Chapter 2 Tax and the Fiscal Framework
This is the first Draft Budget in which our spending plans are underpinned by revenue-raising powers devolved by the Scotland Act 2016 in addition to taxes already fully devolved.
Since 2015-16 a proportion of Scottish spending has been funded by revenues from Land and Buildings Transaction Tax and the Scottish Landfill Tax. In 2016-17, the Scottish Parliament was able to set the Scottish Rate of Income Tax, a power provided by the Scotland Act 2012. From 2017-18, the Scottish Parliament will be able to set the rates and bands for all Scottish non-savings non-dividend (NSND) income tax. The devolution of Air Passenger Duty and the Aggregates Levy will follow in future years.
In parallel with the devolution of new powers, a Fiscal Framework was negotiated and agreed between the UK and Scottish Governments which sets out the financial arrangements which underpin and support the new powers. The Fiscal Framework also determines how the Scottish Government's block grant will be adjusted in light of its new fiscal powers.
For 2017-18, under the terms of the Fiscal Framework agreement, responsibility for forecasting Scottish income tax receipts has transferred to the Scottish Government, with the Scottish Fiscal Commission ('the Commission') providing independent scrutiny of the forecasting approach for income tax as well as existing taxes devolved under the Scotland Act 2012. The Commission has published a report on the Draft Budget and has assessed forecast tax receipts and economic determinants for forecasts of non-domestic rate income (NDRI) as reasonable. A detailed methodology paper on Scottish Government tax forecasts has also been published.
From 1 April 2017, the Commission will become an independent statutory body and will take responsibility for preparing and publishing forecasts of: demand-driven welfare spending, revenues from the fully devolved taxes and income tax; and onshore GDP in Scotland.
SCOTTISH INCOME TAX
The Scotland Act 2012 provided that, for taxpayers resident in Scotland, the UK income tax rate would be reduced by 10 percentage points and the Scottish Parliament would then set the Scottish Rate, which would be paid in addition to the reduced UK income tax rate. In 2016-17 the Scottish Rate of Income Tax was set at 10 per cent, resulting in the overall income tax rates payable in Scotland being the same as in the rest of the UK.
The Scotland Act 2016 transferred to the Scottish Parliament the power to set all income tax rates and the thresholds of bands, with the exception of the personal allowance. From 2017-18 the Scottish Government will receive all the revenue from income tax on non‑dividend and non-savings income of Scottish taxpayers.
Income tax remains a shared tax. The responsibility for defining the income tax base, including setting or changing income tax reliefs, continues to rest with the UK Government. HMRC will remain responsible for the collection and management of Scottish income tax. It is HMRC's responsibility to decide who is and who is not a Scottish taxpayer as provided for in legislation. The Scotland Act 2012 defines a Scottish taxpayer as someone who is a UK taxpayer and has their main place of residence in Scotland. It is essential that HMRC continue to take actions to test and improve the accuracy of their Scottish taxpayer database.
On 22 March 2016 the Scottish Government published its proposals for using Scotland's new income tax powers. This Draft Budget document confirms those proposals.
The Scottish Government is committed to protecting low-income taxpayers and, as such, is proposing to freeze the basic rate of income tax at 20 per cent. The Scottish Government is also proposing to freeze the higher and additional rates at 40 per cent and 45 per cent respectively. The higher rate of income tax threshold is proposed to increase by inflation to £43,430 in 2017-18. This increase in the higher rate of income tax threshold, when combined with the increase in the personal allowance, means that low and middle income taxpayers will be protected at a time of rising inflation, while priority is given to the protection of public services over a substantial tax cut for the top 10 per cent of taxpayers.
The Scottish Government can also confirm that the higher rate of income tax threshold will increase by a maximum of inflation in all future years of this Parliament.
Rates and Bands
In 2017-18 we propose to set the rates and bands of Scottish Income Tax as summarised in Table 2.01 below.
