You take the high rate, and I’ll take the low rate

The Autumn Budget 2017 has now been and gone. And while there was plenty of speculation beforehand about possible reductions in pensions tax relief and the annual allowance, Chancellor Hammond’s red box was thankfully short on surprises on the pensions front.

That’s not the end of the budget fun, however, as the Scottish government will publish its 2018-19 Draft Budget today (Thursday 14 December).

While the general remit is narrower than the UK Budget, one thing that could change is Income Tax. If it does, it will have the clear potential to create challenges for advisers with clients north of the border.

What could change?

From April 2016, the Scottish government has had the power to vary the income tax paid by Scottish taxpayers. This works by taking the UK rates as a starting point and then reducing them by ten basis points. The Scottish government can then decide how much tax to add back on top of that.

So far, they have simply added the ten basis points back to keep the rates the same as in the UK. However, this could change in 2018/19.

What does this mean?

First and foremost, this would mean different tax calculations for different clients, which creates an extra level of complexity for advisers. From a pensions perspective, this will also mean slightly different calculations for pension contributions in terms of tax relief entitlement and annual allowance availability, not to mention tax on income drawdown and annuity payments.

However, the key challenges are likely to come in practical areas. Where members made contributions in the 2016/17 tax year, HMRC will notify pension providers if those members are on an ‘S’ tax code (i.e. Scottish taxpayer) or an ‘rUK’ tax code (i.e. rest of UK taxpayer). The providers will then be able to claim tax relief on contributions and pay tax on income at the appropriate rates.

For members who didn’t contribute in 2016/17, there will be an online HMRC look-up service that providers can use. At the time of writing, our understanding is that this only allows you to check one member at a time. There is no bulk download provision.

As such, there is clearly a resource implication for providers here, and it may not be feasible for providers to look up the tax code of every single member. In the absence of an ‘S’ tax code, a provider must use the ‘rUK’ code. Therefore, there is a real possibility that some Scottish taxpayers will end up being treated as UK taxpayers.

How could this work in practice?

Alison, a Scottish taxpayer, wants to make a gross contribution of £10,000. Let’s say the Scottish basic rate has decreased from 20% to 18%, so she pays in £8,200 net.

However, the provider still has Alison down as a UK taxpayer, so they claim back 20% tax relief. This results in a gross contribution of £10,250.

Firstly, Alison has now claimed more tax relief than she is entitled to. Secondly, as she is also subject to the maximum annual allowance taper, it means she has exceeded her annual allowance by £250.

The overpayment is not huge by any means, but it’s something that will still need to be sorted out after the event, creating an extra administrative burden for her and her adviser.

Who will be affected?

These issues will primarily affect Scottish taxpayers. Under the definition, an individual must first be tax resident in the UK as a whole before they can be a Scottish taxpayer. The definition then looks at factors like main residence and days spent in Scotland.

At a conservative estimate, the number of members affected could run into the hundreds of thousands, so it’s something that providers and advisers will need to stay on top of.

And the interesting cases will be those where a client works during the week in, say, London, Leeds or Manchester, but goes back to the family home in Scotland at weekends and holidays. It could come down to literally counting the days spent outside of Scotland. You could also then have a situation where that client is a UK taxpayer but their partner is a Scottish taxpayer.

What’s more is that this might just be the start. Referendum results notwithstanding, the direction of travel on devolved powers is clear. A future scenario with four elected assemblies setting four different tax regimes has clear scope to create challenges for those of us looking to help people save and invest for their future.

Technical Team Leader

After completing his postgraduate studies at Lancaster University, Martin spent two years working for a leading insurance company before joining AJ Bell in April 2007. Martin worked initially on the AJ Bell Investcentre product before moving to a technical role in 2009. His main focus is providing technical support to the various teams and departments within the business. He is also involved in delivering training to staff on the rules and regulations that affect our customers.