Taxes heading north

Irrespective of the outcome of the 2014 independence referendum, one area in which we are already starting to see significant divergence from the rest of the UK – and are likely to see considerably more in the years to come – is that of tax.

The Scottish Government is in the process of setting up a Scottish tax system and has appointed Eleanor Emberson, the former chief executive of the Scottish Court Service, as the head of Revenue Scotland, the new Scottish tax authority. Initially, Revenue Scotland will be responsible for two new Scottish taxes, the land and buildings transaction tax (LBTT), which will replace stamp duty land tax for transactions involving land in Scotland, and the Scottish landfill tax, which applies to the landfilling of waste.

In addition, from April 2016 the Scottish Parliament will be required to set the Scottish rate of income tax (SRIT) each year, as a result of which Scottish taxpayers may pay a different rate of income tax from their counterparts in the rest of the UK. Two land-based taxes and the SRIT may seem an odd foundation for a tax system; however these were the changes recommended by the Calman Commission which have been included in the Scotland Act 2012.

The introduction of the new Scottish taxes will have significant implications for the legal profession, particularly since most of those involved in submitting SDLT returns are lawyers. The profession in Scotland needs to prepare for the changes which are in prospect.

“Scottish SDLT”

From April 2015, UK SDLT will cease to apply to transactions involving land in Scotland and will be replaced by the Scottish LBTT. The Scottish Government consultation on LBTT, “Taking Forward a Scottish Land and Buildings Transaction Tax”, ran from 7 June to 30 August 2012 and many submissions from stakeholders were received. Details of these are available at www.scotland.gov.uk/consultations. The LBTT Bill is to be introduced to the Scottish Parliament in November.

Although initially LBTT will be modelled on SDLT, it will take into account Scots law and conveyancing practice (which SDLT fails to do in many respects). The consultation document proposed:

• a progressive rate, rather than the “slab” system of SDLT;
• no LBTT on residential leases;
• a general anti-avoidance (or anti-abuse) rule;
• the possibility of a different LBTT regime for commercial leases, partnerships and trusts.

LBTT returns and online system

LBTT will be collected by Registers of Scotland (RoS), and a new online system will be developed for the submission of LBTT returns and collection of LBTT. The RoS team tasked with this project is well aware of the many problems which have been caused by the complexities of SDLT returns, such as the wide range of information which has to be included despite not being relevant to the computation of SDLT liabilities. The significant cost of varying the SDLT online system also makes change very difficult.

It is to be hoped that the new LBTT online system will be agile and responsive, and will have the inbuilt flexibility required for the Scottish Government to change the tax base and rates without the system having to close down for 10 days, as is often the case with SDLT.

The RoS project team has the advantage of understanding the importance of registration of land in Scotland and how the process works, and so should be able to avoid the difficulties which accompanied the introduction of SDLT. Many readers will remember the special workaround arrangements which had to be introduced in Scotland (such as the personal presentation of SDLT returns over the counter at the Edinburgh Stamp Office), to ensure that the property industry in Scotland did not grind to a halt.

Transition from SDLT to LBTT

While the Scottish Government is designing LBTT, HM Revenue & Customs (HMRC) is planning the so called “SDLT switch off” project. To ensure that SDLT returns are not submitted for LBTT transactions, it is likely that the Scottish local authority codes will be removed from the SDLT online system.

Some transactions which complete after April 2015 will be subject to SDLT rather than LBTT because of the transitional rules. For example, if a contract is entered into before 1 May 2012 (the date of Royal Assent to the Scotland Act), SDLT will be payable rather than LBTT when the contract completes (and it is expected that online returns will be possible for these post-2015 SDLT transactions). Adequate guidance for practitioners will be essential; members of the Law Society of Scotland’s Tax Committee and others are already working with HMRC Stamp Taxes to achieve this.

Will LBTT be better ?

Some responses to the LBTT consultation read like a wish list of changes to the UK tax system in general and SDLT in particular. Recurrent themes include:

• the need for guidance that is clear, comprehensive, easily understood and takes Scots law into account;
• helplines staffed by specialist technical advisers;
• support for the progressive rate, particularly for residential property;
• the importance of a simple tax system.

Is it likely that LBTT will live up to expectations?

Scottish tax principles

John Swinney, Cabinet Secretary for Finance, Employment and Sustainable Growth, set out his vision for tax in Scotland when he introduced the LBTT consultation and explained that the approach to tax would be based on the four maxims set out by Adam Smith in The Wealth of Nations, namely:

• the burden proportionate to the ability to pay;
• certainty for the taxpayer;
• convenience/ease of payment;
• efficiency of collection.

