Finance and Constitution Committee

Meeting date: Wednesday, November 29, 2017

Official Report 594KB pdf

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Draft Budget 2018-19

Item 3 is a discussion on the administration and collection of Scottish income tax with Her Majesty’s Revenue and Customs. We are joined by Jim Harra, who is director general, customer strategy and tax design, and Sarah Walker, who is deputy director, devolution.

I thank the witnesses for joining us. Let us get straight into the costs of running our new tax system. In a response to a parliamentary question from my colleague Bill Bowman last week, the Cabinet Secretary for Finance and the Constitution said that the system would cost about £1.5 million a year to run if bands and rates were kept consistent with those in the rest of the United Kingdom, but admitted that increasing the rates would cost the public purse more. The finance secretary said:

“A more significant divergence between the rates and bands that apply in Scotland when compared to the rest of the UK may lead to an increase in costs of up to £5m.”—[Written Answers, 22 November 2017; S5W-12712.]

Will you comment on the finance secretary’s response and give more information about differences in the costs of the Scottish Government’s proposals?

Yes, those are the estimated costs; I will explain them. First, while rates and thresholds do not diverge very much, we expect very low levels of contact from Scottish taxpayers about Scottish income tax issues and their Scottish taxpayer status, but if there is more divergence we can expect, first, more contact from people who have queries, and secondly, to have to consider what compliance work we need to do to manage the risks that arise from divergence. That is where the estimate of £5 million comes from.

Those figures are just estimates. What kind of compliance plans we would put in place and what costs we would formally estimate at the time would depend on the nature and level of the divergence.

Do you have different estimates for the different proposals?

We have been looking at the proposals in the discussion paper that has been published and working out our responses. We have not yet come to or shared any conclusions in that regard. Obviously, the greater the divergence between Scottish rates and thresholds and UK rates and thresholds, the more likely we are to see behavioural effects, some of which will be non-compliant and will require a compliance response.

Thank you.

None of us would expect HMRC to offer a policy view on the preferable position in relation to tax policy in Scotland, but I am sure that we are all interested in hearing about the practical implications for you of the various options in the Scottish Government’s paper and about whether the efficiency of tax collection would vary under the different scenarios.

The word “divergence” has been used. So far, it is only the UK Government that has created divergence, by changing the threshold for the higher rate south of the border—that is where the only divergence has originated. Why do we have the notion that only Scottish changes create divergence? We have two different jurisdictions, which are responsible for tax policies in two different areas.

Yes. I did not intend to imply that only decisions of the Scottish Parliament create divergence; different decisions will result in divergence and give rise to different behavioural effects. Some of those behaviours will be perfectly compliant and will not involve us in extra costs in monitoring compliance, but some might not be compliant.

On the different options in the discussion paper, we can deliver any of them, in administrative terms, and stand ready to do so. You are right to suggest that different options have different administrative implications and therefore different cost implications. In particular, if new bands were to be added at the bottom—for example, if the basic rate band was split—we would have to think through some policy and administrative changes to cope with that, because various reliefs are given at source at the basic rate, and some things that currently happen automatically might require intervention to make them work in the future.

Similarly, if there are lots of bands, there is greater scope for people’s tax affairs in year—for example, in pay as you earn—not to be quite right, so when we do our reconciliation at the end of the year, there are likely to have been a higher number of underpayments and overpayments than there would have been if there were just a few rate bands.

However, all those options are capable of being administered.

At an organisational level, have you looked at other countries that have different income tax regimes across different parts of single states? In other European countries there are a number of areas in which people pay a different rate of income tax in different sub-state jurisdictions. Have you looked at that?

Yes, we look regularly at the position in other countries. A lot of other countries are different in that they expect everybody to submit a tax return every year, and we do not. We have a PAYE system that is very sophisticated and which tries to get most people’s affairs right at the end of the year without them having to complete a tax return. That is a difference, in administrative terms, between how we work and how other countries work.

We study the behaviour of taxpayers in reaction to different tax rates in different parts of the country, or even between different countries, and we learn from that and make our plans in the light of that experience.

Is there any further evidence that you could give us in writing after this meeting that demonstrates what you have learned about those comparisons with other jurisdictions?

I am not sure that there is anything specific in writing. We can have a look and see whether there is.

