Scottish residents will be blocked from dodging higher taxes, HMRC says

Is there a serious risk that Scotland’s tax revenues would be hit hard by people fleeing south to avoid the new top rates of tax advocated by Labour or the Scottish Greens? HM Revenue & Customs is not convinced that there is.

With a new Scottish rate of income tax (SRIT) taking effect within days, from Wednesday 6 April 2016, HMRC has confirmed it has put in place tight tests and processes, and has full data on all Scottish taxpayers to prevent residents dodging their liabilities.

It told the Guardian this week:

Although the Scottish rate of income tax is new, tax compliance risks around residency are not and HMRC has a range of powers it can use to encourage and enforce compliance with tax laws.

The issue is now central to the political battle over Holyrood’s enhanced tax powers, to set all Scotland’s income tax rates and bands on earnings from April 2017 (until then the SRIT will be identical to the UK rate). The Scottish Greens called for an additional rate of 60% on earnings over £150,000; Scottish Labour believes it should be 50%.

Before the Greens upped the ante earlier this week, Nicola Sturgeon, the Scottish National party leader and first minister, denounced Labour’s 50% additional rate at first minister’s questions as too dangerous to introduce, claiming it would push the wealthiest Scottish taxpayers to leave.

Her officials had warned that if just 6% or 1,000 of Scotland’s 18,000 additional rate taxpayers left to avoid that rate, Holyrood would lose £30m which could be otherwise spent on the NHS or other public services. That, Sturgeon said:

would not be radical. It would be reckless. It would not be daring. It would be daft. Therefore, we will not do it straight away. Instead, we will continue to consider it in the light of our experience and analysis.

The Scottish government refused to discuss the HMRC’s latest statement. Even though this concerns government policies and processes – and official documents issued at a first minister’s press conference, it claims it is barred from doing so by the “purdah” rules restricting government announcements during an election. Sturgeon’s officials passed the Guardian’s questions to the SNP.

The debate about the risks of tax flight does matter: while there are fewer and less wealthy additional rate taxpayers in Scotland than the UK as a whole, at 0.7% versus 1.1% and earning £310,000 on average against £370,000 in 2010/11, they still contribute nearly 14% of Scotland’s income tax, or some £1.5bn.

But the evidence about the risks of flight are far from conclusive, and Sturgeon’s officials know this, as does the SNP.

HMRC experts cast doubt on how serious this threat would be in evidence to Holyrood’s SNP-dominated finance committee last October – a session attended by three senior Scottish government civil servants.

In one highly illuminating aside at that session, the committee chairman, SNP MSP Kenny Gibson, said his committee had picked up first hand evidence on this from a visit to the Basque country – a largely autonomous region of Spain – evidence which contradicts Sturgeon’s recent position. Gibson said:

As far as the Basques are concerned, there does not seem to be any impact at all from the differentials in taxation between that part of Spain and the rest of Iberia, even though there are significant tax differentials.

And despite Sturgeon’s stance at first minister’s questions, her government’s official assessments of the risks are more nuanced and cautious on the risks of flight than her robust rhetoric suggests.

In fact, its official briefing issued when Sturgeon unveiled her tax plans said that the threat of losing £30m a year (0.28% of Scottish income tax revenues) was the worst case of three scenarios – scenarios which did not factor in revenues potentially raised by changing other, lower tax bands.

It states that if no tax payer left Scotland because of it, a 50% rate would raise £110m. And under the middle “low behaviour” scenario, defined as one at the “lower range of the elasticities” in people’s behaviour by the Institute for Fiscal Studies and HMRC, it would raise £50m extra.

The briefing said there is “considerable uncertainty” about how much extra tax might be raised, because of the “uncertain, potentially large” changes in taxpayer behaviour. Different rates north and south of the border “may” push the wealthiest to move their income, it noted cautiously.

The key point about the debate in Scotland is that, unlike tax flight generally at UK level or globally, this relates only to salaries – it does not effect investment earnings, shareholding profits or other forms of income routinely part of a high earner’s wealth. And that is linked directly to where you live.

