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Scotland’s system of income tax rates and bands: how it works

From 6 April 2017, the Scottish Government were given powers to set a Scottish rate of income tax which applies to any non-savings, non-dividend income for those deemed to be Scottish taxpayers. These rates apply to an individual’s earned income, pension and most other taxable income.

However, confusingly, for any savings income and dividend income, a Scottish taxpayer will use the same tax bands and allowances as the rest of the UK. These rates and bands are still set by the UK Government, as are any other allowances or reliefs such as the personal allowance and personal savings allowance.

Additionally, it is the UK tax bands which are used to determine the rate of capital gains tax an individual pays on any taxable gains.

The new Scottish system adds a 19% ’starter’ rate for those on lower incomes, as well as a 21% rate for those who earn above the median salary. It also adds a penny to the higher and top rates, bringing them to 41% and 46% respectively.

Under these new tax bands, the Scottish Government has claimed that 55% of Scottish taxpayers pay less than they would in the rest of the UK, and 70% pay less than they did in 2017/18.

However, those earning more than £100,000 continue to have their personal allowance reduced by £1 for every £2 earned over £100,000. This means that someone earning £110,000 has their personal allowance reduced by £5,000 bringing it down to £6,850, and income over £123,700 would remove the allowance altogether. They are therefore liable to pay tax on a larger proportion of their income, as well as paying at a higher tax rate.

These changes mean there are widening differences between what people on the same wage pay in tax in Scotland compared with the rest of the UK.

It is possible for someone to be a higher rate taxpayer for Scottish income tax purposes but below the UK higher rate threshold.

Case study

Joey lives in Edinburgh and his sister Gina lives in York. Below are the differences in income tax they both pay on their earned incomes.

Based on a gross earned income of £46,000:

Joey’s Scottish income tax Gina’s UK income tax
£11,850 @ 0% £0 £11,850 @ 0%         £0
£2,000 @ 19% £380 £34,150 @ 20%      £ 6,830
£10,150 @ 20% £2,030
£19,430 @ 21% £4,080.30
£2,570 @ 41% £1,053.70
£7,544 £ 6,830

In retirement, their incomes reduce to a gross pension income of £25,000

Joey’s Scottish income tax Gina’s UK income tax
£11,850 @ 0% £0 £11,850 @ 0%         £0
£2,000 @ 19% £380 £13,150 @ 20%      £ 2,630
£10,150 @ 20% £2,030
£1,000 @ 21% £210
£2,620 £ 2,630

In his Budget speech, Finance Secretary Derek Mackay said the new tax rates and bands would make Scotland’s system ‘more progressive” and deliver more money for public services.

He added: “Our income tax policy has factored in behavioural effects, and even after those are applied, the Scottish Fiscal Commission forecast it will deliver an additional £1.2bn over the next five years to support public services and the economy.”

IFS economists, Thomas Pope and Tom Waters, said the changes meant that Scotland was set to raise £225m more in tax than if it had kept the 2017/18 system unchanged.

So how does all this affect an individual’s pensions and investments?

Pensions

When people pay into a pension they get tax relief on their pension contributions up to certain limits each year. The Scottish income tax rates apply to pension tax relief. That means someone in Scotland who pays higher tax can also claim higher tax relief than elsewhere in the UK.

However, those on the starter rate of tax don’t lose out as detailed fully below:

  • Non taxpayers

Being a non-taxpayer in Scotland is no different to the rest of the UK. Individuals who don’t pay tax can still contribute up to £2,880 net a year into a pension and receive tax relief at source of 20%. This effectively makes the contributions worth £3,600 gross.

  • Starter rate taxpayers

Individuals earning between £11,850 and £13,850 will pay tax at 19%. However, their pension contributions will still receive tax relief at 20%.

  • Basic rate taxpayers

Individuals pay tax at 20% on their earnings between £13,850 and £24,000 and receive tax relief at the same rate as the rest of the UK at 20%.

  • Intermediate rate taxpayers

Individuals pay tax at 21% on earnings between £24,000 and £43,430. They are able to claim tax relief at 21% on their pension contributions. However, they will only receive tax relief at source of 20% and so will need to claim the extra 1% through self-assessment.