Table 2.01: Scottish Income Tax Rates and Bands
| Scottish Income Tax Rates || Scottish Bands |
| Scottish Basic rate 20% || Over £11,500* - £43,430 |
| Scottish Higher rate 40% || Over £43,430 - £150,000 |
| Scottish Additional Rate 45% || Over £150,000 and above** |
*Assumes individuals are in receipt of the Standard UK Personal Allowance.
**Those earning more than £100,000 will see their Personal Allowance reduced by £1 for every £2 earned over £100,000.
Scottish Government forecasts for income tax receipts are set out in Table 2.02 below.
Table 2.02: Scottish Income Tax Revenue Forecasts (£ million)
| Financial Year || 2017-18 || 2018-19 || 2019-20 || 2020-21 || 2021-22 |
| Forecast Receipts || 11,829 || 12,290 || 12,912 || 13,647 || 14,559 |
The net impact on the Scottish budget after the Block Grant Adjustment (BGA) relating to income tax is made, is £79 million in additional revenue for 2017-18. This reflects the policy choice of increasing the higher rate of income tax threshold in line with inflation, which means that more revenue is raised in Scotland than would have been under the UK Government's tax policy of increasing the higher rate threshold faster than inflation.
LAND AND BUILDINGS TRANSACTION TAX
Land and Buildings Transaction Tax (LBTT) replaced UK Stamp Duty Land Tax (SDLT) in Scotland from 1 April 2015. LBTT is a tax applied to residential and commercial land and buildings transactions (including commercial leases) where a chargeable interest is acquired. The Additional Dwelling Supplement (ADS) was introduced from 1 April 2016 and is payable on purchases of additional residential properties, such as buy-to-let properties and second homes.
Our policy priority for residential LBTT remains to help first-time buyers enter the property market and to assist people as they progress through the property market.
In the first 19 months of LBTT to end-October 2016, we:
- took nearly 15,700 residential purchases out of tax compared to SDLT;
- reduced the residential tax charge relative to SDLT for a further 66,500 house purchases; and
- ensured that 93 per cent of taxpayers were no worse off than under SDLT by paying either less tax or no tax at all.
Our approach to non-residential transactions ensures that smaller businesses pay the lowest or zero rates of LBTT. Our non-residential tax rates will ensure that Scotland is a competitive and attractive location for business.
Rates and bands
In 2017-18 we propose to maintain residential and non-residential rates and bands of LBTT at their current (2016-17) levels, as summarised in Table 2.03 below.
Table 2.03: Land and Buildings Transaction Tax rates and bands for residential and non-residential property transactions
| Purchase price |
| LBTT Rate || Purchase price (Non-residential transactions) || LBTT Rate || Net present value of rent payable |
| LBTT Rate |
| Up to £145,000 || 0% || Up to £150,000 || 0% || Up to £150,000 || 0% |
| £145,001 |
| 2% || £150,001 to £350,000 || 3% || Over £150,000 || 1% |
| £250,001 |
| 5% || Over £350,000 || 4.5% || || |
| £325,001 |
| 10% || || || || |
| Over £750,000 || 12% || || || || |
The Additional Dwelling Supplement is three percentage points of the total price of the property for all relevant transactions above £40,000 and will be charged in addition to the rates set out in Table 2.03.
Forecast tax revenues for residential and non-residential LBTT for the five-year period 2017-18 to 2021-22 are set out in Table 2.04 below.
Table 2.04: Land and Buildings Transaction Tax Revenue Forecasts 2017-18 to 2021-22 (£ million)
| || 2017-18 || 2018-19 || 2019-20 || 2020-21 || 2021-22 |
| Land and Buildings Transaction Tax || 507 || 543 || 571 || 597 || 624 |
| of which: |
| Residential transactions (excl. ADS) || 211 || 235 || 251 || 265 || 280 |
| Additional Dwelling Supplement (ADS) || 72 || 75 || 78 || 80 || 82 |
| Non-residential transactions || 224 || 233 || 242 || 252 || 262 |
SCOTTISH LANDFILL TAX
Scottish Landfill Tax (SLfT) was introduced on 1 April 2015, replacing UK Landfill Tax. It is a tax on the disposal of waste to landfill, charged by weight on the basis of two rates: a standard rate and a lower rate for less polluting materials.
