Publication - Research and analysis

Scottish Income Tax: 2018-19 policy evaluation

A policy evaluation of Scottish Income Tax in 2018-19

Scottish Income Tax: 2018-19 policy evaluation
8. Operational and administrative impacts

8. Operational and administrative impacts

Two of the principles which underpin the Scottish approach to taxation are Convenience and Efficiency. In adapting these principles to the present context, the Scottish Government believes that the tax system should be as simple as possible and easy to understand and comply with, and that tax policy should be cost-effective to administer.

Therefore in addition to evaluating the impact of the 2018-19 policy against the four tests, this evaluation also seeks to understand the operational and administrative impacts of the policy on businesses and taxpayers. The majority of evidence was gathered from a focus group of tax and payroll professionals, which took place in July 2021.

8.1 Key findings

  • In their report Administration of Scottish Income Tax 2018-19, the National Audit Office found that HMRC "framed adequate regulations and procedures to secure an effective check on the assessment, collection and proper allocation of revenue, and that they are being duly carried out".
  • Any initial issues that materialised as a result of the policy changes have mostly been resolved. As such, the administration and collection of Scottish Income Tax is now operating under business as usual.
  • The reforms introduced additional complexities to the tax system, which could already be complicated for some taxpayers, although technology lessened any impacts.
  • Communication around tax policy and administration is key. The Scottish Government should develop further communications activity jointly with HMRC.
  • Overall, the processes and procedures put in place by HMRC to administer Scottish Income Tax are robust and enable it to be collected efficiently and effectively, representing value for money for Scottish public finances.

8.2 Governance arrangements between Scottish Government and HMRC

HMRC are accountable for the collection and management of Scottish Income Tax and are required to produce evidence that they are doing so in an efficient and effective manner.

To ensure a consistent quality of service to Scottish Income Tax taxpayers and to allow both HMRC and Scottish Government meet their respective responsibilities, a Service Level Agreement (SLA) was agreed between the two organisations[27]. The SLA describes the requirements and performance measures for the operation of Scottish Income Tax, including HMRC's responsibility for identifying and maintaining a robust record of the Scottish Income Tax population.

One of the key requirements of the SLA is for HMRC to report annually on its delivery of the agreed services[28]. This work is audited by the National Audit Office (NAO) and Audit Scotland[29]. The latest report by NAO was published in January 2021[30].

The Scottish Income Tax Board meets quarterly, chaired by the relevant Deputy Directors in each organisation (or their delegates). The Board considers any relevant matters arising from the delivery aspect of the SLA. This includes all business as usual activity around Scottish Income Tax, across operations, compliance, data and policy. The Board also reviews the financial data provided by HMRC for this period in line with the quarterly reporting and invoicing requirements.

Bi-annual review meetings are held between Directors in each organisation, who are also signatories of the SLA, at which the overall effectiveness of the SLA and HMRC's performance against it is kept under review.

HMRC produce monthly finance reports for review by Scottish Government. These reports provide details of the monthly operational costs, key movements, updated costs forecasts for the quarter and the recharge cost for the month. HMRC recharges the Scottish Government for any net additional costs wholly and necessarily incurred as a result of the administration of the Scottish Income Tax powers. The recharge costs are approved at the quarterly Board meetings.

In order for HMRC to identify and maintain an accurate and robust record of the Scottish taxpayer population they undertake a variety of identification and address assurance activity each year. HMRC present their results at both the Board and the Bi-annual Review meetings so that senior staff at Scottish Government are able to assess HMRC's performance.

8.3 Preparations for the commencement of the Scottish Rate of Income Tax in 2016

Scottish Income Tax applies to Scottish taxpayers' wages, pensions and most other taxable income[31], except for dividend and savings income. It is collected by HMRC through the PAYE system by assigning Scottish taxpayers a tax code starting with an 'S' or is collected through SA where taxpayers are asked to confirm their address on their tax return.

Two new processes were created in order for HMRC to be able to collect the Scottish Rate of Income Tax, and subsequently, Scottish Income Tax, and identify relevant receipts accordingly. First, the identification of relevant Scottish taxpayers and secondary attaching a 'S' prefix to their PAYE codes.

Prior to the introduction of Scottish Income Tax, HMRC maintained its database of taxpayers and their addresses across the UK. However, because a taxpayer's address would be the primary source of identifying them as a Scottish taxpayer, and to allow HMRC to identify which receipts should be allocated to the Scottish Government, there was an increased onus on HMRC to ensure the data it held was as accurate as possible and for taxpayers to advise HMRC of their correct address.

There are a number of tests that can be used to define a Scottish taxpayer, as set out in section 80D of the Scotland Act 1998, with the location of their main residence being a key factor[32]. HMRC identify a taxpayer as living in Scotland by using the postcode recorded on their PAYE and SA systems. Additionally, HMRC undertake data clash exercises with postcode data available from third party sources to monitor their address assurance of Scottish taxpayers[33]. This work is audited by the National Audit Office and most recent report was published in January 2021[34].

