In the wake of the Scottish government’s decision not to replicate the UK Treasury's tax cut for higher earners, the National Audit Office (NAO) is warning that HMRC faces ‘significant’ challenges in administering the Scottish rate of income tax (SRIT), and is still having problems ensuring that all Scottish taxpayers are correctly identified despite a £1.1m marketing campaign
The audit watchdog’s report on the administration of SRIT in 2015-16 highlights HMRC’s difficulties ls, following an error in the design of HMRC’s taxpayer identification exercise in December 2015 which was supposed to check address details. This meant that 420,000 potential Scottish taxpayers did not receive a notification letter to check their status.
The NAO said that HMRC had spent £1.1m on communications with potential Scottish taxpayers but was stil having problems identifying all those who should be taxed under the Scottish rate of income tax.
HMRC engaged its IT supplier to investigate the issue in January 2016, and confirmed the total number of affected individuals in April 2016. The 420,000 omitted taxpayers received coding notices which informed them of the change in their annual tax code, and provided basic information on what was meant by an ‘S’ code.
However, the NAO says that by not issuing the same level of information as the 2.45m taxpayers originally identified in December 2015, HMRC may have created a less informed group of taxpayers.
An interim solution was put in place by June 2016 to issue coding notices for the 2016-17 tax year to the 420,000 taxpayers omitted from the initial identification scan. A permanent IT solution was implemented in October 2016 to bring these taxpayers within HMRC’s automated process for future years, and to ensure that all in-year changes of Scottish taxpayer status for these customers were correctly reflected in 2016-17 codes.
In addition, HMRC has undertaken specific analysis into high-risk areas within the taxpayer population. This has included individually assessed all taxpayers with postcodes spanning the Scotland-England border and contacting all taxpayers with a Scottish correspondence address directly. It is also in the process of cleansing incomplete Scottish addresses.
NAO warns that HMRC’s ability to assure the amount of tax collected for the Scottish government will be undermined where taxpayers fail to update their address details, and says it must continue to get this key message over to taxpayers. In 2015-16, HMRC spent £1.1m on communications with potential Scottish taxpayers about SRIT.
Scotland will have full powers over income tax rates and bands from April 2017. In his draft budget last week finance secretary Derek Mackay confirmed he will not be making any changes, but he did say he would not be replicating the UK tax cut for h high earners. As a result, the 40% threshold will only rise by inflation, to £43,430 in Scotland, compared to £45,000 elsewhere in the UK.
The NAO report cautions: ‘A future divergence of tax rates or thresholds between Scotland and the rest of the UK presents the possibility of tax avoidance and evasion. HMRC has developed a compliance strategy that considers this risk. The majority of compliance activity will commence in 2017-18.’
A significant future risk is the ability to provide an IT solution allowing personal pension providers to claim relief at source as a significant risk for the future. If tax rates between Scotland and the rest of the UK diverge, Scottish taxpayers will be due a different rate of relief-at-source on their personal pension contributions. From 2018, HMRC must notify pension providers of the correct rate of income tax for their scheme members to allow pension providers to apply the correct rate of relief-at-source.
NAO says HMRC is working closely with the pensions industry to deliver the solution required for the relief at source system to accommodate the SRIT.
Amyas Morse, NAO head, said: ‘HMRC face significant challenges in administering SRIT, particularly when tax rates and thresholds differ between Scotland and the rest of the UK. It is crucial that it maintains accurate address information for Scottish taxpayers, and ensures that the potential for tax avoidance and evasion is mitigated. HMRC also needs to be able to report the actual amount of SRIT collected to the Scottish government, and provide an IT solution that allows private pension providers to claim relief at source.’
Responding to the NAO report, a Scottish government spokesman said: ‘Our officials regularly meet with HMRC to receive assurances that the identification process is carried out in a satisfactory manner, that the integrity of Scotland's income tax base will be maintained and to ensure where any issues are identified that they are addressed quickly.
‘HMRC is a UK organisation and draws on resources across the UK to deliver against all their responsibilities. The Scottish government has been reassured that a reduction in staff in Scotland will not impact on the ability to robustly operate Scottish income tax.’
An HMRC spokesman said: ‘HMRC is fully on track to deliver devolved tax powers to the Scottish Parliament on time and within budget.’
The NAO says the total cost incurred by HMRC and reimbursed by the Scottish government, from the start of the SRIT project in October 2012 to 31 March 2016, is £11.1m. The costs relating to 2015-16 activity amounted to £8.4m. HMRC currently estimates the final total costs of implementing the SRIT project to be in the region of £30m over the seven-year period from 2012-13 to 2018-19.
The NAO report into administration of the Scottish Rate of Income Tax 2015-16 is here