So to avoid paying a 50% or 60% SRIT, a taxpayer would need to move home, lock stock and barrel – and move their spouse and children, changing schools and facing potentially higher English housing costs and English university fees in the process. Which is why HMRC’s latest statement matters.

In advance of October’s finance committee evidence session, the HMRC stated it was creating a special Scottish taxpayers’ list, cross-referenced with the Department of Work and Pensions, and other sources, including the voters register.

Its submission stated:

If the Scottish rates diverge from the rates which apply elsewhere in the UK, there will be an incentive for taxpayers to claim that they live on one side of the border, when they live on the other.

HMRC will use external data to highlight changes of address, and identify high risk cases such as mobile employees and taxpayers with high incomes and will undertake appropriate compliance activity to address any risks that arise.

Two HMRC experts, Edward Troup and Sarah Walker, said they were taking deliberate steps to stop tax flight happening – in conjunction with Scottish government officials and the new agency Revenue Scotland.

Troup acknowledged that HMRC experience with the wider tax system was that differential rates clearly influenced the wealthiest; it would influence those able to switch between homes in say London and Edinburgh.

Even so, he noted earlier:

It will take quite a strong differential to encourage people to move entirely for tax reasons, but if you are buying a house near the border it may be one of the factors – along with stamp duty rates and everything else – that will determine which side of the border you want to live.

Walker then told the committee the wealthiest taxpayers actually behaved differently, and were policed differently by HMRC: it has a “high net worth unit” to oversee very wealthy individuals. And these people tended to pay income tax through self-assessment, not PAYE, a process carrying clear risks of giving false information.

She said that unit had been investigating the impact of SRIT on its taxpayers and how to control evasion:

it should know quite a lot about them, including their up-to-date addresses. It is looking at whether we ought to do more to pick up any risks that relate to those people, particularly if, as we discussed earlier, the rate is different.

After the end of the year, self- assessment taxpayers – people on higher incomes tend to self-assess far more than others – will be asked directly whether they lived in Scotland for most of the year. A positive return will be required from those people.

Troup added:

We are not that worried about people giving false information, because the better-off are aware of the consequences. The concern is about ensuring that we have in our net everybody who ought to be there. People are more likely to be tripped up by a lack of awareness than a deliberate misstatement of their position.

The Scottish government’s briefing paper identified a further complication: the risk of tax flight was greater for those working for non-Scottish companies, because executives in London-based firms could more easily change primary residence. That would be far harder for Scottish-company executives.

This is an important and relevant point. A far larger proportion of Scotland’s economy measured by GDP is owned by companies based outside Scotland than is the case in the wider UK economy – a particular issue for major Scottish industries associated with high earners, the finance sector and oil and gas.

A Guardian investigation in 2014 found that at least 70% of Scotland’s GDP was controlled by non-Scottish companies, compared to 36% of the UK’s. The Scottish figure fluctuates each year, but tellingly, the data excludes the country’s valuable finance sector because so much of its ownership and HQ structure is opaque, and many of the world’s largest banks don’t have Scottish registered offices. That implies the foreign GDP figure is larger than estimated.

The Scottish government briefing also points out that a 50% rate could also strongly influence the choices made by new high value recruits considering Scottish jobs. (Equally, it does not point out that the SNP’s decision to increase taxes on the most expensive homes, both through sales taxes and council tax, will likely add to that effect.)

In its conclusion, the briefing says that because the risk of tax flight increases the more someone earns, that amplifies the financial impact on revenues of their decision to stay or move: “A single very high income earner will account for the same tax receipts as a larger number of less high income earners.”

Stung by the backlash to her refusal to raise higher rates, Sturgeon has sincesuggested she was open to a 50p rate within a couple of years; the Scottish government’s council of finance advisers will study the risks of tax flight she has said. Perhaps the next Holyrood finance committee will now want to revisit this too, and subject this to far greater scrutiny now the tax powers are in place.