Scottish income tax

These FAQs are for financial advisers only. They mustn’t be distributed to, or relied on by, customers. They are based on our understanding of legislation at the date of publication.

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The Scottish Budget on Thursday 14th December 2017 announced proposed changes to income tax rates(Opens new window) for those living in Scotland for the 2018/19 tax year.

Following that announcement, HM Revenue & Customs issued a Scottish income tax newsletter(Opens new window), which contained the following wording:

'As you may know, new Scottish Income Tax rates and thresholds were announced in the Scottish Budget on 14 December 2017.

Her Majesty's Government and HM Revenue and Customs (HMRC) will be working closely with the Scottish Government and with pension providers on the implications of that change for pension tax relief, and to clarify how the mechanisms for providing relief will operate in respect of Scottish pension savers.'

We’ll provide a further update when we find out more.

Since 6 April 2016, Scottish taxpayers have been subject to UK tax at 10% lower than the full UK rates. The Scottish Government can then set a Scottish rate of Income Tax to apply to Scottish taxpayers. 

For the 2016/17 tax year, the Scottish Government were only able to set one tax rate to apply to all tax bands and they chose to set a rate of 10%. This meant that Scottish taxpayers paid tax at the same rates as taxpayers in the rest of the UK. So, for all Scottish and ‘rest of the UK’ taxpayers, the basic rate of income tax was 20%, the higher rate was 40% and the additional rate was 45% for that tax year. 

From 2017/18 onwards, the Scottish Government has powers to vary the tax rates for existing bands and to alter or introduce tax bands although they are unable to alter the personal allowance. In 2017/18, they chose to freeze the higher rate threshold at £43,000 for Scottish taxpayers whilst the threshold for taxpayers in the rest of the UK increased to £45,000.

Scottish Income Tax applies to employment, pensions and rental income. It does not apply to savings or dividend income so UK rates continue to apply to income from these sources. HM Revenue & Customs (HMRC) still administers the operation of Scottish Income Tax although money collected from it effectively goes to the Scottish Government.

Firstly, a person must be UK resident for tax purposes in order to be a Scottish taxpayer. In other words, if someone is not UK tax resident then they cannot be a Scottish taxpayer. 

A person is classed as a Scottish taxpayer by their residency status rather than their nationality or where they work. Essentially, someone is a Scottish taxpayer if their sole or main residence is in Scotland. An individual will either be resident or non-resident in Scotland for a tax year. So, a UK resident will either be classed as a Scottish taxpayer or a UK taxpayer for a tax year – there cannot be a situation where someone is treated as a Scottish taxpayer for part of a year. 

Every MSP (member of the Scottish Parliament) is classed as a Scottish taxpayer. In addition, every MP (member of the UK Parliament) and MEP (member of the European Parliament) who represents a Scottish constituency is classed as a Scottish taxpayer, irrespective of where they live.

An individual must tell HMRC if they move address to or from Scotland. If HMRC changes a person’s tax rate, the new rate will be backdated to the start of the tax year in which they moved. The tax taken from a person’s salary or pension income will adjusted automatically so the correct amount of tax is paid for the relevant tax year.

There will be situations where determining residency status may not be straightforward. HMRC’s technical guidance on Scottish taxpayer status includes a number of examples of this. Here’s a selection to highlight the type of examples covered:

  1. A person lives in England during the week but stays in a holiday home in Scotland each weekend. Their doctor is in England, their English address is used on the electoral register and their car is registered to their English address. HMRC say that this person has two places of residence but their main place of residence is in England so they are not a Scottish taxpayer.
  2. A person lives in England but moves to Scotland in July to live and work. HMRC say that this person has two main places of residence in the tax year but their main place of residence is in Scotland as this is where they will spend the most time in the tax year.  They will therefore be a Scottish taxpayer for that tax year.
  3. A person lives in England but works offshore in Scottish waters on a four weeks on/four weeks off basis. Their possessions are at their home in England, their car is registered to that address and they are also registered to vote there. HMRC say the person’s main place of residence is in England so they are not a Scottish taxpayer.
  4. A person has lived and worked in England for a number of years. They start a one year secondment in April in Scotland so rent out their home in England. They move into accommodation provided by their employer and change their home address for bank accounts and energy suppliers to their new temporary address. They also change their voting address and doctor’s surgery. Despite still owning a home in England and intending to return there after the secondment ends, their main place of residence for the tax year is in Scotland. They are deemed to have a close connection with the country and are therefore treated as a Scottish taxpayer. 
  5. A person has a family home in Scotland but works in Wales during the week. They stay in a rented flat whilst in Wales and return home to Scotland each weekend.  Their Scottish address is where they are registered to vote and is used for all correspondence matters. Their doctor’s surgery is also in Scotland. The person’s main place of residence is in Scotland so they have a close connection with the country and are therefore deemed to be a Scottish taxpayer.
  6. A person is a US citizen and employed by a US company. They accept a two year secondment to the UK where they will be based in Scotland. They will be treated as a UK resident from the date they arrive in the UK. They rent a house in Scotland for the two years only returning to the US to visit family during holidays. The person is UK resident for tax purposes whilst they are in the UK and their place of residence is in Scotland. They have a close connection with Scotland and are therefore treated as a Scottish taxpayer. 