  • Higher rate taxpayers

Individuals pay tax at 41% on earnings between £43,430 and £150,000. This threshold is lower than in the rest of the UK and the rate of tax is 1p higher than the higher rate tax rate elsewhere. Claiming this extra tax relief is via self-assessment tax return.

  • Top rate taxpayers

Individuals earning more than £150,000 a year will pay tax at 46% on those earnings. The threshold is the same, but in the rest of the UK the rate of tax relief is 45% claimed through self- assessment tax returns.

Where employees who are subject to Scottish income tax make pension contributions under net pay arrangements, their contributions will be deducted from pay before income tax is applied, meaning they will receive relief automatically at their marginal Scottish income tax rate.

The situation is slightly different for pension schemes which operate a relief-at-source mechanism. Administrators of such schemes will continue, for 2018/19 at least, to claim tax relief at 20% for members who are Scottish taxpayers.

Chargeable event gains on bonds

As the Scottish income tax does not apply to savings income, the Scottish tax rates and bands will not apply when calculating chargeable gains from investment bonds. Instead the UK tax rates and bands are used.

Example

Tina pays Scottish income tax on her annual pension income of £40,000. This is calculated as:

Gross earned income £40,000

Scottish income tax
£11,850 @ 0% £0
£2,000 @ 19% £380
£10,150 @ 20% £2,030
£16,000 @ 21% £3,360
£5,770

= Net income £34,230

In September 2018, if Tina realised a chargeable gain on a UK investment bond of £24,000 she had held for 4 complete years, she would need to use the UK basic rate threshold of £46,350 to calculate the tax on her chargeable gain as follows:

  • Tina’s total income increases to £40,000 + £24,000 = £64,000.
  • Her total income exceeds the UK basic rate band; therefore her personal savings allowance would be £500.
  • The bond is through a UK provider and therefore carries a basic rate tax
  • As the gain has taken her into a higher tax band, she would be able to use top slicing relief to reduce the tax on the

Top sliced gain = £6,000 (£24,000/4 complete policy years)

Top slicing keeps Tina within the basic rate tax band and therefore there is no additional tax to pay.

Summary

Scottish taxpayers suffer the same tax as the rest of the UK on dividends and savings interest, capital gains tax, chargeable gains on life policies and inheritance tax. However the introduction of Scottish income tax added a layer of complication: a Scottish taxpayer who has both earned income, and taxable savings income may have to consider both the UK and Scottish rates and thresholds, in order to calculate their total income tax liability.

Added to this is the introduction of Welsh income tax due in April 2019. Therefore it is as important as ever to be aware of how these different tax regimes can impact the income received from various sources and the consequences these additional complications have for financial advisers.

Further details can be found on the Canada Life Briefing Note for Scottish Income Tax:  https://www.canadalife.co.uk/adviser/ican-academy/briefing-notes

Francesca Gandolfi, Technical Manager, Canada Life

Francesca Gandolfi has over 20 years experience in the industry, having previously worked as a financial adviser focusing on wealth management, IHT planning, retirement planning, and later life advice.

About Canada Life

Canada Life is part of a group of companies controlled by Great-West Lifeco Inc., a diversified financial services holding company headquartered in Winnipeg, Canada. Through its subsidiary companies, Lifeco has operations in Canada, the United States, and Europe. Great-West Lifeco and its insurance subsidiaries have received strong ratings from major  rating agencies.

Canada Life Limited, a wholly owned subsidiary of Great-West Lifeco, began operations in the  United Kingdom in 1903 and looks after the retirement, investment and protection needs of individuals and companies alike. As  well as providing stability and security through its  individual contracts, Canada  Life Limited has grown to become the leading provider of  competitivelypricedgroupinsurance solutions. www.canadalife.co.uk.

Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the  Financial Conduct Authority and the Prudential Regulation Authority. Canada Life International  Limited and CLI Institutional Limited are Isle of Man registered companies  authorised and regulated by the Isle of Man Financial Services  Authority. Canada Life  International Assurance Limited and Canada Life International Assurance (Ireland) DAC are  authorised and regulated by the Central Bank  of Ireland.

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