Scottish income tax uncertainties

Scottish notes and coins
Donald-Drysdale By Donald Drysdale for ICAS

15 February 2017

As Holyrood is poised to pass a Scottish rate resolution for 2017/18, Donald Drysdale raises some practical questions about the new Scottish income tax.

Scotland first

I’m not flag-waving. I’m simply stating a fact.  In the case of income tax, Scotland is the trailblazer among the devolved administrations.

The Scottish rate of income tax (SRIT) has applied since 6 April 2016.  Although this may have happened virtually unnoticed by the traveller on the Leith omnibus, SRIT has already had a fundamental impact on the way the Scottish Government’s budget is funded.

On 6 April 2017 the new Scottish income tax (SIT) will be implemented, and it will be more noticeable. Income tax rates and thresholds, to be set by the Scottish Parliament, will apply to all non-savings non-dividends income of Scottish taxpayers; that is, broadly, the earnings and pensions of individuals who live in Scotland.

Fiscal devolution adds additional intricacies to a UK tax regime that’s already over-complicated, and these may be regarded by some as an acceptable price to pay for greater local accountability.  But as April rapidly approaches, it is becoming apparent that some of the practical issues surrounding Scottish income tax have not been properly explored in advance.

Notices of coding

HMRC administer SIT on behalf of the Scottish Government, albeit at the latter’s expense. As the SIT rates and thresholds for 2017/18 were not set by the end of November 2016, HMRC and the Scottish Government were able to agree on an assumption to be used in the main issue of PAYE ‘S’ codes.  There’s even an administrative provision allowing interim use of UK rates and thresholds in deducting tax from Scottish taxpayers.

By November, Scottish Finance Secretary Derek Mackay must have been far advanced in preparing his draft Budget for 2017/18, which he delivered on 15 December.  This explains why HMRC have issued ‘S’ codes in respect of employees who are Scottish taxpayers, based on the original Budget proposal that the Scottish higher rate income tax threshold would be £43,430.

On 2 February, as a result of political jostling during the parliamentary debate on the Budget, the proposed higher rate threshold was reduced to £43,000.  Reacting informally to this at the time, HMRC said they would issue revised ‘S’ codes as soon as possible – suggesting they hadn’t planned in advance for such a situation.

After gentle nudging from ICAS (and possibly others), they re-considered.  Given that the revised figure of £43,000 is still nothing more than a proposal and might change further, practitioners will be relieved to know that HMRC now plan to defer re-issuing ‘S’ codes until a Scottish rate resolution has been passed.

Childcare vouchers

An employee may receive help from their employer towards the costs of childcare, using childcare vouchers or other schemes.  They may receive up to £55 a week from childcare vouchers, depending on how much they earn and when they joined the scheme, and these are free of income tax and NICs.

The limit of £55 applies where the taxpayer’s relevant earnings do not exceed the higher rate income tax threshold; in other cases the limit is £28.  This would be straightforward but for the fact that the legislation fails to specify clearly whether the limit for Scottish taxpayers is governed by the threshold for Scotland or for the rest of the UK.

The conundrum here is that the relief for childcare vouchers, which is a UK-wide income tax relief determined by Westminster, is calculated by reference to earnings which – for a Scottish taxpayer – will be subject to SIT. In a move that is good news for Scots, HMRC have said they will publish guidance saying that the £45,000 threshold in the rest of the UK will be applied uniformly across the UK for childcare purposes.

As many practitioners will attest, it is highly unsatisfactory for taxpayers to be taxed by law and untaxed by concession.  They would face the possibility that HMRC might change their interpretation at any time. Making tax law is a task for Parliament, which should legislate accordingly.

A new scheme is to be launched shortly, allowing working families to claim 20% of yearly childcare costs up to certain limits.  This will replace existing schemes except for taxpayers already within them, and doesn’t seem to suffer from the same lack of clarity.

Software implications

UK tax administration is increasingly dependent on technology.  HMRC’s IT systems support and process the calculation of self-assessed taxes and associated collection and enforcement tasks.  All these would grind to a halt were it not for HMRC’s ubiquitous reliance on third parties such as employers, payroll bureaux and tax practitioners – all of whom are heavily dependent on commercial tax software products.

It has become accepted practice that UK income tax rates and thresholds are announced far enough in advance to ensure that both HMRC and independent software providers have time to update their products before the beginning of each fiscal year.  Indeed, the cycle at HMRC starts even earlier – with the need to issue PAYE coding notices in advance.

Devolution has changed all that. With the Scottish Government going to the wire before setting the SIT rates and thresholds, software engineers will have little time to update, test and deliver their products by 6 April. Issues such as the lack of clarity on childcare vouchers cause them further problems.

There is no easy solution.  Politicians need flexibility in setting taxes, and the devolved administrations are already constrained by what is decided at Westminster and when. But employers, software providers and practitioners need clarity in time to do their work.  This tension between setting tax rates and administering the taxes is likely to remain a big issue.

The elephant in the room

For SRIT in 2016/17, the Scottish rate resolution was passed by Holyrood on 11 February 2016.  It had to be passed by 5 April 2017, but this presented little difficulty for a majority administration.

Had the rate resolution for 2016/17 not been passed, SRIT would have been at 0%.  The effective tax rates on earnings and pensions of Scottish taxpayers would have been 10%, 30% and 35%.  The Scottish Government would have lost some £4.3 billion of funding, and the impact on the Scottish economy would have been devastating.

For SIT in 2017/18, the Scottish Government hopes that Holyrood will pass a Scottish rate resolution next Monday, 20 February.  If anything were to falter, there would still be another six weeks to get a resolution through.

Strangely, the provisions that governed SRIT in the absence of a resolution have been swept away.  The new legislation seems unclear on what would happen if no Scottish rate resolution were passed by 5 April.  Would the rate of SIT for 2017/18 fall to 0%?  If so, the Scottish Government would have lost revenues of around £11.2 billion.

A sobering thought for an administration without a clear parliamentary majority, and presumably a few more sleepless nights for the Finance Secretary.

Article supplied by Taxing Words Ltd


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