Changes to the Scottish Income Tax rates and thresholds
This is an important update on Scottish Income Tax that has potential to impact pension contributions, tax relief and salary exchange.
On 14 December 2017, the Scottish Government announced plans to change the way Scottish residents will be assessed for Income Tax. Scotland will have different income tax thresholds (including two additional income tax bands), and different income tax rates, when compared to the rest of the UK.
The Scotland Act 2016 gave powers to the Scottish Government to set income tax rates and thresholds for Scottish taxpayers with effect from 6 April 2017. For the 2017/18 tax year this power was exercised only to freeze the higher rate income tax threshold at £43,000. Rather than increasing it to £45,000 in line with the rest of the UK. The changes confirmed for 2018/19 go far beyond that, introducing two new income tax bands (starting rate band and intermediate rate band), and setting the tax rate applicable to each band as shown below.
Who is affected by these changes?
Essentially, Scottish income tax will be paid by anybody who is a UK resident for tax purposes and whose main residence is in Scotland. Their tax code will start with an ‘S’ instead of a ‘rUK’. HM Revenue and Customs (HMRC) guidelines help to determine what constitutes a ‘main residence’ and are particularly relevant to those people with more than one home in the UK or mobile workers, for example.
What are the implications?
Scottish taxpayers need to be aware of the changes to Scottish income tax rates as it will directly affect their tax liability. Scottish income tax will apply to wages, pension and most other taxable income. However, UK rates and thresholds will continue to apply to savings income (such as interest and dividends). This could become extremely complicated to understand and administer.
Employers need to be aware of any employees subject to Scottish income tax in order to make the correct PAYE deductions to employee benefit planning and pension scheme administration.
Tax relief on pension contributions
Pension schemes operating a net pay system (where contributions are deducted from a members earnings before tax is applied), will not be directly affected by these changes. This process inherently gives tax relief on contributions at the correct and full rate. However, where relief is granted at source, (which is the system commonly operated by personal pension providers), things become more complex.
Tax relief on Salary Exchange arrangements
Under a relief at source pension scheme, pension providers automatically claim basic rate tax relief at 20% from HMRC on member contributions and add it to their fund. HMRC have confirmed that this should continue to be the case for Scottish taxpayers in 2018/19, even when they are only liable to income tax at the starter rate of 19%. HMRC have confirmed that in these circumstances they will not recover the difference. Higher and additional rate tax payers who are members of relief at source pension schemes usually claim additional tax relief through their tax returns. This will continue to be the case for Scottish taxpayers liable to tax at 41% and 46% in 2018/19, up to their marginal rate.
This process will now also be necessary for Scottish taxpayers liable to income tax at the intermediate rate of 21%, in order to claim back the additional 1% due on some or all of their contributions. The question is, will individuals be bothered to do so and instead miss out on this extra tax relief?
A further potential headache to pension providers is identifying those scheme members subject to Scottish income tax. HMRC sent scheme administrators a notification of residency status report at the end of January 2018. This was based on information submitted on the annual return of individual information for 2016/17, and was available to download for 6 days only. A second opportunity to receive the information was available briefly in February 2018. In March 2018 controlled access to a look up service was available to those who applied, before its final launch on GOV.UK which is expected shortly.
Going forward, in addition to the look up service, a notification of residency report will be issued each January based on data from the last annual return of individual information submitted for the previous tax year.
There is much for Scottish taxpayers and their employers to get to grips with following the 2018/19 changes to Scottish income tax rates and thresholds. This starts with employers being able to correctly identify those subject to Scottish income tax, in order to tax them correctly. Individual employees need to understand how their income is to be taxed, and how to ensure they receive all the tax relief on pension contributions to which they are entitled.
We will keep you updated of any further developments and how they might affect your employees, and your business planning in terms of employee benefit design and pension scheme administration. If you have any questions about how your business will accommodate these changes, please get in touch with the Workplace Pension team.