The building blocks for the Scottish tax system will be set out in a Taxes Management Act (TMA) to be introduced to the Scottish Parliament in 2013. The Scottish Government will have the significant advantage of starting from a clean sheet of paper, and the holy grail of a simpler tax system may be within its reach.

In particular, the Scottish Government is considering the inclusion of a general anti-avoidance or anti-abuse rule (GAAR) in the Scottish TMA. The UK Government is also currently consulting on a UK GAAR, but it may be that in Scotland the GAAR could be accompanied by simpler legislation. In addition, tax policy will need to be set out in a policy memorandum which will accompany the LBTT Bill, making it easier to determine the intentions of Parliament. The Finance Committee at Holyrood has responsibility not just for looking at the Scottish tax bills but also at the implementation and operation of Scottish taxes, which should help to make things run smoothly.

Scottish landfill tax

Consultation on the Scottish landfill tax will start later this year. However Mr Swinney has stated: “My key consideration is that the landfill tax must effectively and implicitly support the good progress that is being made on encouraging the improvement in recycling in Scotland as we move towards the zero waste objective. We must establish that link and, ideally, find ways of incentivising further improvements in that practice.” (Official Report of the Finance Committee meeting, 5 September 2012, col 1470.)

Scottish income tax

The Scottish Parliament has always had the power to vary the basic rate of income tax for Scottish taxpayers by up to three percentage points, but that power has never been used.

The Scottish rate of income tax (SRIT) arrangements are quite different because the Scottish Parliament is required to set the SRIT each year. The income tax rates applying to Scottish taxpayers will be reduced by 10p, and the SRIT set by the Scottish Parliament will be added to the reduced UK rate. The table below illustrates the result for a range of different SRITs.

Unlike LBTT and Scottish landfill tax, which will be administered in Scotland, the SRIT is not a devolved tax. The Scottish Parliament only has responsibility for setting the SRIT, and HMRC will establish the list of Scottish taxpayers, issue the special tax codes, and administer and collect the SRIT. The costs of administering the SRIT, anticipated by HMRC to be £45 million, will be borne by the Scottish Government (and therefore by the Scottish taxpayer).

Who is a Scottish taxpayer?

Identifying a Scottish taxpayer may not be straightforward. First of all, the individual must be a UK resident for tax purposes. The next consideration is where their sole or main residence is located. Individuals with more than one residence in the UK will be Scottish taxpayers if they are resident for the longest period of time in Scotland. If necessary, the individual will need to count the number of days (on an end-of-day basis) spent in Scotland and elsewhere in the UK, in order to determine whether they are a Scottish taxpayer. There are exceptions for those transiting through the country and for Scottish MPs and MEPs.

PAYE “S” codes

HMRC will issue Scottish taxpayers with a tax code prefixed by an “S”, and payroll systems are expected to be able to apply the different rates of tax for Scottish and rest-of-UK taxpayers (although this has yet to be tested).

All UK and, indeed, overseas employers will need to be aware of the SRIT, even if they employ only a handful of Scottish taxpayers, since the SRIT applies to Scottish taxpayers regardless of where the employer is based. Some Scottish taxpayers will also need to submit self assessment tax returns to get their tax bill right.

SRIT practical issues

The SRIT is not a straightforward concept:

• The SRIT applies to “non-savings income” (including employment, pension and rental income).
• Savings and dividend income will remain liable to the UK rates.
• The tax status of cross-border workers may not be obvious.
• Some Scottish taxpayers may have to complete tax returns to get their tax payments right.
• The Scottish Parliament may set the SRIT at 10%, so there would be no practical difference for taxpayers.

Contentious issues

Taxpayers require access to a fair and independent appeal system, and Scottish taxpayers may need access to both the UK and Scottish tribunals.

The Scottish Government is looking at reforming the tribunals system and has already set up a new Scottish Tribunal Service (STS) to administer Scottish tribunals. Whilst the tax tribunal is not yet part of STS, it may become so. In 2011, the Ministry of Justice decided to merge the administration of courts and tribunals into one integrated body known as HM Courts Service & Tribunals (HMCST), which administers the courts in England & Wales, and tribunals across the UK. Perhaps the Scottish tribunals should be removed from HMCST (though that would require Westminster legislation)?

The Scottish tribunal judges will have a further layer of tax law to deal with as compared to their colleagues in other parts of the UK, and the burden of clarifying the meaning of the new Scottish tax rules will fall solely on the Scottish tribunal judges.

Looking forward

LBTT and the Scottish landfill tax are here to stay, regardless of the outcome of the current constitutional debate. The fate of the SRIT is less certain, given the cost and complexity of administering it. Discussions in the run-up to the independence referendum may consider complete devolution of income tax to Scotland, and the desire of the Scottish Government for a lower rate of corporation tax in Scotland is well known.