The data clash exercise involves HMRC comparing their dataset of Scottish taxpayers' records against third party data sources. In the most recent exercise the majority of records were successfully matched to a third party Scottish address. For a small number of records that matched but were identified as having a different residency, based on the postcode recorded on HMRC and the third party's databases, HMRC wrote to these individuals asking them to check and update, if required, the address held by them. For the remaining records that could not be verified by comparing to third party data sources, HMRC compared these records against their internal SA data or Real Time Information provided by employers. Of these records HMRC successfully matched most to a Scottish address. A small number also matched to an address in the rUK. For the remaining unmatched records HMRC undertook further analysis and discovered that the vast majority had temporary reference numbers so they considered that these records were no longer active.

HMRC also liaised with Royal Mail and National Records of Scotland to establish postcodes that spanned the Scottish/English border and identified the actual postal addresses that were affected to make sure that the ones in Scotland were correctly flagged on their systems. Additionally, HMRC undertakes regular scans to identify and update Scottish instances of missing or partial postcode.

The results of this exercise provided evidence to suggest that HMRC's identification of Scottish taxpayers was correct in 98% to 99% of cases.

The Scottish Government asked HMRC asked to comment on the operational and administrative impacts on HMRC of the move to the five bands of Scottish Income Tax.

HMRC responded as follows:

'The Scotland Act 2016, alongside the Scotland Act 2012, gave Scottish Parliament additional powers to set Income Tax thresholds, bands and rates for non-savings, non-dividend income for Scottish taxpayers. The Scottish Government introduced two new Income Tax bands, the Starter and Intermediate Rates, for Scottish Taxpayers for the 2018/19 tax year in light of this new legislation.

HMRC identified several administrative and operational impacts when delivering the Further Scottish Income Tax Powers (Scottish Income Tax) Project to implement these new bands on behalf of the Scottish Government.

IT functionality changes were made to PAYE, Self-Assessment and Compliance processes, providing flexibility for the Scottish Government, and ensuring Scottish taxpayers are taxed correctly.

HMRC also identified that changes to letters sent out to Scottish taxpayers would be required to reflect the different rates of Income Tax applicable in Scotland.

In addition, training was provided to HMRC's operational staff to raise awareness of the implementation of the wider Scottish Income Tax Devolved Powers, and HMRC identified that there would likely be an increase in customer contact which could therefore require additional resource.

The Scottish Government met the £24.3m total cost of delivering Scottish Income Tax. This includes the implementation of the Scottish Rate of Income Tax between 2012-13 and 2018-19, the implementation of Further Scottish Income Tax Powers between 2016-17 and 2018-19, and the implementation of Relief at Source between 2015-16 and 2019-20. The ongoing costs of operating Scottish Income Tax are separate.''

8.4 Focus group results

In order to gain insight into the administrative and operational impacts of the move to the 5-band structure of Scottish Income Tax in 2018-19, the Scottish Government spoke to the Institute of Chartered Accountants of Scotland to better understand the impact that the policy change had on accountants, tax and payroll professionals, and taxpayers.

Following this, the Scottish Government arranged a focus group comprised of tax and payroll professionals. The analysis in the remainder of this section refers to the feedback provided by this group on two core questions, the full notes from which are available at Annex B.

Question one: what was the impact - both financial and administratively - on businesses and payroll software providers?

Although not specifically part of the 2018-19 changes, the group initially discussed the introduction of the 'S' PAYE code and the issues it caused. The 'S' code is integral to the collection of the correct amount of Scottish Income Tax as a result of any changes made to the Scottish Income Tax rates or bands.

As the 'S' code prefix is determined by where a taxpayer lives rather than where they work, the group commented that this created confusion in the beginning, particularly as it is ultimately the responsibility of the individual taxpayer to make sure their tax code is correct. There was a general consensus from the group that communication on what was driving the change to 'S' code prefixes was a significant issue at the time of the change but any issues were short lived and it has now bedded in successfully.

The introduction of the 'S' code also created some problems initially for payroll software as it did not correctly identify Scottish taxpayers. The group noted that there was some dissatisfaction amongst affected taxpayers and further administrative burdens for employers identifying people manually before software updates were made available to recognise Scottish Income Tax taxpayers automatically. The group advised that while this was a challenge for the payroll profession, issues like those which materialised were to be expected during any transitional period.

The group stated that the introduction of the new five band tax rate structure for Scottish Income Tax initially caused frustration and more complication, particularly as it took longer for the calculation of PAYE and tax liabilities to be processed and checked. However, the general consensus amongst the group was that the software and technology significantly lessened the impact of this. There was concern from the group that further complications could arise if there were frequent changes to the rates and bands in the future.

