Scotland Act 2012 financial provisions implementation: fifth annual report

Chapter 2 - The Scottish Rate of Income Tax (SRIT) and Scottish Income Tax

23. Over this year, the Scottish Government has continued to work with HMRC and DWP on both the remaining implementation work for the Scottish Rate of Income Tax ( SRIT), including the solution that will allow pension providers to claim relief at source at the correct rate from next year, and also the implementation work to support the devolution of the further income tax powers in the Scotland Act 2016 (the 2016 Act).

24. The Scottish Parliament's Finance and Constitution Committee took evidence on HMRC's collection and management of SRIT and implementation of Scottish Income Tax from Jim Harra, HMRC's Additional Accountable Officer for Scottish income tax, and Sarah Walker, Deputy Director Devolution, on the 14 December 2016 ^[9] .

25. The National Audit Office ( NAO) published its second report on the Administration of SRIT on the 19 December 2016 ^[10] . Audit Scotland also reviewed and endorsed the approach taken by the NAO in its own report ^[11] on the same day. Caroline Gardner, Auditor General for Scotland and Steven Corbishley, Director, NAO gave evidence on their respective reports to the Scottish Parliament's Public Audit and Post-Legislative Scrutiny Committee on 23 March 2017. The on-going work within the Scottish Government on the Scottish income tax powers was also considered by Audit Scotland as part of its separate report, Managing Financial Powers - An Update, published on 23 March 2017. ^[12]

26. These reports and evidence sessions have provided additional assurance to the Scottish Government on HMRC's administration of SRIT in 2015-16 and the work undertaken for the introduction of the further powers in April 2017.

Scotland Act 2012

27. The Scottish Parliament set SRIT at 10% on 11 February 2016 ^[13] , and from 6 April 2016, HMRC has been collecting it from Scottish taxpayers. The Office of Budget Responsibility forecast that SRIT would raise £4,900m in 2016-17 and this is the amount that has flowed from HM Treasury into the Scottish Government's Consolidated Fund during the course of this financial year. As part of the transitional arrangements agreed for SRIT, there will be no adjustment to the Scottish Government's block grant if the outturn data for 2016-17 differs from this forecast when it becomes available in 2018.

28. Due to lower costs incurred this year than forecast, HMRC has reduced its lifetime cost estimates for implementing SRIT to £20m - £25m, which it has split between non- IT costs of £7m, and IT costs of £13m - £17m. To date, the Scottish Government has been invoiced for £13.8m.

29. In 2015-16, the Scottish Government paid HMRC £8.4m in SRIT implementation costs. In 2016-17, up to Q3, HMRC have invoiced the Scottish Government for £2.7m, with a forecast spend in Q4 of £1.9m expected.

30. The remaining implementation costs are expected to fall primarily in 2017-18, but extend into 2018-19. Provision has been made in the Scottish Government's budget for 2017-18 on the basis of HMRC's forecasts. Provision for the costs in 2018-19 will be set as part of the next spending review.

31. The SRIT powers commenced for the 2016-17 tax year. This is therefore the first instance of running costs being incurred which will be rechargeable to the Scottish Government. In 2016-17, up to Q3, HMRC have invoiced the Scottish Government for running costs of £0.03m. These are forecast to be around £0.2m in total for this year.

32. HMRC have previously estimated that 'business as usual' running costs for Scottish income tax will be around £1.5m per year. Work is underway, however, within HMRC to identify all the business as usual costs that would be rechargeable to the Scottish Government which, alongside experience of actual costs incurred, will refine this estimate for future years.

33. DWP has also reduced its lifetime cost estimates for implementing SRIT to £1.2m. In 2015-16, the Scottish Government paid DWP £0.9m for implementing SRIT. In 2016-17, up to Q3, DWP had invoiced the SG for £0.2m.

Scotland Act 2016

34. The further Scottish income tax powers will take effect from the 2017-18 tax year.

35. The Memorandum of Understanding ^[14] between the Scottish Government and HMRC has been updated to take account of the work being done for the 2016 Act income tax provisions, and governing arrangements between the Scottish Government and the DWP were similarly updated in an Exchange of Letters. ^[15]

36. The Scottish Parliament agreed on the 21 February 2017 ^[16] to maintain the income tax rates that apply in the UK, but to freeze the higher rate threshold in cash terms at £43,000 for the 2017-18 tax year. The Scottish Government has estimated that this will raise £11,857m which will be available to the Scottish Government to draw down from HM Treasury throughout that financial year. There will, however, be a reconciliation process against the final outturn figure once this is known in 2019, to determine the adjustment to the block grant. The Scottish Government's income tax forecast for 2017-18 was endorsed as reasonable by the Scottish Fiscal Commission.

37. HMRC estimates that the implementation of the further income tax powers will cost £2.6m, split between a total non- IT cost of £1.3m and a total IT cost of £1.3m. For the implementation of the further income tax powers up to Q3 of 2016-17, HMRC has invoiced the Scottish Government for £0.6m, with a further £0.8m forecast for Q4.

38. Additional costs will also be recharged to the Scottish Government to reflect the work undertaken by HMRC to update the PAYE system to allow it to recognise the new rates and thresholds agreed by the Scottish Parliament in February for the start of the tax year.

39. The Scottish Government and HMRC have always agreed that a robust process for the identification of Scottish taxpayers is not only critical to the successful implementation of the Scottish income tax powers, but that it will also be a key on-going exercise. Therefore, during 2016-17, the Scottish Government has worked closely with HMRC as it continues to refine and update its processes for identifying Scottish taxpayers, which are now based on live data. This has included HMRC putting in place a solution to ensure that a significant number of potential Scottish taxpayers who had not been identified during the initial identification scan in December 2015, were subsequently correctly identified within their systems by October 2016. HMRC did not recharge the Scottish Government for the costs of implementing this solution.

40. Further analysis of the degree to which - once identified within HMRC systems as Scottish taxpayers - the correct 'S' tax code has been applied to relevant PAYE returns has also been undertaken.

41. HMRC continues to estimate that there are around 2.6m Scottish taxpayers; figures on the actual total population will be available for the first time in 2018.

42. The Scottish Government has engaged with HMRC on the compliance processes and activity that will take place each year following the agreement of both the Scottish and UK Government's income tax rates and bands, and which will take account of the degree to which there is any consequent divergence. Overall, the Scottish Government will benefit from the compliance work that HMRC conducts to protect UK income tax yield as well as bespoke activity identified for Scottish income tax. In addition, the Scottish taxpayer identification work which HMRC conducts will also have an input to the enforcement and compliance work.

43. To reflect transition from solely implementation to live running of the Scottish income tax powers, HMRC and the Scottish Government are in the process of drafting a Service Level Agreement which will cover operational aspects.

44. The Scottish Government has also continued to work with the DWP to ensure that that DWP's systems can recognise and process information on Scottish taxpayers. DWP's implementation of the further income tax powers is estimated to cost a total of £0.5m. The Scottish Government has been invoiced for £0.2m up to Q3 in 2016-17.