That would be helpful. The debate over potential behavioural effects is one that rattles back and forth every once in a while. Most of the evidence that I can find is pretty thin about the extent of those behavioural effects, but if there is more out there, it would be useful to see it.

Ultimately I would expect the Scottish Fiscal Commission to have to make some judgments and assumptions about what those behavioural effects would be.

It is interesting and curious. If we know how much it is costing the Scottish Government to make some of these changes, how much did it cost when the UK Government changed the higher-rate tax threshold from £43,000 to £45,000?

I do not have a figure for that. We cost all the policy changes that the Treasury asks us to make. We have, within our baseline, a certain amount of funding that we are expected to use for regular changes such as uprating.

With regard to specific policy changes, our advice to ministers ahead of a budget includes what money we will need to implement those measures and whether we can implement them within our existing baseline funding.

It would be helpful for us to get an understanding of the cost of that change. If we have to make a judgment in the future about whether the Scottish Government and the Scottish Parliament are getting best value from HMRC, seeing the whole picture would be helpful to us. If you could write to us with that further information, if it is available—

I will certainly see what is available and give you it.

Thank you.

Good morning. I have had a look over the service level agreement several times, and I want to ask about the role of scrutiny. I do not see any direct mention of opportunities for members of Scottish Parliament committees to scrutinise the process. Does that need to be further developed in the agreement on this area that has been reached between HMRC and the Scottish Government?

One of the papers that we sent to the committee for this meeting is our first annual report on our performance against the service level agreement. It is fairly limited at this stage, because we have had only one year of operation and we have not had a full cycle of the income tax, but we would expect to produce that report once a year and send it to the committee. That would be an opportunity for scrutiny.

Do you have a formal role in appearing before, say, the Public Accounts Committee at Westminster on matters relating to tax, although there is no equivalent requirement or expectation for you to appear before the Scottish Parliament’s Public Audit and Post-legislative Scrutiny Committee?

I have appeared before the Public Audit and Post-legislative Scrutiny Committee.

Yes, but that is by invitation, is it not? As I understand it, that is not a formal part of the scrutiny process.

I am formally HMRC’s accounting officer for Scottish income tax. Therefore, I account to the Scottish Parliament for that in the same way that my chief executive accounts to the Public Accounts Committee at Westminster for the UK income tax.

11:30  

I am looking at paragraphs 37 to 40 of the service level agreement, which are about review, monitoring and reporting. They are all about exchanges between directors and accountable officers; there is no mention of the elected members of the Parliament and what their formal role in the process might be. Would you welcome the opportunity to come to this committee or the Public Audit and Post-legislative Scrutiny Committee to give more evidence as the process develops?

Yes. The document is a service level agreement between HMRC and the Scottish Government. It sets out what we have agreed with the Scottish Government and what it can expect from us with regard to service levels and data exchange. The Scottish Government will hold us to account on that, but I am quite happy to be scrutinised by a committee of the Parliament about how we are performing against the agreement. As Sarah Walker said, we will produce an annual report that summarises our performance.

Thank you for coming to talk to us this morning. The main questions that I want to focus on are about data availability, but I might want to come back later to do a wee bit more digging on the cost of changes to the tax bands.

There is a complex situation with the tax structure vis-á-vis the Scottish Government’s policies and the outturn from that relative to what happens in the rest of the UK, and what that means for the fiscal framework. At one level, we will get complete outturn data at some point several months after the final deadline in January for self-assessment forms being submitted, when you will do some number crunching and we will get something back. That means that, for 2017-18, it will probably be the end of, or well through, 2019 before we get the full picture.

I am keen to understand what data we can or do see at Government level at the moment on the monthly performance of the tax. At that stage, you only know what is happening with PAYE—although, to be fair, that will be the biggest part of the tax take—and you will be looking for variations between what you thought was going to happen and what is happening on a seasonally adjusted basis. Where are we with getting that data? Is it being delivered month by month to the Scottish Government?

Yes. We are working with the Scottish Government, and the statisticians have done a lot of work to make sure that we understand that data. We now have an arrangement with the Scottish Government to provide the monthly data for Scottish taxpayers. As you say, that is of limited value because it is only a partial picture and there might be some lags in the identification of Scottish taxpayers, but it is the best way we have of establishing any trends or divergence from the forecasts. Those figures are being looked at by HMRC and the Scottish Government each month as they come through. We hope to publish that series in the future, but we want to get a bit of experience of the figures and make sure that we understand them before we make them a public document.

