Scottish income tax
12 March 2018
This article was featured in the April 2018 issue of the magazine.
Jill Smith MCIPPdip, CIPP policy manager, sets out the effects of changes to Scottish tax rates and earnings bands
On 6 April 2016, the Scottish rate of income tax came into force. For the 2016–17 tax year, Scottish taxpayers (STP) were subject to tax at 10% lower than the standard UK rates; the Scottish government then set a Scottish rate to apply on top of the reduced rate to STPs.
For the 2016–17 tax year the Scottish government was able to set only one tax rate to apply to all tax bands and it chose to set it at 10%. This meant that STPs paid tax at the same rates as taxpayers in the rest of the UK (rUK); the basic rate of income tax was 20%, the higher rate was 40% and the additional rate was 45%.
From 2017–18 onwards, the Scottish government has had powers to vary the tax rates for existing bands and to also alter or introduce tax bands. (The personal allowance remains reserved to Westminster, so this cannot be altered by the Scottish government.) In 2017–18, it chose to freeze the higher rate threshold at £43,000 for STPs whilst the threshold for taxpayers in the rUK increased to £45,000. So, some STPs who would not have moved into a higher tax bracket under the rUK threshold (i.e. earning £44,000) found themselves paying more in tax than someone on the same earnings resident in England, Wales or Northern Ireland.
An individual can only be classed as an STP in a year in which they are a UK tax resident. Residency is key, regardless of nationality or where their employer is based; someone is a STP if their sole or main residence is in Scotland. The exception to that rule applies to members of the Scottish Parliament; they are STPs regardless of where their main residency is located. A UK resident will either be classed as a Scottish taxpayer or a UK taxpayer for a tax year – there cannot be a situation where someone is treated as either for part of a year.
It is important that individuals inform HM Revenue & Customs (HMRC) if they move address to or from Scotland. According to the National Audit Office, maintaining accurate address records of the 2.6 million Scottish taxpayers remains the biggest risk facing HMRC in ensuring that Scottish income tax is assessed and collected properly.
From April 2016, HMRC has been telling employers whom they should treat as a Scottish taxpayer by allocating them a tax code with a prefix letter S. If HMRC changes a person’s tax code, the new code will be backdated to the start of the tax year in which they moved. The tax taken from a person’s salary or pension income will be adjusted automatically so the correct amount of tax is paid for the relevant tax year.
Change in rates and thresholds for 2018–19
Currently Scotland has three income bands – a 20p basic rate, a 40p higher rate for earnings over £43,001 and a 45p additional rate on earnings over £150,000. Following the draft Scottish budget in December 2017, two new bands have been added, a 19p starter rate and a 21p intermediate rate. There is also an increase to the existing 40p band to 41p, and to the 45p band to 46p; all of which are due to take effect from April 2018. At the end of January, the Scottish government also decided to reduce the higher rate threshold to £43,430 (originally planned to be £44,273).
These changes to the income tax system mean that almost all employees in Scotland (STPs) will notice some difference in their take-home pay. Looking ahead to the new tax year, let’s consider some examples of how this could affect an employee who is a STP and compare them to a counterpart, resident in England, Wales or Northern Ireland who is subject to rUK tax rates and thresholds. For these examples, the thresholds have been converted into approximate monthly amounts.
Example 1 confirms a low earner will be better off if they are a Scottish taxpayer, but Examples 2 and 3, based on an annual income of £28,000 and £48,000, show as predicted that high earners will be hit the most if they are Scottish taxpayers.
...powers to vary the tax rates for existing bands and to also alter or introduce tax bands
Another area of consideration for the employee is National Insurance contributions (NICs). The UK government still sets the rates and thresholds for NICs as this is a reserved matter.
For the 2018–19 tax year, higher earning STPs begin paying higher rate income tax at earnings of £43,430 but their NICs rate does not drop from 12% to 2% until their earnings reach £46,350. For those in the rUK, higher rate income tax kicks in at the same point that the NICs rate drops.
Those employers that have agreed PAYE (pay as you earn) settlement agreements (PSAs) with HMRC must already ensure that their recordkeeping identifies STPs separately in the calculations. These calculations will be made more complicated by the changes in the Scottish bands from April 2018.
Employers must ensure that the earnings of STPs are assessed against the rUK higher rate threshold and not against the Scottish threshold when making the basic earnings assessment for employer-supported childcare (typically childcare vouchers). This annual assessment involves comparing anticipated annual earnings against the rUK tax bands to identify the maximum values of tax-free childcare support that an employee can have.
...HMRC started to release the residency status reports...
Individual taxpayers are entitled to income tax relief on their contributions to registered pension schemes at their marginal rate, so now that tax rates can vary across the UK, the amount of tax relief available can vary too. UK government and HMRC are working closely with the Scottish government and pension providers to explain how providing tax relief will operate for Scottish pension savers.
Pension schemes that use the relief at source (RAS) method for providing tax relief do so by claiming the tax relief due on an individual’s pension contributions from HMRC and adding it to the individual’s pot. Relief is claimed at the basic rate and taxpayers with a higher marginal rate can claim any further tax relief from HMRC through self-assessment.
If/when the Scottish and rUK tax basic tax rates diverge, RAS pension scheme administrators must claim a different amount of tax relief for scheme members who are STPs than they would for rUK taxpayers. Therefore, pension scheme administrators need to identify the tax residency status of all their scheme members. On 29 January 2018, HMRC started to release the residency status reports to scheme administrators who had sent an annual return of individual information by 30 September 2017 so that they can update their records.
The report will have an extra field for residency tax status that will show ‘S’ for STP status, ‘U’ for an unmatched record and will be blank for rUK status.
Pension scheme administrators who do not receive a residency status report must use the rUK rate for all members for the 2018–19 tax year, unless they use the residency tax status lookup service (currently under development).
And then there’s Wales…
There are many areas to consider and we could look upon this as good practice for April 2019, because this is when the Welsh Assembly’s powers come into effect. Although it does not have the power to vary the number of tax bands or the thresholds, it does have the power to vary the three tax rates independently.
Our gradually devolving United Kingdom will over time see four nations, with three very different tax systems, and no doubt more changes to come beyond 2019.
If you have ever done manual calculations (as I have in the examples), you need to keep your wits about you. Though the method is the same as for the rUK, there are additional steps due to the introduction of the new bands.
Annual income £15,000 ÷ 12 = £1,250.00 per month less pay adjustment £988.25 = £261.75 taxable pay
£167 × 19% = £31.73
£94 × 20% = £18.80
Total tax due is £50.53 × 12 = £606.36 per annum
Rest of UK rate
Annual income £15,000 ÷ 12 = £1,250.00 less pay adjustment £988.25 = £261.75
£261 × 20% = £52.20 × 12 = £626.40
Annual income £28,000 ÷ 12 = £2,333.33 less £988.25 = £1,345.08
£167 × 19% = £31.73
£846 × 20% = £169.20
£332 × 21% = £69.72
Total tax due £270.65 × 12 = £3,247.80
Annual income 28,000 ÷ 12 = £2,333.33 less
£988.25 = £1,345.08
£1,345 × 20% = £269 × 12 = £3,228.00
Annual income £48,000 ÷ 12 = £4,000 less £988.25 = £3,011.75
£167 × 19% = £31.73
£846 × 20% = £169.20
£1,619 × 21% = £339.99
£379 × 41% = £155.39
Total tax due £696.31 × 12 = £8,355.72
Annual income £48,000 ÷ £12 = £4,000 less £988.25 = £3,011.75
£2,875 × 20% = £575
£136 × 40% = £54.40
Total tax due £629.40 × 12 = £7,552.80