The evolution of devolution
Donald Drysdale considers the impact of fiscal devolution on governments, tax authorities and taxpayers.
Two publications in the final week of January 2016 brought the progress of fiscal devolution into sharp focus. They question the extent to which Holyrood should continue to use its devolved powers to mirror tax systems elsewhere in the UK with only minor variations, or whether we will start to see more fundamental divergence.
The McMillan Report
On 25 January the Independent Commission for Competitive and Fair Taxation in Scotland, established by the Scottish Conservatives and chaired by Sir Iain McMillan, published its Final Report.
This addressed how existing devolved powers, and the wider devolution proposed by the Smith Commission, might best be used to promote Scotland’s economy and competitiveness, while ensuring strong and sustainable public services and a regime which is fair to the taxpayer.
The Commission advocated simplicity and transparency in taxes. It recommended that administration costs should be minimised. While wider tax raising powers for the Scottish Parliament present opportunities, they also present risks and weaken the safety net of the Barnett Formula. Scotland’s overall tax burden should not be higher than in any other part of the UK, and should be lower when affordable.
Income tax should be progressive and smoother, the Commission suggested, with a new band between 20 per cent and 40per cent and the top rate no higher than elsewhere in the UK; council tax should become a fairer, more local and progressive tax with reliefs aimed at low income households; land and buildings transaction tax (LBTT) should be made flatter and eventually abolished; and air passenger duty should be replaced by a competitive departure tax linked to travel distance.
The Commission also advised that business rates should be frozen at least until the end of the next Parliament and reliefs reformed to encourage employment and investment; and that the Scottish Government should exercise a more rigorous and transparent approach to its financial reporting.
Divergence of income tax
Post-Smith, the Scottish Parliament will have unrestricted power over income tax rates and thresholds. While this will become a key policy tool in the hands of the Holyrood administration elected in May, it may be hard to use effectively.
Income tax on non-savings, non-dividend income will be by far the largest tax devolved to Scotland. Changes in income tax rates or thresholds would significantly impact on Scottish revenues, and budgetary constraints might prevent any meaningful reduction in tax burdens on those with lower incomes.
The creation of one or more new rate bands could substantially alter the ‘look and feel’ of income tax in Scotland compared with that south of the border.
Conversely, increasing income tax on higher earners might produce disproportionately low revenue flows. Compared with the UK as a whole, Scotland already has a smaller proportion of higher rate and additional rate taxpayers. Studies from other countries – notably the USA and Switzerland – demonstrate that those with higher incomes are most inclined to migrate across federal borders to save tax.
The McMillan recommendation of a new income tax band at a rate of around 30 per cent, to smooth the progressive nature of income tax, was suggested to reduce income tax for middle income taxpayers. Of course, decisions regarding the actual rates and thresholds have still to be made, so it is difficult to judge the impact of any extra rate bands.
Moreover, the creation of one or more new rate bands could substantially alter the ‘look and feel’ of income tax in Scotland compared with that south of the border. It could mark the beginning of a new era in which Holyrood no longer feels it has to emulate Westminster’s policies. It could also change the criteria on which taxpayers (whether high or low earners) base their migration decisions.
The LBTT supplement
On 27 January the Land And Buildings Transaction Tax (Amendment) (Scotland) Bill was introduced into the Scottish Parliament, proposing a new LBTT supplement from 1 April 2016 on purchases of additional residential properties (such as buy-to-let properties and second homes) costing £40,000 or more.
The supplement aims to protect opportunities for first time buyers to enter the housing market in Scotland, and avoid distortions which would otherwise arise in Scotland when new higher rates of SDLT for the purchase of additional residential properties are introduced in the rest of the UK from 1 April.
The new charge will resemble the SDLT supplement and may lay traps for the unwary (see Will you pay 3% more on moving house?).
The LBTT supplement will hurt. On buying a property at the average Scottish house price, which was £169,397 in the quarter to 30 September 2015, LBTT on a main residence is £488 but on an additional residence will be £5,570.
Divergence of LBTT and SDLT
For the new supplements, the rules for determining whether you own more than one residential property will differ north and south of the border.
For SDLT, spouses or civil partners are treated as one unit, unless separated under a court order or by a formal deed of separation executed under seal, whereas unmarried couples are treated as two separate individuals who can establish two separate main residences if the evidence supports this. By contrast, for LBTT the treatment as one unit applies to spouses or civil partners (unless they no longer live together and don’t intend to live together again) and also cohabiting couples (whether opposite sex or same sex).
For SDLT, property interests of minor children (under age 18) are taken into account. A similar rule applies for LBTT, but in this case the Scottish age of majority of 16 will apply.
In ‘mixed transactions’ or purchases of multiple dwellings the LBTT supplement may apply to residential components, notwithstanding that such a transaction may be subject to LBTT at the non-residential rates. It appears that the SDLT supplement would not apply in similar circumstances.
LBTT applies to properties in Scotland. However, the legislation on married couples, civil partners, unmarried couples and minor children relate to purchasers, who may come from anywhere in the UK or even overseas. There could be substantial difficulties in interpreting how the rules are to be applied.
There will be very real risks of non-compliance, and Revenue Scotland may not have the resources to police the new provisions.
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