Scotland’s constitutional future: a taxing question

The referendum on Scottish independence, to be held by the end of 2014, naturally raises questions about 
how the Scottish tax system might develop if Scotland becomes an independent country. There is also an expectation 
that even in the event of a ‘no’ vote, more taxes will be devolved to Scotland, with all the unionist political parties expressing support for the idea of Holyrood attaining more powers.


The Scotland Act 2012 devolved Stamp Duty Land Tax (SDLT) and Landfill Tax to the Scottish parliament with effect from April 2015, and in relation to both these taxes the Scottish parliament will have control over the rules as well as the rates. Legislation dealing with the Land and Buildings Transaction Tax (LBTT), the Scottish replacement for SDLT, is currently progressing through the Scottish parliament, the rates of which will be set by the Scottish Government at a later date. The introduction of LBTT and Scottish Landfill Tax is not linked to the referendum on Scottish independence, and so these new devolved taxes will apply regardless of the outcome of the proposed referendum, and prior to independence taking effect if there is a ‘yes’ vote.

The Scottish Government decided that the new devolved taxes will not be collected by HM Revenue & Customs, as that would be costly and would not give sufficient flexibility. Instead, LBTT will be collected by Registers of Scotland, the Scottish Government department responsible for compiling and maintaining registers relating to property and other legal documents, and the Scottish Landfill Tax by the Scottish Environmental Protection Agency.

A Scottish tax authority, Revenue Scotland, has been set up to oversee these devolved taxes. It is currently expanding its team 
and in the process of recruiting a chief operating officer. Revenue Scotland recently launched a consultation on Scottish tax management provisions to deal with the overarching administrative provisions for the devolved tax system, including whether a Scottish general 
anti-avoidance or anti-abuse rule should be included. It has also set up a consultation forum called the Devolved Tax Collaborative; the idea being to involve more organisations and professional bodies so as to ensure that the new devolved taxes operate as effectively and efficiently as possible.

The Scotland Act also introduces the Scottish Rate of Income Tax (SRIT) from 2016. The SRIT is not a devolved tax, since the UK government retains control over the legislation and HMRC will continue to collect income tax from Scottish taxpayers. The Scottish parliament simply has to set the rate of SRIT.


So what further taxes could be devolved to Scotland under the current constitutional arrangements, and if further taxes were to be devolved, what could Scottish taxpayers expect?

Given the approach to LBTT and Scottish Landfill Tax, it seems clear that devolution of further taxes would be very much on a ‘made in Scotland’ basis, under the auspices of Revenue Scotland and with collection of the taxes taking place in Scotland rather than being subcontracted to HMRC. This is likely to mean that any new devolved taxes will be based more closely on Scottish law and influenced by the requirements of the Scottish economy. Of course, any further devolution of tax powers to the Scottish parliament would require the agreement of the UK government, and a great many factors would influence whether that agreement would be forthcoming. It is important to bear in mind, though, that EU rules also come in to play.


EU member states are obliged to impose VAT, and EU legislation provides that VAT cannot be charged at different rates within a member state. This means that VAT cannot be devolved to Scotland so long as it remains part of the UK (assuming the UK remains part of the EU).

There is, however, an alternative possibility, which is for part of the UK VAT revenues to be assigned to the Scottish parliament, and this has been proposed by a number of bodies currently arguing for greater devolution of tax powers. Since this was considered and dismissed by the Calman Commission, which was set up by the unionist parties to look at further devolution of tax powers, the assignment of VAT revenues is perhaps unlikely to be looked upon favourably by the UK government.


The Scottish Government has consistently called for a lower rate of corporation tax in Scotland, but would it be possible for a lower rate of corporation tax to be introduced? EU rules are involved here too, and recent decisions of the Court of Justice of the European Union – including in a case involving the Azores – indicate that a different rate of business tax can be introduced in part of a member state provided the region satisfies certain requirements of constitutional, procedural and financial autonomy. It is generally believed that the constitutional and procedural tests could be met by devolving the relevant powers to the Scottish parliament so that it was free to set the 
tax rate without interference from Westminster. The fiscal consequences 
of any reduction in the rate must not be offset by aid or subsidies from central government, so there would need to be a clear and corresponding reduction in the block grant that Scotland receives from Westminster.

