UK: Scottish Budget 2019-20: The Scottish Rate Of Income Tax - Where Are We Now?

The Scottish Finance Secretary, Derek Mackay, presented his 2019-20 Scottish Budget this afternoon. Ever since Phillip Hammond announced his UK Budget on 29 October, anticipation has been building as to how the Scottish Government would respond to the Chancellor's announcements on the increase in the UK income tax higher rate (40%) threshold by £3,650 (3%) to £50,000 from 6 April 2019.

The headline-making tax announcements from today's Scottish Budget were:

• The freezing of the income tax higher rate threshold (41%) at £43,430 and the additional higher rate threshold (46%) at £150,000.
• The increase of the income tax starter tax band (19%) threshold from £13,850 to £14,549.
• The increase of the income tax basic rate band (20%) threshold from £24,000 to £24,944.
• The increase of the Land and Buildings Transaction Tax ('LBTT') additional dwelling supplement from 3% to 4% for 'second home' purchasers with effect from 25 January 2019 (if the contract for the transaction was entered into on or after 12 December 2018).
• Changes to non-residential LBTT rates from 25 January 2019 that will result in two-thirds of non-residential property purchasers in Scotland being better-off.

We will look at who will be affected by these changes, what it means in practice and the interaction of the Scottish rate of income tax with other UK wide taxes. For further information on the changes to LBTT, please see this article from our property specialists.

Note:

The tax raising powers relating to LBTT (the Scottish equivalent to SDLT) and the Scottish rate of income tax ('SIT') are devolved to the Scottish Government. Other taxes including capital gains tax ('CGT'), inheritance tax ('IHT') and corporation tax continue to be reserved to Westminster.

Summary

From 6 April 2019 Scotland will have the following income tax thresholds and income tax bands when compared to the rest of the UK.

The Scottish Government have estimated that the introduction of these measures will result in 55% of Scottish taxpayers paying less tax than their counterparts earning a similar salary in the rest of the UK. Overall, it has been predicted that 99% of all Scottish taxpayers will be paying a reduced amount of tax than in the current 2018/19 tax year.

The following table demonstrates how these changes will impact on a higher rate Scottish taxpayer with taxable earnings of £50,000 when compared to a taxpayer resident in another part of the UK in the 2019/20 tax year.

A Scottish taxpayer with earnings of £50,000 will therefore pay £1,543 more income tax than their counterparts in the rest of the UK. This tax gap will only widen for Scottish higher rate taxpayers as their earnings increase.

What is the Scottish rate of income tax?

The SIT is a power which the Scottish Parliament has to set the thresholds and rates of income tax for Scottish taxpayers and therefore the amount that the Scottish Government has to spend. It is estimated that income tax receipts in Scotland amounted to around £10.9 billion in the 2017/18 tax year.

The SIT applies to the earnings of Scottish taxpayers arising from employment (e.g. salaries, bonuses, etc.), self-employment (e.g. sole-trader and partnership profits), pension income and income from property (e.g. rent). The UK thresholds and rates of income tax continue to apply to savings income (e.g. interest, dividends, etc.).

The UK Parliament retains control of all other aspects of the income tax regime, including setting the level of the personal income tax allowance and introducing and altering available income tax reliefs, such as those applicable to gift aid donations to charity and pension contributions. Scottish taxpayers will therefore benefit from the increase in the income tax personal allowance by £350 (5.5%) to £12,500 from 6 April 2019 announced at the UK Budget in October.

How does the Scottish rate of income tax work?

The Scotland Act 2016 gave unrestricted powers to the Scottish Parliament to set income tax rates and thresholds for Scottish taxpayers (excluding savings income) with effect from 6 April 2017. The Scottish Parliament will set the thresholds and rates of the SIT on an annual basis in the Scottish Budget. This further devolution of taxation powers was first proposed in the Smith Commission's report published in November 2014 following the independence referendum.

The current 2018/19 tax year had been the first time the Scottish Parliament had used its powers to both vary the income tax thresholds and introduce additional income tax bands. Up until 6 April 2017, the Scottish Parliament had chosen to retain the status quo with the rest of the UK by not exercising any of its devolved income tax powers to vary Scottish income tax rates.

To whom does the Scottish rate of income tax apply?

The question of whether or not you will be treated as a Scottish taxpayer should be relatively clear in the vast majority of cases. The basic rule of thumb is that you will be a Scottish taxpayer if you are UK resident for tax purposes and your main residence for most of the tax year has a Scottish post code. HMRC have stated in their guidance that the test is not based upon location of work, location of income source, travelling in Scotland or even your national identity. What is important is where you live, rather than where you work.

There will, of course, be certain instances where during the course of a tax year UK resident taxpayers have interests both north and south of the border and their tax status will not be so simple to establish. Where a taxpayer has more than one residence in the UK they will have to establish to which residence they have the "closest connection". This will be a question of fact (e.g. where family live, where registered to vote, where registered for doctor, etc.). If this does not provide a clear answer, then it will be a question of counting the number of days the taxpayer spends in Scotland compared to the rest of the UK. Where the taxpayer spends at least as many days in Scotland as elsewhere in the UK he or she will be treated as a Scottish taxpayer.

How is the Scottish rate of income tax administered?

HMRC have previously advised employers and pension providers if they require to treat any of their employees and members as Scottish taxpayers. PAYE codes with a suffix "S" letter have been introduced to enable employers and pension providers to identify Scottish taxpayers and apply the correct rate of PAYE. There has been no other change to how employers and pension providers UK-wide report or make payments for income tax to HMRC. It is the taxpayer's responsibility (not their employer's) to notify HMRC of any change in his or her residential address or other circumstances that may impact on residence status for the SIT.

Scottish taxpayers with self-employment and/or property income will also have to apply the SIT when reporting their taxable income on their self-assessment tax returns.

Does the Scottish rate of income tax have other implications?

It is important that Scottish taxpayers are aware of the potential implications for them of different rates and thresholds of income tax being applied in Scotland.

Scottish taxpayers have been from 6 April 2017 subject to two different sets of income tax rates where they have both earned and/or property related income (SIT) and savings income (UK rates and thresholds). The introduction of two new tax bands from 6 April 2018 further complicated income tax calculations as a result of income being taxed on a stack basis (i.e. earned income is taxed first, followed by savings income and finally dividend income). 

Scottish taxpayers will receive income tax relief for pension contributions and gift aid payments at the appropriate Scottish rate based on whether they are a starter, basic, intermediate, higher or additional higher rate taxpayer.

Income tax marriage allowance may be forfeited in certain circumstances where an individual is treated as a higher rate taxpayer in Scotland even though he or she would have been treated as a basic rate taxpayer in the rest of the UK.

CGT has not been devolved to the Scottish Government and therefore a taxpayer's CGT position should be the same no matter where they reside in the UK. Scottish resident higher rate taxpayers with capital gains will require to apply the income tax thresholds applicable in the rest of the UK to establish the CGT rate to be applied to their taxable gains.

What should you do?

The continued divergence of Scottish income tax thresholds from the rest of the UK could well have important political and economic implications, as well as issues for business to address where employees are mobile or there is the need to address equality for employees working north or south of the border.

To establish the impact, if any, that this change in the higher rate income tax threshold and the introduction of a new income tax band will have on you will depend on reviewing a number of factors: primarily whether or not you will be treated as being a Scottish resident taxpayer, together with the sources and level of your taxable income. You may also wish to consider any measures that may be taken in the light of that review.

We will continue to keep you informed on any future announcements about the SIT.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.