Official Report 622KB pdf
The last item on our agenda is an evidence-taking session on legislative consent memorandum LCM-S6-71. We are joined by Ivan McKee MSP, Minister for Public Finance, and the following Scottish Government officials: Merlin Kemp, head of income tax and tax strategy; and Laura Wilkinson, lawyer. I welcome our witnesses to the meeting—good afternoon.
Before we move to questions, I invite the minister to make a short opening statement.
Thank you, convener, and good afternoon. First, I thank the committee for arranging this session at short notice, and with an already busy schedule of business to get through in the run-up to the pre-election period.
The measures that we are discussing today are contained in the UK Government’s Finance (No 2) Bill. Finance bills are subject to an expedited timetable compared with other legislation, which has not given us much time to arrange for the consideration of this LCM.
In her budget statement on 26 November last year, the Chancellor of the Exchequer announced her intention to increase the amount of income tax due on income from property for taxpayers in England. From 27 April, the UK Government intends to separate out income from property from other types of income and increase the amount of income tax due on it by 2 percentage points. It was one of the few budget measures that was not leaked in advance, and there had been no prior consultation with the Scottish or Welsh Governments.
On budget day, we were informed that the plan was to offer the Scottish and Welsh Governments an equivalent flexibility. Both the Scottish and UK Governments agree that it is appropriate for the Scottish Parliament to give legislative consent to this measure, which amends the income tax rules contained in the Scotland Act 1998, and that is why we are here today.
Property income is defined in income tax legislation as income from rent or other receipts from estates and any interest or rights in or over land in the United Kingdom. Because it is already subject to Scottish income tax as a sub-category of non-savings, non-dividend income, the proposed change does not affect the overall Scottish income tax base. The proposal, instead, is to give Scotland a similar flexibility to the one that is being taken in England from 27 April. Under the proposals, whatever Scottish rates and bands of income tax are in place would continue to apply to income from property, but when making a Scottish rate resolution, the Scottish ministers would be able to include separate rates of income tax for income from property for Scottish taxpayers.
It is worth noting that, if the UK Government proceeds as planned and increases income tax on property income from April 2027, it will have a detrimental impact on the Scottish budget. Calculations made by His Majesty’s Revenue and Customs suggest that the changes would mean an increase to the block grant adjustment of around £42 million in 2027-28 and around £31 million subsequently. That would mean an overall worsening of the income tax net position, and, as a result, there will be a financial pressure on a future Scottish Government to use the power in order to offset that impact.
Further work is needed, but our initial analysis suggests that, if Scotland were to follow suit and increase Scottish rates by 2 percentage points, up to £32.5 million could be raised in 2027-28. That would result in a worse net position for that year by about £10 million. With that in mind, in any future discussions on the fiscal framework, we will make the point strongly that there should be no detriment to the Scottish budget as a result of the UK Government’s decision to change income tax in this way.
The UK Government’s decision to increase rates in England will result in a block grant adjustment, whether or not we consent to the additional flexibility, so my view is that it is better that we have that flexibility. I do not come here today with a proposal for how the power should be used—that is for a future Government to decide—but I recommend that we agree to having the additional flexibility.
I note that there will be keen stakeholder interest in how a future Scottish Government might use the power. I expect there to be proper engagement and thorough consideration of the wider interactions and impacts before any such decision is taken.
Thank you. In her letter to the committee, the Cabinet Secretary for Finance and Local Government said:
“This was an unanticipated announcement at the Budget, with no prior consultation or advance notice”
to the Scottish Government. That is another example of Scotland being at the heart of the Labour Government.
The figures that we have seen are somewhat different from yours. We have been told that the UK rate increase is estimated to result in a block grant adjustment of £25 million, but I did not hear you give that figure—I heard you give the figures of £32.5 million and £42 million. It looks as though Merlin Kemp wants to come in on that point.
The £25 million figure in the LCM that is before you, which I drafted, was based on an initial estimate that was provided to us by HMRC. The figures that the minister mentioned are based on updated estimates from HMRC. The £25 million figure is out of date, so the figures are now £42 million and—
The block grant adjustment will be even higher.
Yes. The £25 million figure was HMRC’s initial stab at it, but the figure has been revised upwards.
The Scottish Government is being given a flexibility that it does not currently have, but it will not provide much flexibility. It is a wee bit a case of having a gun to our head. Am I correct in saying that?
The position is clear, although we need to consider the matter more deeply to understand why the figure will be £42 million in the first year before dropping to £31 million in subsequent years. We think that that is to do with the way in which self-assessment works and the timing issues in that regard, but we are engaging with HMRC to get more detail on that.
In principle, you are correct. Once things have settled down, our estimations and HMRC’s estimations are broadly similar. If we choose not to raise rates by a similar amount, there will be a cost in reduced revenue for the Scottish Government.
I know that you do not want to talk about how the power might be used in the future, but an issue will arise in relation to the relative differences in the tax bases. The number of buy-to-let properties north of the border will be different from the number south of the border, so there will be the capacity to raise more money in England if it has a bigger buy-to-let sector. Therefore, would it not be prudent for the Scottish Government to work quickly to encourage people into the Scottish buy-to-let market, given that our budget will be exposed if Scotland has a smaller private rented sector—and, therefore, not as much private rental income—relative to the rest of the UK?
