The Smith Commission has proposed the Scottish Parliament should get more powers over tax. Jonathan Stapleton discovers what this means for pensions and how schemes and employers can define who is a Scottish taxpayer.
The Smith Commission report into the further devolution of powers to the Scottish Parliament recommended the Holyrood government should have additional powers over the rates of income tax and the thresholds at which these are paid for Scottish taxpayers.
Currently, under the Scottish variable rate (SVR), the Holyrood government has the power to vary the basic rate of UK income tax by up to 3p in the pound - a power it has never used.
The SVR will be succeeded by new rules contained within the Scotland Act 2012, which will give the Scottish Parliament the power to vary rates by up to 10p in the pound from April 2016 under what is known as the Scottish Rate of Income Tax (SRIT).
However these rules do not give the Scottish Parliament much flexibility as it would have to change all rates simultaneously - and will have no flexibility over the number of rates or the banding of them.
Today's Smith Commission report recommends that there should now be "no restrictions" on the thresholds or rates the Scottish Parliament can set but the ability to change the personal allowance or amend tax reliefs, such as those applied to pensions, would remain reserved to the UK Parliament.
The impact on pensions
JLT Employee Benefits head of technical John Wilson - a member of the Scotland Act 2012 pensions technical committee - says the changes recommended by the Smith Commission look like an extension of the 2012 SRIT rules, an area in which a lot of detailed work on pensions has already been done.
He says the main change will be for pension providers and pension schemes that operate the relief at source system of pensions taxation.
Contributions to personal pensions and workplace personal pension schemes are deducted from after tax pay and are then grossed up by the pensions provider so that the individual gets basic rate relief and any higher rate relief has to be claimed via the self-assessment system.
The reason that a SRIT impacts these schemes is because this grossing up of the contributions could be different for Scottish rate taxpayers and taxpayers in the rest of the UK.
Wilson says a SRIT will not impact on occupational trust-based schemes as much because a trust based scheme uses a different system of tax relief whereby contributions are deducted from gross earnings before any tax is calculated.
HMRC is currently working with pension providers around the introduction of the Scottish Rate of Income Tax because of the impact on them. They are currently proposing a transitional arrangement in the 2016/17 and 2017/18 tax years.
Should the Holyrood government decide to use its powers to vary tax rates in this interim period, HMRC says it will take on the administration of any difference in pension tax relief for Scottish rate taxpayers who should have a higher or lower rate of relief.
This will be through a balancing payment or charge which will be received or paid through a tax code adjustment for the following year.
Wilson says: "What HMRC is saying is that, in terms of the impact of any changes, for the first two years following the introduction of the Scottish Rate of Income Tax, HMRC will sort out the impact of any differential in tax rates so people will still get a UK rate of relief on the contributions even if Scottish and rest of the UK rates are different, HMRC will then sort out with the taxpayer any balancing that has to be done of the different tax charges north and south of the Border."
From 6 April 2018, the onus for administering this will revert to providers, who will have to operate the relief at source system according to an individual's residency and tax status. This will mean they will have to identify Scottish Rate taxpayers and they will have to do different grossing up for Scottish rate taxpayers and taxpayers in the rest of the UK if and when Scotland has different income tax rates.
However one thing that might help is that, from 2016, all Scottish residents will have an ‘S' prefix to their tax code to identify them as a Scottish taxpayer.
Both trust-based and contract-based pension schemes may have to deduct different amounts of tax from the pensions they pay out - something that will also require them to understand who is and isn't a Scottish taxpayer.
How to define who is a Scottish Taxpayer
The Scotland Act 2012 defines who will be a Scottish taxpayer for the purposes of the Scottish rate. There are a number of steps to determine this.
Firstly, in order for an individual to be a Scottish taxpayer, they must be UK resident for tax purposes - an individual who is not UK tax resident cannot be a Scottish taxpayer.
The remaining parts of the definition are based on the location of an individual's sole or main place of residence. If they have one place of residence and this is in Scotland, they are a Scottish taxpayer.
Individuals who have more than one place of residence in the UK need to determine which of these has been their main place of residence for the longest period in a tax year - if this is in Scotland, they are a Scottish taxpayer.
For example, if an individual with a single place of residence moves house into or out of Scotland part way through a tax year, whether they will be a Scottish taxpayer in that year will depend upon which house is their main place of residence for the longer amount of time.
Individuals who cannot identify a main place of residence will need to count the days they spend in Scotland and elsewhere in the UK - if they spend more days in Scotland, they will be a Scottish taxpayer.
An individual who meets the definition of a Scottish taxpayer will be a Scottish taxpayer for a whole tax year.
There are separate rules which apply to MSPs, MPs representing a constituency in Scotland and MEPs representing Scotland. Such individuals will automatically be treated as Scottish taxpayers, irrespective of where their sole or main residence is located or of where they spend the most days in the UK.