Of course the UK government would 
have to agree to the devolution of corporation tax, whether that was just allowing the Scottish parliament to set the rate applying in Scotland, or devolving control over the corporation tax rules. Is that likely? Northern Ireland has been making a case for a lower rate of corporation tax for a number of years, arguing that the 12.5% corporation tax rate in the Republic of Ireland makes Northern Ireland uncompetitive by comparison. The UK government seems to be no nearer a decision in relation to Northern Ireland’s desire for a lower rate of corporation tax, but if Northern Ireland were to be given powers it would be hard to see why Scotland’s position should not also be given serious consideration.


All the airlines operating in Scotland have called for Air Passenger Duty (APD) to be reduced on the basis that it is a disincentive to connectivity, has an adverse effect on tourism and arguably has a greater impact on businesses in Scotland than elsewhere in the UK. The Scottish Government has indicated that if APD was devolved to the Scottish parliament its intention would be to reduce it, though being mindful of the environmental considerations.

Devolution of APD rates to the Scottish parliament would need to meet the same EU tests as for a lower rate of corporation tax, of course, but although devolution of APD was recommended by the Calman Commission, it was not included in the Scotland Act 2012. This is because APD was being reviewed by the UK government, which considered a change from a per-plane to a per-seat basis. That review has now been completed and the per-plane basis is to be retained. In the meantime the power to set APD rates for long-haul flights was devolved to the Northern Ireland Assembly by the Finance Act 2012. The Northern Ireland Assembly has already used this power to reduce the rate of APD on long-haul flights departing from Northern Ireland to zero from January 2013. There seems little appetite at Westminster to devolve APD to Scotland in the immediate future, but the Northern Irish experience does suggest that APD may be high on the list of issues likely to be devolved to Scotland in the event of a ‘no’ vote in the independence referendum.


The operation of the SRIT will be by no means straightforward, and is likely to involve many practical difficulties such 
as the identification of Scottish taxpayers, the fact that the Scottish rate does not apply to all types of income and the requirement that the Scottish rate apply uniformly across the basic, higher and additional rates of tax. That requirement means it will not be possible for the Scottish government to reduce income tax rates for basic rate taxpayers while raising the rates for the higher paid.

The proposed timing of the introduction of the SRIT in April 2016 places a significant question mark over whether it will ever actually be introduced. If there is a ‘yes’ vote in the referendum, the Scottish Government has said that ‘independence day’ would fall in March 2016, after which the Scottish parliament would have full control over all taxes. If there is a ‘no’ vote, the likely discussions on further devolution of powers may be well advanced by that stage, and may result in an alternative income tax proposal. Devolving income tax to Scotland in its entirety could be a great deal simpler, and indeed this has been called for by a number of influential commentators in recent months.


Turning now to what might happen in the event of a ‘yes’ vote, the ‘Edinburgh agreement’ signed by David Cameron 
and Alex Salmond on 15 October 2012, requires the referendum to take place by the end of 2014.

In the event of a vote in favour of independence, a great many issues would need to be negotiated and discussed between the Scottish and UK governments. How long that would take is difficult to predict, but certainly the Scottish Government has stated that independence would happen by March 2016. That would be around 16 months after the likely referendum date, which seems like a very demanding timescale in which to carry out the necessary negotiations between the two governments. The Scottish Government has acknowledged that the negotiations may not have concluded by then, but it certainly seem to believe that the changes required to achieve independence could be made within that transition period.

The Scottish Government has also said that an independent Scotland would preserve the existing laws that were in force immediately prior to independence (presumably encompassing both legislation and case law), including existing UK tax legislation as well as the Scottish legislation relating to the devolved taxes. Scotland’s tax law would then diverge if and when the new Scottish parliament created new rules.

In relation to tax, the Scottish Government appears to be well aware that the greatest risk to economic stability is constant change, so fundamental reforms within the first few years of independence would perhaps be unlikely. Looking further forward, however, what tax changes could Scotland expect in the event of a ‘yes’ vote?


As mentioned above, VAT is required 
under EU law. There has been much 
debate in recent months as to whether a newly independent Scotland automatically would be an EU member state upon independence, or would have to apply 
for EU membership as a new entrant. The Scottish Government has recently conceded that the terms of Scottish membership would have to be negotiated and agreed with the other EU member states, but Scotland would not exit the EU at any point because negotiations on those terms would be concluded within the 16-month transition period mentioned above. That timescale may be even more demanding for those negotiations than it would for discussions with the UK government, but nevertheless it seems likely that an independent Scotland 
would, sooner or later and on one set of terms or another, become an EU member state. The need for negotiation and agreement with the other member states means that this membership may not be 
on the same terms as those enjoyed currently by the UK and so, while VAT would continue to be charged in Scotland, would the Scottish VAT system be the same as 
the current UK VAT system?