It is great to hear that. Following up on the scrutiny aspect, my next question would be to ask at what point this committee will get to look at those figures, but I understand what you are saying about wanting to establish confidence in the process. The committee might follow that up, probably directly with the Scottish Government, to see what we can get on-going access to.

Over time, as you get a data series, it will be more valuable. We will do the final reconciliation about 15 months after the end of the tax year and, as time goes on, we will be able to identify much more closely where the correlations do and do not exist between the monthly data and the final picture. I expect that, initially, there will be some concerns about how you can really tell what the figures are telling you, because of the limitations in the data.

For example, as you say, the data does not include self-assessment data, which accounts for about 14 per cent of Scottish income tax. Furthermore, someone can appear to be a Scottish taxpayer at a certain point in time, but the test is for the tax year as a whole, so you can know if they are a Scottish taxpayer only after the end of that tax year. In addition, our PAYE codes include adjustments for certain reserved matters, which would not flow through to Scottish income tax. It will take us a bit of time to gain confidence in what that data does and does not tell you and the level of confidence that you can have in it. That will grow over time.

I want to do a bit more digging into the potential costs of policy changes that the Scottish Government is considering. I understand that you will not want to give us a number, but I am keen to understand the magnitude of such costs. If you cannot give us an indication now, when would you be able to tell us that? If we are going to make a tax change and the Scottish Government expects to raise £100 million, but you are going to charge £20 million for implementing the change, clearly that is significant. However, if it will cost the Government only £1 million to implement the change, that is a different kind of decision. Is there any sense of the magnitude of such costs?

We could give a reasonable amount of certainty around the information technology changes; as the convener said, we already make IT changes for the UK Government, so we should be able to get some confidence around those costings. What is less known is how customers will respond to changes—how many of them will ring or write to us with queries or requests for explanations about what is happening. It is fair to say that, to date, we have probably overestimated the costs of administering Scottish income tax in that we have not seen the levels of contact that we had planned for on a contingency basis. There is quite a lot of estimation in that area, so it could turn out to be significantly wrong over time.

So even at the point at which we take the policy decision we might not know the answer to that question.

It will always be an estimate.

I want to ask about Scottish taxpayer identification, which is an issue that the committee has considered previously. You have given us quite a lot of information about the work that you are doing in that area. What do you estimate the margin of error to be in working towards accurately assessing people with an S code?

We have a high level of confidence that we have identified Scottish taxpayers on our systems. Having put that flag on our systems for people with Scottish addresses, we have carried out work to corroborate the accuracy of our address database against a number of other data sets. We have been able to have a high level of corroboration—we have corroborated about 98 to 99 per cent of those addresses. That does not mean that the other 1 to 2 per cent are wrong; it just means that they have not been corroborated. In several instances, we have found that the address data that we hold is more up to date than that in many of the data sets to which we have compared ours.

It is a never-ending job. We have to improve on that accuracy all the time and maintain it, because people move all the time. However, we have that good level of corroboration.

The other work that we are doing is comparing the flags on our systems with payrolls—for example, the Scottish Government’s payroll, because it is among the large employers—and against a set of different scenarios, in order to identify whether there are people for whom we do not hold a Scottish address but who live in Scotland. Again, we have found very low levels of non-corroboration.

We are currently working with employers to ensure that the flags on our system have fed through to S codes that they are operating in their payrolls, as some payroll software does not pick up all of that. That would not impact on the Scottish Government at a fiscal level, as we would calculate the correct amount of tax because we have the flag on our system. However, it could mean that those taxpayers would have an underpayment or an overpayment at the end of the year and, as Sarah Walker said, the aim of pay as you earn is to get people’s tax affairs right as the year goes on. We are carrying out those checks over the course of this year as part of our employer compliance checks to ensure that everyone’s payroll is working as it should.

Our estimate of 2.6 million Scottish taxpayers is staying firm.

From your paper, I see that you have a wealthy taxpayer unit—that sounds like a happy place to work—and you are giving that extra attention. Have you had any cases of individuals disputing whether they have an S code?

So far, we have not had a single dispute from a taxpayer arguing that they are not a Scottish taxpayer when we have said that they are. However, I am aware of one case of someone having expressed disappointment that they had not been flagged as a Scottish taxpayer. Unfortunately for Scotland, when we looked into it, they were not a Scottish taxpayer. [Laughter.]