Scottish Landfill Tax rates continue to provide financial incentives to support delivery of our ambitious targets to reduce waste, increase recycling and cut waste going to landfill.
Landfill operators are able to voluntarily contribute a capped proportion of their landfill tax liability to the Scottish Landfill Communities Fund and claim 90 per cent of the contribution as a tax credit. In order to claim a credit, the funds must be used for one or more of the objectives set out for the Communities Fund.
We propose to increase the Standard Rate of SLfT to £86.10 per tonne and the Lower Rate of SLfT to £2.70 per tonne in 2017-18 in line with RPI inflation and Landfill Tax charges in the rest of the UK. This helps to address concerns over potential 'waste tourism' should one part of the UK have a lower tax charge than another.
We also propose that the credit rate for Scottish Landfill Communities Fund for 2017‑18 will remain at a maximum of 5.6 per cent of an operator's tax liability. This will ensure that that landfill site operators can continue to contribute to community and environmental projects near landfill sites to a greater degree than their UK counterparts, without any increase in the overall tax burden.
Forecast tax revenues for Scottish Landfill Tax in the period 2017-18 to 2021-22 are set out in Table 2.05 below.
Table 2.05: Scottish Landfill Tax Revenue Forecasts 2017-18 to 2021-22 (£ million);
Adjusted for payments to the Scottish Landfill Communities Fund
| || 2017-18 || 2018-19 || 2019-20 || 2020-21 || 2021-22 |
| Scottish Landfill Tax || 149 || 118 || 109 || 112 || 106 |
AIR PASSENGER DUTY
Following the commencement of section 17 of the Scotland Act 2016 on 23 May 2016, the Scottish Parliament now has the power to legislate for a tax which will replace Air Passenger Duty (APD) in Scotland.
As set out in the Programme for Government 2016-17, we will introduce a Bill in the first year of the current Parliament to establish the tax which will replace APD in Scotland from 1 April 2018.
We remain committed to delivering a 50 per cent reduction in the overall tax burden of APD by the end of this Parliament. This will deliver sustainable growth for the Scottish economy by helping to generate new direct air routes, sustain existing routes and increase inbound tourism.
Aggregates Levy is a tax paid on the commercial exploitation of aggregates (i.e. sand, gravel and rock). The Scotland Act 2016 gives the Scottish Parliament the power to legislate for a tax to replace the Aggregates Levy in Scotland. However, there are ongoing legal issues in relation to the UK tax which are required to be resolved prior to the power being commenced.
The ability to set the rate of Aggregates Levy will provide opportunities to better integrate waste and other environmental policies within Scotland. The Scottish Government is aware of concerns in relation to double taxation and will work with the UK Government and stakeholders to address this and other key issues.
VALUE ADDED TAX ASSIGNMENT
The Scotland Act 2016 provided for the first 10 pence of the standard rate of Value Added Tax (VAT) and the first 2.5 pence of the reduced rate to be assigned to the Scottish Government. The assignment of VAT will be based on a methodology that will estimate expenditure in Scotland on goods and services that are liable for VAT. The details of the methodology are currently being agreed with HMRC.
The Fiscal Framework set out that VAT assignment will be implemented in 2019-20. In addition, there will be a transitional period during which VAT assignment will be forecast and calculated but with no impact on the Scottish Government's budget. The effectiveness of the methodology will be reviewed in the final year of the transition period.
BLOCK GRANT ADJUSTMENT
Changes in the Scottish Government's block grant will continue to be determined via the operation of the Barnett Formula. The block grant to the Scottish Government will then be adjusted to reflect the retention in Scotland of devolved revenues.
