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Tax relief for Scottish taxpayers

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AR011072 02/2018

Scotland now has the power to vary the rates and limits for income tax. The Scottish Government used these new powers in the current tax-year 2017/18 and plans to implement further changes in the 2018/19 tax-year. In this article, we will examine the changes, how income tax rules differ from the rest of the UK and how the changes impact pension tax relief.    

Scottish income tax 2017/18

From 6th April 2017, the point at which higher rate tax starts, was different in Scotland to the rest of the UK.

Like the rest of the UK, the personal allowance – the first part of income that isn’t taxed – increased on 6th April 2017 from £11,000 to £11,500.

However, unlike the rest of the UK, the basic rate tax band in Scotland is £31,500, meaning that higher rate tax starts to be paid when taxable income reaches £43,000 (£11,500 plus £31,500). In the rest of the UK, the basic rate band is £33,500 and higher rate tax starts when taxable income reaches £45,000.

For those receiving income in Scotland, for example from their employer or from their pension, this means that anyone earning £45,000 or more will pay an extra 20% tax on £2,000 of their income (£400 extra tax) compared to a similar person resident elsewhere in the UK.

Although higher earners in Scotland will pay a bit more tax than elsewhere in the UK, pensions allow tax to be reclaimed via tax relief. For example, a Scottish income tax payer, with taxable income of £45,000, who pays a £2,000 pension contribution, will receive tax relief at 40% whereas a similar person elsewhere in the UK will only receive 20% tax relief.

Scottish income tax 2018/19

Like 2017/18, Scotland will adopt the same personal allowance as the rest of the UK – this will rise from £11,500 to £11,850. However, above the personal allowance, the Scottish Government plans a radical departure from UK income tax by introducing five bands of tax compared to three in the UK.

On 31st January 2018, the Scottish Government announced the following proposals for income tax rates and bands.  

Bands

Band name

Rates (%)

Over £11,850*- £13,850

Starter Rate

19

Over £13,850 - £24,000

Basic Rate

20

Over £24,000 - £43,430

Intermediate Rate

21

Over £43,430 - £150,000**

Higher Rate

41

Above £150,000**

Top Rate

46

 The bands for the rest of the UK are as follows:

Bands

Band name

Rates (%)

Over £11,850*- £46,350

Basic Rate

20

Over £46,350 - £150,000**

Higher Rate

40

Over £150,000**

Additional Rate

45

 * Assumes person is in receipt of the Standard UK Personal Allowance

** Personal Allowance is reduced by £1 for every £2 earned over £100,000

Scottish income tax and pension contributions

Tax relief is currently given on contributions paid into your pension in one of two ways:

  1. Relief at Source. You pay contributions from your net pay and the pension provider automatically claims back 20% tax relief from the government, even for non-taxpayers. Taxpayers who pay more than the basic rate claim extra tax relief through self-assessment. This method applies to personal pensions and group personal pensions and a small number of occupational pensions, such as the government’s National Employment Savings Trust (Nest) pension scheme.

  2. Net pay. Your contributions are deducted from your gross pay before tax is calculated. Under this method  you automatically receive tax relief at your highest marginal rate; pension savers whose pension contribution takes them into a lower tax band will receive tax relief at two different rates. Non-taxpayers do not receive any tax relief if contributions are deducted from gross pay. This method is mostly used by occupational pension schemes.

If you are unsure what method your pension scheme uses, ask your employer or your pension provider.

Scottish taxpayers whose contributions are deducted using the Net pay method (2 above) will still receive the appropriate amount of tax relief up front relevant to their own personal tax situation.

However, non-taxpayers will also continue to receive no tax relief on their pension contributions if their pension scheme uses this method.

For Scottish taxpayers paying into personal pensions, group personal pensions and occupational schemes, like Nest, that use the Relief at Source method (1 above) the situation is more complex.

The final rules for Relief at Source pension tax relief are not yet in place, but the following is the most likely outcome:

Tax band

Amount of tax relief and how it is claimed

0%

20% added automatically by your pension provider or pension scheme.

19% (Starter rate)

20% added automatically by your pension provider or pension scheme. Although this is 1% more tax relief than the rate of tax paid, there is no requirement to repay the extra 1%.

20% (Basic rate)

20% added automatically by your pension provider or pension scheme.

21% (Intermediate rate)

20% added automatically by your pension provider or pension scheme. Pension savers in this band will be due another 1% tax relief. They can reclaim this by submitting a self-assessment return, if this is something they do already. For those who don’t complete a self assessment return, which will be the bulk of taxpayers in this income bracket, the extra 1% relief can be claimed by contacting HMRC.

41% (Higher rate)

20% added automatically by your pension provider or pension scheme. Additional 21% tax relief claimed via self-assessment process following the tax-year end or for those who do not complete a self-assessment return, by contacting HMRC.

46% (Top rate)

20% added automatically by your pension provider or pension scheme. Additional 26% tax relief claimed via self-assessment process following the tax-year end.

Other issues

National Insurance contributions are payable in addition to income tax at 12% between the Primary Threshold of £162 a week and the Upper Earnings Limit of £892 a week. Above that, the rate is 2%.

However, the National Insurance Upper Earnings Limit is aligned with the UK income tax threshold for higher rate income tax. This produces anomalies for Scottish earners as set out in the following table:   

Income tax bands

Rate %

National insurance  bands

 Rate %

Combined  income tax and National Insurance rate %

£0 - £8,424

0

£0 - £8,424

0

0

£8,424 - £11,850

0

£8,424 - £11,850

12

12

Over £11,850*- £13,850

19

£11,850 - £13,850

12

31

Over £13,850 - £24,000

20

£13,850 - £24,000

12

32

Over £24,000 - £43,430

21

£24,000 - £43,430

12

33

Over £43,430 - £46,384

41

£43,430 - £46,384

12

53

Over £46,384 - £150,000**

41

£46,384 - £150,000

2

43

Above £150,000**

46

£150,000

2

48

 * Assumes person is in receipt of the Standard UK Personal Allowance

** Personal Allowance is reduced by £1 for every £2 earned over £100,000

You will see that people with gross earnings between £43,430 - £46,384 pay a combined tax and national insurance rate of 53%, which is much higher than the bands of income above and below this range.

Therefore, anyone that can pay a pension contribution that has the effect of reducing their income below £46,384 but not below £43,430 will receive higher rate tax relief of 41%.

However, if they also enter into a salary sacrifice arrangement with their employer, whereby they reduce their income in return for an employer pension contribution, they could save on both income tax and National Insurance and receive an effective rate of tax relief on the income sacrificed/pension contribution of 53%.

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