How will the new Scottish income tax rates affect your business
Justine Riccomini sets out some example scenarios following the introduction of the new Scottish rates and bands.
After the Scottish Rate Resolution was passed on 20 February 2018, we drew up some simple examples of Scottish taxpayers in different earnings bands, both as sole traders/partners and company directors.
The following highlights the tax position in each scenario, based on UK 2018-19 Scottish rates and bands:
Example 1A - Jamie (Sole trader or partner)
Jamie’s taxable business income is £34,500. As a sole trader or as a partner in a partnership business, Jamie pays Scottish Income Tax, and UK National Insurance contributions (NICs).
Jamie’s top rate of income tax is 21%. He also pays UK NICs at 9% between the lower and upper profits limit (£8,424 - £46,350)* - a total of 30%.
If Jamie earned £1 more, his tax rate would not move into a higher band. His total tax bill would remain £4,615 tax and £2,346.84 Class 4 NICs
He also pays Class 2 NICs* at £2.95 a week (£153.40 pa) – approximately equivalent to another 0.45% on his earnings of £34,500, bringing his total taxes to £7,115.84.
If Jamie were not a Scottish taxpayer, he would pay 29p in tax (£4,530) and NICs (£2,346.84) plus Class 2 NICs – i.e. a total of £7,030.24 assuming he is entitled to a full UK Personal Allowance
* Assumes no expenses deducted from gross profits
Example 1B - Jamie Limited
If Jamie runs his business through a limited company and takes out all the £34,500 profit, with a salary just below the NICs threshold and the balance as dividends, he would pay slightly less in tax and NICs, but this would probably be outweighed by the administrative costs of running a company.
Jamie would have no earnings liable to Scottish Income Tax. His top rate of income tax would be the UK basic rate dividend rate of 7.5%. There is no NICs due on dividends. The amount paid out as dividends would be taxable profit in the company attracting a top rate of 19%. The top rate of tax payable by both Jamie and the company is 26.5%. None of the income tax paid would reach the Scottish purse as dividends and savings are not devolved to Scotland. Jamie’s personal tax bill in this scenario would therefore be £1,548.75.
On one additional £1 earned as paid out as dividends, the company would still pay 19p and Jamie 7.5p – a total of 26.5p.
Example 2A - Shona (Sole trader or partner)
Shona’s business has taxable profits of £43,430. As a sole trader or as a partner in a partnership business Shona pays Scottish Income Tax, and UK NICs.
Shona’s top rate of income tax is 21%. She also pays UK NICs at 9% - between the lower and upper profits limit (£8,424 - £46,350)* - a total of 30%. Assuming she has a full UK Personal Allowance, her total tax bill would be £6,490.30 + £3,150.54 Class 4 NICs.
She also pays Class 2 NICs* at £2.95 a week (£153.40 pa) – approximately equivalent to another 0.35% on her earnings of £43,430, bringing her total tax bill to £9,794.24.
If Shona earned an additional £1 or more, she would become a 41% taxpayer and also pay 9p in NICs – a total effective tax rate of 50%, which may not be an incentive for her to build her business as a sole trader. This liability would personally cost Shona £6,490.71 plus Classes 2 & 4 NICs as above, assuming she has a full UK Personal Allowance.
If Shona were not a Scottish taxpayer, she would pay 29p in tax (£6,136) for every additional pound earned, as she would still be within the UK basic rate band up to the rest of UK higher rate threshold of £46,350. This would equate to a total tax liability of £9,439.94 assuming she is entitled to a full UK Personal Allowance.
* Assumes no expenses deducted from gross profits
Example 2B - Shona Limited
If Shona runs her business through a limited company and takes out all the £43,430 profit, with a salary just below the NICs threshold and the balance as dividends, she would pay around 10% less in tax and NICs, but this would be offset by the administrative costs of running a company.
Shona would have no earnings liable to Scottish Income Tax. Her top rate of income tax would be the UK basic rate on dividends of 7.5%. There is no NICs due on dividends. The amount paid out as dividends would be taxable profit in the company attracting a top rate of 19%. Shona’s top rate of tax – for her and the company is 26.5%. None of the income tax paid would reach the Scottish purse as dividends and savings are not devolved to Scotland. Shona’s personal tax bill in this scenario would, therefore, be £2,218.50.
On one additional £1 earned as paid out as dividends, the company would still pay 19p and Shona 7.5p – a total of 26.5p.
Example 3A - Morag (Sole trader or partner)
Morag’s business has taxable profits of £75,000. As a sole trader or as a partner in a partnership business Morag pays Scottish Income Tax, and UK NICs.
Morag’s top rate of income tax is 41%. She also pays UK NICs at 9% up to the upper profits limit (£46,350) and 2% on the balance over the upper profits limit.
If Morag earned £1 more, she would not pay an increased rate and would thus continue to pay a marginal 43p (41%+ 2%) in taxes on each additional £1 earned.
She also pays Class 2 NICs* at £2.95 a week (£153.40 pa) – approximately equivalent to another 0.2% on her earnings of £75,000. Her total tax bill would, therefore, be £19,434 plus £3,986.34 and £153.40 in NICs in this scenario assuming she is entitled to a full UK Personal Allowance – a total tax bill of £23,573.74.
If Morag were not a Scottish taxpayer, she would pay 42p for every additional pound earned. Her total tax bill would thus be £18,360 plus £3,986.34 and £153.40 NICs, totalling £22,499.74 assuming she is entitled to a full UK Personal Allowance.
Example 3B - Morag Limited
If Morag runs her business through a limited company and takes out all the £75,000 profit, with a salary just below the NICs threshold and the balance as dividends, she could pay around 5% more in tax and NICs, but this would depend on the exact format of the remuneration package.
Morag would have no earnings liable to Scottish Income Tax. Her top rate of income tax would be the UK higher rate on dividends of 32.5%. There is no NICs due on dividends. The amount paid out as dividends would be taxable profit in the company attracting a top rate of 19%. Morag’s top rate of tax – for her and the company is 51.5%. This may be attractive to Morag as her personal tax would be lower. In this scenario, Morag’s total personal tax liability would be £11,748.75.
On one additional £1 earned as paid out as dividends, the company would still pay 19p and Morag 32.5p – a total of 51.5p.
Note: If Morag’s profits are uneven, for example, they averaged out at £45,000 a year, she might reduce her tax bill by leaving some money in the company in high earning years. For example, rather than taking out £75,000 in salary and dividends, if she left £30,000 in the company, this would be taxed at 19%. She could then withdraw this money the following year and avoid the higher dividend rate of 32.5%.
*Note that from 6 April 2019, it is anticipated that Class 2 NICs will be abolished and transitioned into a Class 4 NICs charge which will be reformed to include a new threshold known as the called “Small Profits Limit”.
Anomalies thrown up by the new rates and bands
Some anomalies were thrown up by the new rates and bands – the main one being pensions tax relief for ‘relief-at source’ pensions, but also marriage allowance, gift aid, PAYE codes, employer-supported childcare, and the fact that the NICs Upper Earnings threshold is not aligned with the Scottish Higher Rate threshold, meaning that someone earning between £43,430 and £46,350 now has a marginal rate of tax of 53%.
The pensions tax relief, marriage allowance, gift aid and employer-supported childcare anomalies have been addressed by HMRC, working with the Scottish Government.
PAYE codes are an ongoing matter because HMRC is responsible for identifying Scottish taxpayers – however, it is generally acknowledged that this will never be 100% accurate due to various factors such as migration.
Recap of the 2018/19 rates and bands, together with available pension relief