As agreed in the Fiscal Framework, the adjustments involve two elements: (i) an initial block grant baseline adjustment; and (ii) an indexation mechanism.
Initial baseline adjustments
The initial baseline adjustments are equal to the UK Government's tax receipts generated in Scotland in the year immediately prior to devolution of the powers. This is set out in Table 2.06 below:
Table 2.06: Initial Baseline Adjustments (£ million)
| Tax || Initial Baseline Deduction || Notes |
| Income Tax NSND || 11,525 || This is based on OBR forecasts of total NSND income tax receipts in Scotland under UKG income tax policy in 2016-17. Initially this will be forecast and then reconciled against outturn data once this is available.4 |
| LBTT || 468 || This is based on HMRC statistics of revenues in Scotland in 2014-15.5 There is a reduction of £20 million to account for the forestalling effects associated with residential SDLT receipts in 2014-15. |
| SLfT || 149 || This is based on an average of the GERS6 and HMRC methodology for apportioning UK Landfill Tax revenues to Scotland and applied to UK receipts in 2014-15. |
An indexation mechanism will be applied to each initial baseline adjustment.
Over the period to 2021-22 the block grant adjustments for tax will be indexed using the Comparable Model (CM) and the results will then be adjusted to achieve the outcome delivered by Indexed Per Capita (IPC). Each year it will therefore be necessary to concurrently calculate the block grant adjustments based on both the CM and IPC mechanisms. The methodology for calculating the block grant adjustments is set out in the technical annex to the Fiscal Framework.7
Table 2.07 below sets out up to 2021-22:
- the block grant adjustments for each tax using CM and IPC mechanisms;
- the Scottish Government forecasts of revenues from each tax; and
- the net impact on the Scottish budget (differences between the Scottish Government forecasts and IPC block grant adjustments).
Table 2.07: Block Grant Adjustments (£ million)
| Block Grant Adjustments || 2016-17 || 2017-18 || 2018-19 || 2019-20 || 2020-21 || 2021-22 |
| Income Tax NSND || Block grant adjustment (IPC) || || 11,750 || 12,159 || 12,672 || 13,233 || 13,898 |
| Block grant adjustment (CM) || || 11,790 || 12,240 || 12,794 || 13,399 || 14,110 |
| Scottish forecast || || 11,829 || 12,290 || 12,912 || 13,647 || 14,559 |
| Net impact against IPC || || 79 || 131 || 240 || 414 || 661 |
| LBTT || Block grant adjustment (IPC) || 504 || 545 || 585 || 634 || 689 || 741 |
| Block grant adjustment (CM) || 507 || 550 || 592 || 643 || 700 || 755 |
| Scottish forecast || 538 || 507 || 543 || 571 || 597 || 624 |
| Net impact against IPC || 34 || (38) || (42) || (63) || (92) || (117) |
| SLfT || Block grant adjustment (IPC) || 137 || 119 || 104 || 97 || 92 || 90 |
| Block grant adjustment (CM) || 138 || 120 || 106 || 99 || 94 || 93 |
| Scottish forecast || 133 || 149 || 118 || 109 || 112 || 106 |
| Net impact against IPC || (4) || 30 || 14 || 12 || 20 || 16 |
| Total Tax || Block grant adjustment (IPC) || 641 || 12,414 || 12,849 || 13,403 || 14,014 || 14,729 |
| Block grant adjustment (CM) || 645 || 12,460 || 12,938 || 13,536 || 14,194 || 14,958 |
| Scottish forecast || 671 || 12,485 || 12,951 || 13,592 || 14,356 || 15,289 |
| Net impact against IPC || 30 || 71 || 102 || 189 || 342 || 560 |
Elements of the non-tax changes reflected in the total block grant adjustment are still under discussion with HM Treasury. In accordance with the principle of no detriment these are assumed to be revenue neutral pending final resolution of the position. Once final agreement has been reached between the Scottish and UK Government's these changes will be fully incorporated within the appropriate portfolio.