Something needs to be clarified in relation to the first year—2027-28—but, when a tax is devolved, a calculation is done to find out how much has been raised in Scotland, and that is what constitutes the BGA. Therefore, we will start from the position of where we are, not from the position of where we are relative to the rest of the UK, if that calculation is done correctly. That needs to be worked through. As you will have seen with other taxes, the first year involves a settling-in process so that we can get more accurate data in order to set the baseline for the BGA.
The percentage of the total UK rental market that is in Scotland should not have an impact, but there might be an impact if there were differential growth rates in that market. I accept the point that you are making, but that will be for a future Government to consider.
I like the word “flexibility”, but other people might say that it equals risk. Last week, when Professor Heald was giving evidence to the committee, he made the point that, every time we take on a new power—broadly speaking, I want us to take on new powers—the risk increases, but there is no equivalent increase in our borrowing powers and so on to cover that risk. I accept that this particular case is tiny in the scheme of things, so I am not worried about it, but I wonder what your thinking is. As we take on aggregates tax, air passenger duty and so on, does the UK Government understand that? Are you putting the argument to the UK Government that the fiscal framework has to change?
You have a valid point. As you said, it is not a big number in the scheme of things, but conversations on the fiscal framework are on-going both on the specifics of this change and, more broadly, with regard to increased borrowing powers. You are right to say that, as flexibility increases, the risk increases by the nature of it, and the whole point of having borrowing flexibilities is to build a cushion against that risk.
Even though it is one little thing, it seems to be part of a longer-term trend.
Can I be clear that I understand the level of flexibility that is being offered to Scotland in this regard? A future Scottish Government would have the option, if it was so minded, of charging rental profits at a lower rate of income tax or at a higher rate of income tax than presently—higher or lower than elsewhere in the UK, or higher or lower than other forms of income? Is that correct?
I will defer to officials in a minute. My understanding is that that is indeed the case. I will ask officials to clarify, but I suppose that we could say that we could charge a lower rate of tax on income from property than we do on other income, which would be an interesting scenario.
That is not a position that you would expect me to support, but the flexibility is there.
Yes. In theory, the 2 per cent could go to zero. In theory, it could go negative, I think, but I will ask officials to clarify that. It is my understanding that it could also increase above that 2 per cent. I do not think there are any limits on that, but Merlin Kemp can clarify.
Yes, you are right. We cannot set bands and thresholds that are different from the ones that apply to the rest of income tax in Scotland. The income tax bands and thresholds that currently apply would continue to apply, but each of those could be set separately for property income. It could be varied by 2 per cent more or 2 per cent less, or it could be a combination of bits and pieces. If we want to continue with our progressive approach, where at the lower end we tax less and at the higher end we tax more, we could do that. There is quite a lot of flexibility, but it has to apply to the existing bands.
So, if a person has a good level of income from employment but it is not enough to reach the additional rate of tax, but they also have enough property income that their total income would reach it, a future Scottish Government would be able to say that it is all income, so it will be taken together and they will pay the additional rate on their income, or it would be able to say that property income should be taxed at a higher rate and we would have a system that makes that distinction.
Yes, but just to be clear, the HMRC still sets the rules for the way in which tax is assessed. When someone submits their self-assessment return, there is an order in which income is taken into account. For example, income from employment is set against the personal allowance first. The hierarchy of taxes that is set by the UK Government continues to apply, so earned income would be considered first, and then property income would follow that.
I have a slightly technical question that, arguably, follows on from that. I appreciate that you have not had a chance to think about how it will affect investment or supply or rents, and you will have to look at that. However, for private landlords who are subject to section 24 of the Finance (No 2) Act 2015, all rent is assumed to be income and only 20 per cent of any mortgage is netted off. That is going to skew the issue even further. Could they potentially be paying the additional rate, which is deemed to be on all the income, even though it is not actually all income, if that makes sense? Have you had a chance to consider that yet? Depending on the level of gearing, it could have a big impact. In other words, people could be put into a loss-making position if it is deemed to be all income and it is not at all, and that will lead to exit from the market and impact on wider housing supply.
12:30
Okay—where to start with all that? I will invite Merlin Kemp to come in in a minute.
It is a bit technical.
You said that that is all income, but surely the expenses would be netted off?
That is the whole point. Only 20 per cent can be netted off because of section 24 of the 2015 act. For the sake of argument, if you have a rent of £100 and a mortgage of £80, HMRC judges you to have an income of £100, but, of course, the net after expenses is not that at all and, if there is a tax increase of 2p, it could have a skewed impact if they are geared quite highly.
I am glad that it is the next Government that will have to decide on that.
There is that, and, to be honest with you, we have not worked all that through because it is for a future Government. However, it is probably worth making the point that the UK Government is going to change the finance cost relief to 22 per cent to match its plans to increase property income tax from the base rate of 20 per cent. There are interactions between the decisions taken by the UK Government and what we do in Scotland.
There is also that complexity that my colleague John Mason talked about around working out what you will actually get, because there are also behavioural impacts that will take a bit of working through.
As there are no more questions, are members content for the clerks to draft a report recommending that the legislative consent motion is approved by Parliament?
Members indicated agreement.
All members are agreed, and that was the final item on our agenda. Before I close the meeting, I thank all members for their contributions this morning. It has been a four-hour shift and we have another eight hours plus in the chamber this afternoon, so I appreciate everyone’s contributions.
I will see you next week.
Meeting closed at 12:33.
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