I am interested in that issue in the context of possible future divergence and behaviour change. I understand that there is no legal obligation for people to make HMRC aware of their correct address. If somebody tells the agency that they have moved away from Scotland, how will it ensure that they are genuine? What checks will be carried out to ensure that that information is correct?

We carry out matching exercises. At a macro level, we take our entire database of Scottish addresses and compare it with the address lists that others such as retailers hold or with the electoral roll and so on. If that highlights a discrepancy, we contact the taxpayer to follow that up and make sure that we know where they really live. We have a much more personal relationship with high earners. For instance, we have started reviewing the people who we think might have more than one residence or home, and we are thinking about how we would tackle such cases. We have two levels—one for the mass market and one for the high earners.

At the moment, there is a low risk that people will game the system, which gives us the opportunity to establish a baseline. We are doing a lot of work to understand that baseline so that we can monitor trends in the future against it as rules change.

I envisage a scenario in the medium term whereby the agency identifies someone who should have been flagged up as a Scottish taxpayer but was not. If staff felt that the agency had been given the wrong information on purpose, would HMRC seek penalties to dissuade such behaviour?

Absolutely. Although you are correct in saying that there is no legal obligation on anyone to tell us of a change of address, if someone tells us their address and claims that they live there but that is untrue, that is tax evasion. Existing powers both to go back to earlier years to recover the tax and interest but also to penalise them apply.

I would like to double-check the cut-off point of the two levels that Sarah Walker mentioned—for the mass market and the high earners. Are you talking about the additional rate, or is there a different cut-off point between those two levels?

There is a personal relationship with people who are looked after by our high-net-worth unit.

We have two levels of people, and the affluent level, who earn more than £150,000, get an extra bit of attention. I cannot remember the exact figure for the high-net-worth individuals, but they are wealthy people. That judgment is not necessarily based on their income, as it can be based on their capital wealth. A compliance manager is appointed to them who is expected to get to know their affairs individually, to keep track of what they are doing, their attitudes to tax compliance and the advisers whom they engage, and to manage them on a case-by-case basis. I do not have the exact criteria for that with me, but I can get them for you.

That is fine. That helps me to get the picture. Thank you.

Paragraph 16 of the summary in the National Audit Office report that was published earlier this week states:

“The biggest challenge facing HMRC is maintaining accurate address records of Scottish taxpayers.”

Paragraph 17 then states:

“Neither taxpayers nor employers are legally required to tell HMRC of changes of address.”

That might not have been necessary previously in the tax process, because we were all in the same jurisdiction, but the Scottish Government has no devolved powers to deal with that issue. Is HMRC considering whether there should be a legal requirement for it to be informed about tax changes? If not, why not?

11:45  

We will keep that under review. There are obligations in a few areas. Employers are obliged to give the addresses of new employees, and people who self-assess are required to confirm their address, which is populated on their return. Nevertheless, you are right in saying that it has not been necessary to place a legal obligation on people until now.

The level of corroboration of our address data to date suggests that we do not have a problem. Any legal obligation, including the penalties and everything that would flow from it, would have to be proportionate to the problem. However, we are in a new situation in which where someone lives in the UK will be relevant to the level of tax that they will have to pay, so we will keep the situation under review. At the moment, we feel that we have good processes for keeping track of where people are.

The high-net-worth individuals whom you are talking about will work through an accountant or an agent who submits returns on their behalf. What guidelines have been issued in that regard? What conversations have been had with agents?

They have been quite extensive, particularly on the need to keep us up to date with where people live. Apart from the day-to-day engagement that we have with agents, we issue about six bulletins a year to them in which we remind them that it is important that they keep us up to date with where their clients are living. We expect our compliance managers to have one-to-one dialogue frequently with the agents of the most wealthy of them. It is likely that high-net-worth individuals have more than one home and use several addresses.

In our early work to establish the identity of Scottish taxpayers, we identified 2,000 cases in which people had a correspondence address and another address that was outside Scotland, which they said was their main home. We looked into all those cases and found that they were all fine and that the address that they had identified as their main home was, indeed, their main home. We do monitor that.

Thank you, Jim and Sarah, for coming along today. It was helpful in beginning our process of scrutinising the budget, which will eventually be published on 14 December.

Meeting closed at 11:47.