The forecasts for both Scottish tax revenues and the BGA are produced based on the latest available information at the time of the Draft Budget. Once the outturn data is available for the Scottish tax revenues and the BGA, a reconciliation will be carried out as per the timetable set out in the Fiscal Framework. For Scottish income tax outturn data is likely to be available 15 months after the end of the financial year and for LBTT and SLfT this is likely to be available six months after the end of the financial year.
The Office for Budget Responsibility (OBR) will continue to produce economic and fiscal forecasts for the whole of the UK as well as all forecasts of UK Government tax and spending required for the operation of the Fiscal Framework.
The Fiscal Framework for Scotland determines: how the Scottish Government's block grant will be calculated in light of its new fiscal powers; an agreed transfer of funding for administration and implementation costs; the levels and conditions for resource and capital borrowing powers for Scotland; the establishment of the Scotland Reserve; information sharing requirements; and arrangements for independent fiscal scrutiny and forecasting.
Administration and Implementation Costs
There are administration and implementation costs associated with the new powers and functions being devolved. The UK and Scottish Governments agreed that the UK Government will provide a one-off non-baselined transfer of £200 million to the Scottish Government to support the implementation of the new powers and a baselined transfer of £66 million to cover the ongoing administration costs associated with the new powers.
Within these totals, £100 million for implementation costs and £22 million administration costs will be transferred for 2017-18. The remaining transfer(s) will be agreed by both Governments in due course.
Machinery of Government Transfers
To reflect the new powers and functions being devolved from April 2017, the Scottish Government has agreed with HM Treasury transfers to reflect the additional costs incurred or revenue generated as a result of delivering these powers and functions. These powers and functions are Consumer Protection (devolved in May 2016), the Coastal Communities Fund, the Crown Estate, Discretionary Housing Payments and Employment Support Services.
Borrowing and the Scotland Reserve
The Fiscal Framework and the Scotland Act 2016 increase the Scottish Government's capital borrowing limits to £3 billion. The annual limit on capital borrowing also increased to 15 per cent of the overall borrowing cap, i.e. £450 million per year. The Scottish Government may borrow through the UK Government from the National Loans Fund, by way of a commercial loan or through the issue of bonds. The new limits come into effect from 2017-18.
From 1 April 2017, the Scottish Government will have the power to borrow up to £600 million each year within a statutory overall limit for resource borrowing of £1.75 billion. The Fiscal Framework set out the conditions and limits for elements of resource borrowing:
- for in-year cash management, an annual limit of £500 million;
- for forecast errors, an annual limit of £300 million; and
- for any observed or forecast shortfall where there is or is forecast to be a Scotland-specific economic shock, an annual limit of £600 million.
Resource borrowing will continue to be from the National Loans Fund and the repayment period will be between three and five years, as determined at the time of borrowing.
These borrowing powers replace those put in place under the Scotland Act 2012 whereby the Scottish Government had the power to borrow for resource spending up to an overall limit of £500 million and to borrow an overall limit of £2.2 billion.
The new Scotland Reserve applies from 2017-18 onwards and will enable the Scottish Government to manage tax volatility. The Scotland Reserve will be separated between resource and capital. Payments into the resource reserve may be made from the resource budget including tax receipts. Funds in the resource reserve may be used to fund resource or capital spending. Payments may be made into the capital reserve from the capital budget and capital reserve funds may only be used to fund capital spending.
Detailed arrangements for reporting and repaying borrowing and the operation of the Scotland Reserve are being agreed with the UK Government.
Reporting on Implementation
Section 33 of the Scotland Act 2012 made provision for Scottish and UK Ministers to report on the implementation and operation of the finance powers and functions devolved under that Act. This requirement also extends to those functions and powers devolved under the Scotland Act 2016 and will also include reporting on the implementation of the Fiscal Framework. The first report will be laid before Summer 2017.