The group's view was that no significant costs arose to businesses or payroll operators - the software providers included the additional upgrades to calculate Scottish Income Tax as part of their annual statutory update and the costs were part of the usual annual charges. Furthermore, as many businesses outsource their payroll, there was little additional time and monetary costs for the businesses themselves. Although the focus group was again concerned that further complexity may result in higher costs.

The group also advised that there was a direct cost to cross-border businesses in terms of the PAYE Settlement Agreement (PSA)[35] as separate calculations had to be carried out for employees in Scotland and the rUK. However, the cost is relatively small and is generally passed on to the taxpayer (i.e. the employer) by their accountants or payroll service provider.

For the future, the group suggested that further changes to rates, bands and thresholds of Scottish Income Tax should not be an issue, so long as the tax and payroll professions are given reasonable notice. They stressed it was very important that when upgrades to software are required, sufficient time is allowed for development, testing, and quality assurance. In this respect, stakeholders have previously highlighted the recent uncertainty caused by delays to the UK and Scottish Budget processes[36].

Question two: have the changes made the tax system more complicated?

The general consensus from the group was that tax and payroll professionals are experienced in coping with legislative and regulatory changes, such as those made to Scottish Income Tax in 2018-19. The group also recognised that it was inevitable that gradual or partial devolution would lead to divergence and therefore more complication.

The group was concerned about the level of understanding of tax, particularly amongst unrepresented individuals and micro businesses, and this needs to be taken into account when considering whether the changes to Scottish Income Tax made the tax system more complicated [37] [38]. The group noted that taxpayers need to be consistently reminded of any tax changes as it is easy for them to forget, particularly if they are running a business and are required to meet various other legal and regulatory obligations.

To communicate the changes to Scottish Income Tax in 2018-19, HMRC used a range of communication channels, including the Employer Bulletin, Agent Update, Customer Compliance Managers' engagement with large businesses and public bodies, forums for employers, payroll managers and agents, GOV.UK and social media.

The group discussed at length the importance of good communication on tax matters. They suggested that:

  • while HMRC are the trusted messenger for communicating to the general public on tax matters, more joint communications by the Scottish Government and HMRC would help to improve public understanding of tax in Scotland;
  • the rules around determining Scottish taxpayer status are relatively straightforward to explain and that more communication would help to further improve understanding in this area;
  • when further policy decisions are made, it will be important to identify who they affect and tailor communications activity accordingly;
  • there is a need for wider communication and continued support to, in particular, individual taxpayers with complicated tax affairs, businesses and tax professionals.

The group noted that feedback received from attendees of the recent Citizens' Assembly[39] was positive and suggested more of this type of engagement would be helpful.

The focus group highlighted and discussed the divergence between the tax systems in Scotland and the rUK.

Some larger employers encountered issues with similarly salaried employees being taxed differently in Scotland and the rUK. However, this was to be expected with devolution and was not an overly frequent or complicated issue for business to deal with (as the differing tax systems were ultimately not their responsibility).

One of the main issues the group identified was around pension tax relief. Scottish taxpayers are entitled to receive tax relief on their pensions according to the Scottish rates and bands. Those who contributed to a workplace pension scheme have the correct amount of relief automatically applied and no further action is required on their part.

Where a taxpayer makes pension contributions into a relief at source arrangement, they automatically receive tax relief at the relevant Basic Rate on their contribution. Taxpayers who pay tax at the Intermediate, Higher or Top Rate can then claim extra relief from HMRC.

While this process was well established for Higher and Top Rate taxpayers prior to the introduction of Scottish Income Tax, the addition of the 21% Intermediate Rate band brought a broader base of taxpayers into scope, who are entitled to claim the extra relief from HMRC. Only some taxpayers need to take action, however, and those who normally complete a SA tax return can claim the relief by completing the relevant section on their tax return.

The group were concerned that this would not be widely known amongst Intermediate Rate taxpayers, which is linked to an earlier point made by the group in respect of targeting and tailoring communications to those with more complicated tax affairs.

The group also raised issues with the interaction between diverging Income Tax rates and bands and: National Insurance Contributions; gift aid payments; and the social security system.

The group advised that there were initially some technology issues as a result of the move to the five band system. A very small number of Scottish taxpayers were unable to file online due to a software error, meaning they had to submit paper tax returns. The group felt that HMRC needed more time between the announcement of the policy changes and the start of the new tax year in order to code their software correctly and address any unanticipated issues.

There were various points raised by individuals in the group around making sure that all the Scottish Income Tax is attributed to Scotland and that is was important to ensure that all tax, penalties & interest arising from future tax enquiries were attributed to Scotland by HMRC. Similarly, a point was raised about PSAs and whether HMRC was passing the Scottish Income Tax received under these settlements for amounts assessed at the Scottish rates. During the session of the focus group, attendees were directed to documents which demonstrated how these additional liabilities are attributed to the Scottish Government.