United Kingdom: Income Taxation for Scottish Taxpayers Increases Complexity
The Scotland Act 2012 received Royal Assent in the U.K. on 1 May 2012, and provides the Scottish government with new powers to set a Scottish rate of income tax on the non-savings income of those defined as “Scottish taxpayers,” to be administered by HM Revenue & Customs (HMRC). It is expected to apply from 6 April 2016.
HMRC has published a Technical Note1 looking at the implications of the Scottish rate of income tax together with a FAQ document2 providing more detail on how this change will apply in practice.
Overview of Changes to Tax Regime in Scotland
The rate paid by Scottish taxpayers will be calculated by reducing the basic, higher, and additional rates of income tax levied by the U.K. government by 10 pence in the pound and adding a new Scottish rate set by the Scottish parliament.
For example, if the U.K. basic, higher, and additional rates of income tax were 20 percent, 40 percent, and 45 percent respectively and the Scottish rate of income tax was set at 11 percent, then the rates payable by Scottish taxpayers would be 21 percent, 41 percent, and 46 percent respectively.
The new Act will allow the Scottish parliament to set the rates of income tax lower or higher than the rates that apply in the rest of the United Kingdom. The guidance explains:
• It will affect everyone who is a Scottish taxpayer, which will broadly cover all individuals who live in Scotland as long as they are U.K. resident for tax purposes.
• Non-U.K. residents cannot be Scottish taxpayers.
• Savings income and dividend income arising to Scottish taxpayers will still be taxed at the appropriate U.K. rates.
• Scottish nationals living outside of Scotland are not Scottish taxpayers, while non-Scottish nationals living in Scotland will be.
• An individual with more than one place of residence in the U.K. will need to determine which of these is his/her main place of residence for the longest period in the tax year. If that residence is in Scotland, the individual is a Scottish taxpayer.
• Individuals who cannot identify a main place of residence will need to count the days they spend in Scotland and elsewhere.
• All U.K. employers will have to operate the Scottish tax codes, which means, for example, that an England-based employer with an employee who lives in Scotland will be required to upgrade its payroll systems to cope with a potentially different rate of withholding tax to be applied to Scottish taxpayers than the rate to be applied to employees who live in England.
• Charitable donations made through Gift Aid are made net of basic rate tax. The current proposal is that the U.K. basic rate and not the Scottish rate will apply to such donations. The government intends to keep the issue under review so that if the Scottish and U.K. rates diverge considerably the position can be reconsidered. It will also be reconsidered if Gift Aid relief can be provided at the correct rate without the currently anticipated administrative burdens. Higher rate relief would be at the Scottish rate for Scottish taxpayers.
The tax affairs of Scottish taxpayers will inevitably be more complicated because the Scottish rate only applies to non-savings income with the U.K. rate applying to savings income.
Complications will also arise when an employee’s main residence moves to or from Scotland during the year. For example, if an individual moves from England to Scotland in September, he or she will be regarded as a Scottish taxpayer for the whole year. The withholding on employment income will not then be correct because until the move, the withholding will have been at the U.K. rate not the Scottish rate. This occurs because it is not envisaged that the tax year of U.K. residents will be split into separate periods where the Scottish tax rate applies and the U.K. rate applies on employment income.
It is not expected that employers (and pension providers) will be required to assess whether an individual is a Scottish taxpayer or not. HMRC will make this assessment and issue a PAYE code to inform employers that the Scottish tax rates should apply to employment income. Therefore, if the employer has the software to cope with the parallel tax rates, it is believed that the administrative burden on the employer once the system is up and running should be minor. That said, there is likely to be an administrative cost to determining who is going to be a Scottish taxpayer and payroll departments are likely to get more queries about withholding in the early years of the system.
The Scottish government intends to hold a referendum in late 2014 to ask the Scottish people to vote for Scottish independence from the rest of the U.K., which, depending on the outcome, may have a material impact on whether this Scottish tax rate is introduced in this way.