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The highest rate of tax in the kingdom

17 April 2018

Now that the Scottish Rate of income tax (SRIT) has been passed, Mark Devlin, technical manager (pensions)at Prudential, looks at a particular quirk that exists between the devolved and non-devolved powers, to highlight the highest UK rate of tax (the tartan tax trap?).

Following passing of the new Scottish Rate of Income Tax (SRIT), I want to look at a quirk between the devolved and non-devolved powers to highlight the highest UK rate of tax (excluding tax traps). Given where I live, it’s a subject close to my heart.

The new rates only apply to non-savings non-dividend (NSND) income. So, things such as the personal allowance, dividend income, bond gains etc. will be taxed on the rest of the UK (rUK) rates.

Another non -devolved power is National Insurance (NI), and it’s this that gives rise to a tax rate that seems to hit those with modestly high incomes more punitively than the so-called “fat cat” additional rate of tax for those with adjusted net income over £150,000.

For rUK,the rate at which an individual moves from paying 12% NI to 2% NI (the upper earnings limit (UEL)) is aligned with the higher rate threshold for rUK. You move to 2% NI when you move to 40% tax at £46,350.

But for the SRIT taxpayers you move into higher rate tax from £43,430 onwards, assuming that there is no loss of personal allowance. Higher rate tax under SRIT next year is 41%.

So, on the basis that you treat NI as a tax (which seems to be the populist view) then when you start paying higher rate tax in Scotland you are below the UEL. This gives rise to a 53% tax rate between £43,430 and £46,350.

Is this a tartan tax trap?

While this may only be a 53% tax on £2,920 of earnings, it does have the net effect of £292 paid more in NI owing to the UEL in Scotland not being aligned with higher rate tax.

When you compare this to the Top Rate of tax (the new name for additional rate tax in Scotland) taxpayers, they will pay 46% tax and 2% NI, so they will be receiving 52% of their earnings after taxes as opposed to those in the tartan tax trap where they receive 47% of their earnings, in essence the Revenue is making more from their work than they are.

While pension contributions may now be more attractive in 2018/19 for SRIT higher rate taxpayers (as they will be able to reclaim 21% on their tax return as opposed to 20% for rUK), a normal pension contribution is still subject to NI, so the effect of making a contribution in the £2,920 band means that you will have a net loss compared to rUK.

While a pension contribution will mitigate the effect of this, the only true way to avoid this would be a salary sacrifice arrangement, but for those earning well above this, the level of sacrifice needed may be unaffordable.