RSM's Shirley McIntosh considers the likely impact of the Scottish Budget, and points out that some taxpayers can use the regime to be taxed at more favourable Westminster rates.
Scotland’s finance secretary has already alluded to the possibility of further rate increases for higher taxpayers in Scotland – but at what level of divergence is tolerable for Scottish taxpayers?
Due to tax reform changes in last year’s Budget, Scottish taxpayers earning more than £33,000 already pay more than taxpayers in the rest of the UK, and recent rhetoric suggests there could be further tax increases for middle- and higher-earners.
Even if Finance Secretary Derek Mackay decides to make no changes on Wednesday, there will still be further divergence between Scotland and the rest of the UK as Philip Hammond announced a higher threshold to £50,000 for higher-rate taxpayers. Whereas, the threshold for equivalent taxpayers in Scotland sits at £43,430. This is set to increase in line with inflation so there will be a slight move; but a sizeable gap is expected to still remain.
The changes to the personal allowances from the UK Budget benefits all taxpayers in Scotland, but higher earners will see a greater benefit as a result of this change, which could be seen by the Scottish Government as an opportunity to increase the higher tax rate to rebalance the tax take overall, and gain favour with other parties such as the Greens.
However, Scottish businesses want to reduce the level of tax divergence with the UK to ensure that Scotland remains competitive for investment and talent. Ultimately, the short-term gain of higher tax revenues could accelerate brain drain as higher earners and graduates may look south for career options to mitigate what could be up to a £1,900 drop in income in just one year.
This longer-term flight risk is also exacerbated by technology advancement and a move to more flexible working. Could we see taxpayers working for Scottish businesses choosing to move to Berwick or Cumbria, working remotely from home and travelling in to Scotland for meetings? As Scottish Income Tax receipts are allocated predominantly via a permanent residency, income tax revenues in this scenario would be allocated to Westminster. If the flight risk bites, would, and indeed could, the Scottish government look to introduce a statutory residency test to establish the level of time spent working in Scotland to claw back some of the tax?
Also, many higher rate taxpayers will be able to mitigate any increase as they are likely to be owners of small companies who could take a dividend (taxed by Westminster) instead of salary (taxed by Holyrood) to reduce their tax liabilities.
These scenarios would ultimately lead to a decrease in the tax take in Scotland as tax revenues would be diverted to Westminster - highlighting a behavioural risk to any Scottish income tax changes.
Could this be balanced out by greater support to first-time buyers and business rate relief?
In Scotland, we already have relief from Land and Building Transaction Tax relief for first time buyers on properties up to £175,000. However, city-centre living where millennials might want to buy usually comes with a higher price tag, so could we see some extension to this threshold to encourage young people to settle in Scotland; and bring the relief more in line with the £300,000 level in the rest of the UK?
To give businesses a boost, particularly in the struggling retail sector, Derek Mackay may consider introducing cuts to businesses rates to secure jobs and stimulate economic growth. However, business rates revenue goes directly to local government so any shortfall in income could impact local services. Councils are already facing major challenges in financing service delivery and some are considering innovative ways to raise cash such as Edinburgh’s proposed ‘tourist tax’.
Overall, Derek Mackay has a challenging balancing act to raise more revenue to support public services without adding to the growing deficit, whilst supporting economic growth and encouraging taxpayers to live and work in Scotland. It’s a complex conundrum and Scottish businesses and taxpayers should probably prepare for further complexity as Scotland’s progressive tax system evolves.
Shirley McIntosh is an RSM tax partner based in Edinburgh. She has 25 years’ experience dealing with middle market businesses, high net worth individuals and trusts. She also specialises in offshore structures and providing advice on residence issues.