As part of the devolution process the power to set a number of taxes, either in full or in part, has been given to the regional parliaments. One of the taxes to have been partly devolved is income tax, which means that people in Scotland and Wales could pay different rates of income tax from those in other parts of the UK at some stage in the future.
It is important to note that a large part of the rules regarding income tax will remain with the UK government. These include the setting of rates and bands for savings and dividend income, the personal allowance, the definition of income, the imposition of the annual charge to income tax and income tax reliefs. It has also been confirmed that HMRC will collect and administer all income tax, including that of Scottish taxpayers.
At present, the Northern Ireland Assembly has not been given the power to set income tax rates, although it is possible that this power will be partially devolved at some point.
The biggest impact on pension schemes of a regional parliament choosing to exercise this power is the effect on the amount of tax relief that will need to be claimed by the scheme: a lower tax rate would mean less tax relief should be paid, and vice versa.
Scotland
The Scotland Act 2016 allows the Scottish Parliament to introduce new rates and bands of income tax above the UK personal allowance. This means they will have full powers to set any income tax rates – and the bands in which those rates are paid – over and above the personal allowance. Where more than one rate of income tax is set, the Scottish Parliament must also set out the limits at which those rates will apply, so it is clear which rate or rates apply to a Scottish taxpayer.
Any Scottish rate will have to be a whole or half number, or zero, and the limit of any band set must be a whole number of pounds. It will not be possible to set different rates for different types of income, and any rates will not apply to savings or dividend income.
A resolution setting any Scottish rates or bands must be made in the tax year before the one in which it will apply. The resolution can be cancelled or replaced at any time before the start of the new tax year.
Wales
Under current legislation, the Welsh Assembly will be able to modify one or more of the basic, higher and additional rates; the appropriate UK rate will apply to any rate not modified by the Assembly. However, it has not yet been agreed how or when these powers will be devolved to the Welsh Assembly.
The Welsh basic/higher/additional income tax rate will be calculated by deducting 10 percentage points from the relevant UK rate, then adding the appropriate Welsh rate set by the Assembly. A Welsh rate must also be either a whole or a half number.
And again, a resolution setting a Welsh rate must be made in the tax year before the one in which it will apply. The resolution can be cancelled or replaced at any time before the start of the new tax year.
Taxpayers and residency
Scotland: A UK resident is a Scottish taxpayer if they are resident in the UK and meet one of the following criteria:
– They have only one UK residence, which is in Scotland, and they live there for part of the year;
– They have more than one UK residence, at least one of which is in Scotland, and they live in Scotland for more of the year than they do in any other part of the UK;
– They cannot identify their main residence and spend more days in Scotland than in any other part of the UK;
– They are a Member of Parliament for a Scottish constituency;
– They are a Member of the Scottish Parliament (MSP);
– They are a Member of the European Parliament for Scotland.
Taxpayer status applies for a whole tax year. It is not possible to be a Scottish taxpayer for only part of a tax year.
Wales: Once the Welsh Assembly has the power to set income tax rates, a UK resident will be a Welsh taxpayer if they are a UK resident and meet similar criteria:
– They have only one UK residence, which is in Wales, and they live there for part of the year;
– They have more than one UK residence, at least one of which is in Wales, and they live in Wales for more of the year than they do in any other part of the UK;
– They cannot identify their main residence and spend more days in Wales than in any other part of the UK;
– They are a Member of Parliament for a Welsh constituency;
– They are a Member of the Welsh Assembly (AM);
– They are a Member of the European Parliament for Wales.
Pensions
Tax relief: HMRC intends that tax relief should be given at the employee’s marginal rate; for example, Scottish taxpayers should receive relief at the Scottish rates.
The process for claiming higher- and additional-rate relief will be unaffected as this is claimed through self-assessment. However, until April 2018 the current system will not automatically provide the correct basic-rate tax relief on contributions to a pension scheme that uses the relief at source method, such as personal pensions.
Pension contributions made through a net pay or salary sacrifice arrangement will not be affected.
Where the net pay method is used, employee pension contributions are paid after national insurance has been deducted, but before income tax. Where salary sacrifice is used, the tax saving is achieved through the reduction in the employee’s salary. It also does not affect contributions made to retirement annuity contracts which do not use relief at source, as this tax relief is claimed through self-assessment.
If a regional variation of income tax rates is introduced, it is likely that any examples provided to prospective pension investors will need to confirm the regions to which they do, and do not, apply. This could be complicated further if the Scottish Parliament uses its power to set different tax bands from the rest of the UK, or to create extra tax rates.
Scotland: HMRC has issued Scottish ‘S’ tax codes to Scottish taxpayers. This means that the pension provider will be able to claim and apply Scottish basic-rate relief for Scottish taxpayers and non-Scottish basic-rate relief for those who are not Scottish taxpayers.
To accommodate the changes, pension providers will need to implement system changes no later than April 2018; relief at source claims at the current UK rate will be made until then.
Should the Scottish rate differ from the UK rate, Scottish taxpayers will receive too much – or too little – tax relief. HMRC will identify any Scottish taxpayers and pay any additional relief to, or reclaim excess relief from, the scheme member directly, either through self-assessment or by adjusting their tax code. Nothing further will be paid to, or reclaimed from, the pension scheme.
Annual allowance charge
Scotland: A Scottish taxpayer who exceeds their annual allowance, or money purchase annual allowance, will face a tax charge on the excess calculated using the Scottish basic, higher and/or additional rates (or any other rates created by the Scottish Parliament) as appropriate.
Income payments
Where an individual is receiving a pension income, such as an annuity or income from a drawdown plan, this is taxed under PAYE. The tax is deducted and paid to HMRC by the pension scheme, based on the tax code issued by HMRC.
Danny Cox is a chartered financial planner at Hargreaves Lansdown