In the short term, the answer is probably yes. Even if Scotland had to temporarily leave the EU while membership terms 
were being negotiated, the Scottish Government would want to maintain the operation of VAT in Scotland on the same basis as before, to smooth the path to EU membership. So, in the short term, it is unlikely that there would be any changes 
to the VAT regime.

The UK enjoys a number of derogations from EU VAT law, for example zero rates 
for housing and children’s clothing. Would these continue to apply to Scotland? Given the many other issues that would need to be discussed and negotiated in relation to EU membership, other member states 
could agree to the UK’s VAT regime continuing to apply in Scotland without 
any substantial changes. Alternatively, if the Scottish Government did not feel strongly about these opt outs, it may be willing to forego them in return for other things it valued more.

In the longer term, there would be the possibility of a different rate of VAT in Scotland, though the Scottish Government has so far given no indication of any intention to make significant changes to 
the VAT rates.

Of course, the current UK debate about EU membership raises other issues, including the prospect of Scotland remaining within the EU while the rest of the UK leaves, so in that respect the VAT system in an independent Scotland could actually be more certain than in the rest of the UK.


As mentioned above, previous discussions in relation to corporation tax suggest that lower rates have always been seen by the Scottish Government as a way of encouraging inward investment and stimulating economic growth. However, it is not just a question of rates. When the rate of corporation tax in the UK was 26%, the SNP called for it to be reduced to 20% in Scotland. Later this year, the UK rate will reduce to 23%, however, and the focus has shifted to reliefs and allowances, in particular capital allowances which give tax relief for capital expenditure, but which have been significantly scaled back in recent years in the UK tax system. For example, the Scottish Government has suggested that it would make sense to reintroduce capital allowances for hotels, given the importance of the tourist 
industry in Scotland, or for expenditure 
on renewable energy.

In the event of independence, there would need to be a robust methodology for establishing which profits would be subject to a Scottish corporation tax, and which to UK tax or tax in other jurisdictions. Scotland would also need to enter into double taxation treaties with other countries, including the rest of the UK, to ensure that income and profits were not doubly taxed.

In relation to the UK itself, the current corporation tax system is not uncontroversial, as can be seen from the recent press attacks on multinational companies that appear to pay less UK corporation tax than their activities in the UK might suggest. The Scottish Government has consistently emphasised that tax should follow economic activity, and the current debate on the UK corporation tax system may present opportunities for designing a fairer allocation of corporation tax revenues within the UK.


In any discussions about Scottish independence, oil taxation is perhaps one of the most significant issues, but also one of the most controversial. A recent report by the Institute of Fiscal Studies has suggested that a ‘geographic’ split of North Sea oil would leave an independent Scotland in more or less the same position as at present, though more vulnerable to the volatility of North Sea oil revenues, while a ‘population-based’ division of the revenues (Scotland getting about 
one-tenth of current UK revenues) would require some difficult spending choices to be made. The actual figures would largely depend on where the boundary was drawn but, in the event of a split, what could producers operating on Scotland’s side 
of the line expect?

In 2011 the Scottish Government criticised the UK government’s increase in the supplementary charge, and proposed several options for reducing the tax burden on marginal fields. These proposals included a Norway-style ‘extended field allowance’, or a guaranteed minimum return on investment before the charge applied. The Scottish Government has also proposed a post-independence fund which would invest a proportion of North Sea revenues for future use (though others claim that all revenue would be needed just to fund current spending).

Decommissioning tax relief is another important area, and producers (as well as being interested in the general approach that might be taken to corporation tax)will be particularly keen to know whether the Scottish Government would adopt the agreements entered into by the UK government on decommissioning relief.


Tax decisions are influenced by many different factors, not just the need to raise revenue, but also using tax as an economic lever to achieve social objectives and to encourage inward investment. Given the various processes involved, however, and the importance of stability, it is perhaps unlikely that major tax changes would be made in a newly independent Scotland, in the short-term at least.