The Scotland Bill's uncertain impact on pension costs
Louisa Knox, partner and pensions specialist at UK law firm Shepherd and Wedderburn, draws attention to the problems the current Scotland Bill would pose for the pensions industry.
The pensions industry has suffered more than its fair share of legislative and regulatory change in recent years, with A-Day tax simplification, sex and age discrimination and auto-enrolment all causing headaches. We are now facing another major pensions issue as the potential for differing tax rates proposed in the Scotland Bill is set to impose additional administrative and systems costs on scheme providers.
The Bill, currently making its passage through the Houses of Parliament, was instigated in 2009 following the recommendations of the Calman Commission aimed at giving the Scottish Parliament more fiscal autonomy. It does, however, throw up some very challenging questions and anomalies, not least within the realm of pensions. This will have an impact not just in Scotland but across the UK, as most providers and many schemes will have Scottish members with systems that will need to be revised to accommodate the requirement for tax relief applied at the relevant rate.
Once a pension becomes payable, income tax is required to be deducted at the appropriate rate. Costs in relation to administering differing tax rates are likely to vary, but, in many cases, they will be substantial, particularly in light of the already significant changes being required in relation to auto-enrolment.
Turning to contributions, the actual impact on pensions from differential tax rates will depend to a large extent on the type of scheme. For occupational or public sector pension schemes, the employer typically takes pension contributions from salary before deducting income tax, so full relief is applied immediately in what is known as a net pay schemes. That said, not all occupational schemes operate the net pay arrangements, in which case tax relief will be given at the basic rate by relief at source. Differential income tax rates would still need to be taken into account when a pension under such a scheme becomes payable.
For contributions to a personal pension, income tax is paid on earnings before any pension contribution. The pension provider then claims relief at the basic rate of income tax from HMRC, and, if the individual is a higher-rate taxpayer, higher-rate tax relief can be claimed through a self-assessment tax return. Therefore, if Scotland had an income tax rate of 19% compared with 20% in the rest of the UK, the relief would need to be applied accordingly.
This could all get messy when the issue of residency is determined by the HMRC. Imagine a scenario where an individual starts the tax year resident in England with income tax applied at the current basic rate of 20%. Should this person move to Scotland, where the income tax relief was based on 19%, an adjustment would need to be made at the end of the tax year to reflect the change in status. The pension provider would also be required to repay HMRC the difference.
It may not seem an insurmountable problem, but it clearly places an additional administrative burden on the provider, and the situation is made worse if the individual has purchased an annuity and their pension has become payable in the meantime.
There is also the real potential for residency disputes if, for example, an individual owned property in Scotland and elsewhere in the UK. How will these issues get resolved? While such a dispute is ongoing, this will undoubtedly lead to situations whereby retrospective adjustments to an incorrect rate will need to be made by scheme administrators.
There are also concerns about costs associated with more frequent changes to income tax rates on either side of the border and the flexibility of systems in terms of adjusting to the new rates. While the assumption under the Scotland Bill is that the Scottish Parliament would set a rate in the autumn before any tax rate were to apply the following April, some pension providers are worried about the difficulties inherent in communicating these changes to their members who get relief at source.
Both the coalition government at Westminster and the SNP administration at Holyrood need to give further details on how they intend to address these challenges and provide some transparency on the potential costs resulting from this legislation. This would undoubtedly be welcomed by the pensions industry and enable it to prepare for the necessary changes in good time.
Louisa Knox is a partner and pensions specialist at UK law firm Shepherd and Wedderburn