In practice, HMRC will determine a taxpayer’s status. Where someone has moved between Scotland and the rest of the UK during a tax year, taxpayer status will be based on the longest number of days spent in Scotland or the rest of the UK.

A Scottish taxpayer has the prefix ‘S’ at the start of their PAYE tax code. HMRC issue PAYE tax codes usually prior to the start of each tax year to employers and pension providers.

Since 6 April 2016, pension providers have to tax annuity payments and drawdown income payments, subject to PAYE tax, using the Scottish rates for Scottish taxpayers. They need to do this using ‘S’ tax code identifiers that are obtained from information provided by HMRC. 

Annual P60 statements issued to customers need to show the ‘S’ prefix tax code along with the total tax deducted. There is no need to split the total tax deducted between the Scottish Income Tax amount and the ‘rest of the UK’ amount.

The calculation method for any taxable payments made using an emergency tax code (such as Uncrystallised Funds Pension Lump Sums) have not changed since 6 April 2016. In other words, there will be no specific Scottish emergency tax code. Similarly, small pots payments are still made using the UK basic rate of income tax for Scottish taxpayers with any under or overpayment being dealt with between the recipient and HMRC. 

There are different ways of giving tax relief on personal and third party pension contributions and this will therefore affect how tax relief can be obtained. 

Net pay - for occupational pension schemes, tax relief on personal contributions is given using the ‘net pay’ method. Gross contributions are deducted from gross pay meaning that employees pay the correct amount of income tax through their payslip. When Scottish taxpayers are identified through their PAYE tax code, they will receive the correct amount of tax relief on any personal contributions they make through their pay to an occupational pension scheme. For any personal contributions not made through an employee’s payslip (e.g., for large single contributions paid gross near the end of a tax year), there should be a claim made to HMRC for the tax relief due.

Relief by claim - contributions to retirement annuity contracts are generally paid gross using the ‘relief by claim’ method. An individual then needs to claim any tax relief due through their self-assessment tax return. This process continues to apply with any Scottish taxpayers getting tax relief based on the Scottish Income tax rates and bands. 

Relief at source - for personal pensions, personal and third party contributions are paid using the ‘relief at source’ method. Contributions are paid net of basic rate tax relief with a sum representing the tax relief being claimed from HMRC to add into the pension arrangement. Higher and additional rate taxpayers can claim higher or additional rate tax relief separately through their self-assessment tax return. If contributions are being paid through a payslip, these are deducted net of basic rate tax relief from net pay. 

Collecting pension contributions using the Scottish Income Tax for the ‘relief at source’ method will not affect pension providers until 6 April 2018. This is to allow time for systems and processes to be put in place to allow providers to collect basic rate tax relief at either the UK rate or at the Scottish Income Tax rate depending on whether a particular customer is a UK taxpayer or a Scottish taxpayer. 

In the run-up to 6 April 2018, HMRC will operate a two year transitional period which started from 6 April 2016. During that time, pension providers will continue to claim tax relief at the UK basic rate for all personal and third party contributions that are eligible for basic rate tax relief. HMRC will then use their records to identify Scottish taxpayers and make any necessary adjustment direct with scheme members if the Scottish rate is different to the UK rate. Any adjustments made by HMRC will be done either through self-assessment or PAYE coding. 

Pension providers will need to have systems in place from 6 April 2018 to be able to identify Scottish taxpayers based on information provided by HMRC. Providers will then need to use this identifier to collect the correct amount of basic rate tax relief from HMRC for any personal or third-party contributions paid from 6 April 2018. In effect, providers will need to be able to make relief at source (RAS) claims at both the Scottish basic rate and the UK basic rate.

Even though there is scope for the Scottish tax rates to be different to UK rates, the operation of the existing double taxation treaties that the UK has with many other countries will continue unaffected.

Pensions Technical Services