The introduction of additional rates of income tax for Scottish rate tax payers – identifiable by the ‘S’ prefix to their tax codes – does not mean any change to the ways in which pension schemes give tax relief on member contributions. However it will mean in some cases that employees will have to claim additional relief from HMRC if they are to receive all the tax relief to which they are entitled.
The different tax rates
Scotland still has the same 20% basic rate tax as the rest of the UK but they will also have a starter rate of 19% that applies to the first £2,000 of taxable income before basic rate starts and then an intermediate rate of 21% that will apply from £24,000 to the Scottish higher rate threshold. Scotland has a lower starting point for higher rate tax but like the rest of the UK, the top rate additional tax applies to earnings over £150,000. Scottish higher rate tax and additional rate tax rates are 1% higher than in the rest of the UK.
The following table shows the 2018/19 tax rates and bands for Scotland and for the rest of the UK:
Table 1. Tax rate and earnings bands
|Tax rate||Scotland||Earnings band||Rest of UK||Earnings band|
|Starter rate||19%||£11,850 - £13,850||-||-|
|Basic rate||20%||£13,851 - £24,000||20%||£11,850 - £46,350|
|Intermediate rate||21%||£24,001 - £43,430||-||-|
|Higher rate||41%||£43,431 - £150,000||40%||£46,351 - £150,000|
|Additional rate||46%||Over £150,000||45%||Over £150,000|
Tax relief on employee pension contributions
HMRC gives tax relief in one of two ways, through the net pay arrangement whereby contributions are deducted from pay before tax is calculated and relief at source whereby tax is calculated on full pay and contributions are deducted and paid net of basic rate tax (20%) with HMRC paying the tax relief into the scheme to restore the full contribution amount.
Net pay schemes: most occupational schemes use net pay, the notable exception being NEST that uses relief at source. Members benefit from immediate full tax relief because they pay no tax on the part of their earnings they pay as pension contribution. Members of schemes where the employer operates salary sacrifice for employee contributions effectively benefit from full immediate relief on the amount they have sacrificed for pension contributions.
Relief at source schemes: all ‘contract based schemes’, individual or group personal pension schemes and a few occupational schemes use relief at source. These schemes will continue to operate in exactly the same way as they do at present, deducting all member contributions from pay net of basic rate tax (20%) whether or not their members are Scottish rate tax payers and whatever their true marginal tax rate. This has two repercussions:
- Employees who pay no more than starter rate – as they only pay a top rate of 19% they ought not to benefit from 20% effective tax relief but HMRC have said they will not seek to collect any tax deficit.
Example: for a £100 gross contribution, the employee’s tax relief should be £19 leaving £81 net contribution to be deducted. Rather than follow the individual’s tax rate, their net contribution deducted will in fact remain at £80 and that will be uplifted to the full £100 by HMRC paying £20 to the scheme.
- Employees who pay intermediate rate – the same 20% basic rate will still be used to calculate the net contribution deducted from pay although the employee is entitled to 21% relief. These employees, like those paying higher or additional rate tax, will need to claim their extra tax relief from HMRC. HMRC has indicated the employee can contact them with a view to having their tax code adjusted to allow them their extra relief through pay rather than start completing self-assessment returns.
In short, the introduction of the new Scottish tax rates alongside the continuation of their lower thresholds for higher rate and additional rate tax makes no difference to the way you operate your pension scheme contributions, whether net pay or relief at source. Some lower paid employees in relief at source schemes will benefit through HMRC’s ‘generosity’ in not pursuing them for their 1% saving and a great many more employees in these same schemes will need to reclaim part of their tax relief from HMRC than was the case before.
It is also worth noting that from April 2019, the Welsh Government will have the power to set its own income tax rates for Wales.