% coming from other tax revenues generated in Scotland. The balance of funding will come from the continuing block grant from Westminster, based on the Barnett formula.

The discussion paper identifies four possible approaches to setting income tax rates and bands for 2018/19, as follows:

1. Three tax bands

This would retain the three existing income tax bands. The basic rate would remain unchanged at 20p. The higher rate threshold would increase with inflation, and the higher rate would be increased to 41p. The additional rate would rise to 46p – or perhaps 48p or 50p.

Under this option, all 2.15 million Scottish basic rate taxpayers would pay no more than they pay currently, but all 366,000 existing Scottish higher rate and additional rate taxpayers would pay more. Scottish public revenues would increase by between £80m and £90m.

2. Four tax bands

Within a new income tax band for low earners, based on median income, earnings between £11,850 and £24,000 would still be taxed at 20p. Earnings between £24,001 and £44,290 would be taxed at 21p and earnings between £44,291 and £150,000 at 41p. The additional rate would rise from 45p to 48p or 50p – perhaps in stages.

Around 1.3 million basic rate taxpayers would pay no more tax than they pay now, but the remaining 1.2 million Scottish taxpayers would pay more. Revenues would increase by between £210m and £270m.

3. Five tax bands

The higher rate threshold would increase with inflation, but the higher rate tax band would be split. Earnings between £44,291 and £75,000 would be taxed at 41p and earnings between £75,001 and £150,000 at 42p.

As with approach two, around 1.3 million basic rate taxpayers would pay no more tax than they pay now, and the remaining 1.2 million taxpayers would pay more than before. Revenues would increase by between £220m and £290m.

4. Six tax bands

The number of income tax bands would double from three to six. Earnings between £11,850 and £15,000 would be taxed at 19p and earnings between £15,001 and £24,000 at 20p. Other rates and bands would follow a similar pattern to approach three.

Around 1.4 million taxpayers earning below £27,000 would pay less tax than they do now, while the remaining 1.1 million taxpayers would pay more tax. Revenues would increase by between £150m and £220m.

Assessment of approaches

The discussion paper assesses the impact of these different approaches on the 2.5 million people who pay income tax on earnings in Scotland while noting that two million Scots (44% of the adult population) would not be affected because they earn less than the personal allowance, and thus don’t pay Scottish income tax.

In estimating impacts on public revenues, the paper anticipates possible behavioural changes by taxpayers. Some might change the number of hours they work, while others might retire, relocate, incorporate or switch income between earnings and dividend income (which is subject to tax at the rest of the UK rates and bands). Lost revenue through behavioural change is estimated at up to £50m under approach one, or up to £200m under each of the other options.

Politics

The minority SNP administration in Edinburgh needs political support for its Budget, and the paper summarises the income tax policies of all political parties represented at Holyrood, based on their 2016 election manifestos.

The four approaches put forward by the Scottish Government appear designed to gain support in varying degrees from the Scottish Greens, Labour and Liberal Democrats – apparently in that order.

The discussion paper offers a refreshingly transparent view of the thinking we can expect to support the Scottish income tax proposals for 2018/19.

However, the range of options – particularly a Scottish income tax regime with six bands – suggests that tax practitioners who advise Scottish taxpayers may face an increasingly complex income tax environment which they, their clients, and even HMRC may have difficulty in understanding.

About

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.

Replies

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By DJKL
14th Nov 2017 10:24

Berwick keeps looking more and more appealing, thank goodness I have one English parent re my residency rights but real shame I will have to leave my wife up here, her ancestors all being Scots or Irish. (Certainly what I have told her)

Maybe it is all a cunning plan, if higher rate taxpayers in Scotland more likely to have voted No re Indyref1 maybe drive them all out with higher taxes before Indyref2.

Interesting thing with increased divergence will be how long will software companies embrace the extra frills and cater for it in their programmes, and at what point , if divergence continues, will one need distinctly Scottish software? We could eventually get back to the days (1980s) where with Scottish Legal Accounting there was really only two suppliers, Usher and Pilgrim, who could charge daft sums for compliant software whilst down south had cheaper alternatives which were not compliant re our solicitor account rules.

Suspect we are a fair way away whilst all that is being tweaked is bands and rates, however longer term (post my retirement) do see divergence increasing.

Thanks (2)
By
to DJKL
16th Nov 2017 17:07

Good point about software costs.

I've dealt with tax software providers enough to know that they're unlikely to provide all-singing all-dancing software that copes with complex Scottish income tax just because HMRC asks them to, or just because practitioners need it. At the end of the day it will come down to what makes commercial sense to them, and the market for Scottish income tax products is much smaller than for UK products and caters for a population where income levels tend to be lower than in the south.

So practitioners with Scottish clients shouldn't be surprised to see disproportionately higher software costs in future.

And even more so for Welsh clients from April 1919...

Thanks (0)
By DJKL
to Donald Drysdale
16th Nov 2017 18:31

All my clients are Scottish in the sense they are resident here ; I'm doomed I tell you, doomed.

I do think we are a fair way away if it is just bands/rates, a tick box re most tax software could I think readily revert to an alternative, if tick then calculate using X, but we all know that politicians love meddling, tinkering, it justifies their existence, so considering entropy I expect a spiral over time into chaos.

Ten years from now I will be retired and paying some other poor s** to do my tax return.

Thanks (1)
By
to DJKL
20th Nov 2017 12:21

There is no such concept as 'tax residence' in Scotland. An individual resident in the UK is either a 'Scottish taxpayer' or not a Scottish taxpayer, according to the rules contained in Scotland Act 1998 ss 80D–80F (as amended).

Different bands and rates north and south of the border may cause more complications than you think. Consider, for example, the possible permutations where a Scottish taxpayer with earnings (taxable at Scottish bands and rates) and investment income (taxable at the bands and rates applying in the rest of the UK) decides to exercise his right to allocate his personal allowance to minimise his tax liability.

Thanks (0)
avatar
to Donald Drysdale
20th Nov 2017 11:43

Is it not a case that Software providers will need to incorporate any changes regarding Scottish Income Tax no matter where an employer/company is based. Employers in England may have employees with a Scottish Tax Code (and in the near future a Welsh Tax Code) and the their software will need to cope with whatever complex rules the Scottish government decide to implement.

Thanks (1)
By
to mcbride_r
20th Nov 2017 12:28

Absolutely.

It is already a requirement that employers anywhere in the UK must be in a position to apply PAYE correctly through RTI where an employee is a Scottish taxpayer and therefore has an 'S' code. Likewise, from 6 April 2019, employers anywhere in the UK will have to be able to cope with 'S' codes and 'W' codes.

Even where an employee performs all his work in (say) England, his personal circumstances may be such that his 'main place of residence' is in Scotland or Wales, meaning that he would be taxed as a Scottish or Welsh taxpayer.

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