Scottish Government Third Annual Report on the Implementation and Operation of Part 3 (Financial Provisions) of the Scotland Act 2012

Laid before the Scottish Parliament SG/2015/29

Presented to the UK Parliament pursuant to Section 33(2)(c) of the Scotland Act 2012

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Foreword

This is the Scottish Government's third annual report to the Scottish Parliament on progress with implementing the financial provisions of the Scotland Act 2012.

The background to this report is one of development in the constitutional environment in Scotland and across the UK. The independence referendum in September mobilised Scottish public opinion and participation as never before. The terms of the constitutional discourse in the UK have been altered irreversibly. The work of the Smith Commission, and the subsequent publication by the UK Government of proposals for further legislation on financial devolution to Scotland, demonstrate this.

During the year, significant further progress has been made in implementing the financial provisions in the 2012 Act. The Scottish Parliament scrutinised a substantial Bill to establish Revenue Scotland as Scotland's devolved tax authority, with powers and functions needed to collect taxes efficiently and effectively. This work culminated in the Revenue Scotland and Tax Powers Act being approved in August 2014. Considerable effort also went into preparing and consulting on secondary legislation under all three Scottish taxes Acts, and Parliamentary scrutiny is now complete.

A major milestone was reached in October 2014 when the Scottish draft Budget included proposals for tax rates and bands in relation to Land and Buildings Transaction Tax (LBTT) and Scottish Landfill Tax (SLfT). The Chancellor of the Exchequer's fundamental reforms of Stamp Duty Land Tax (SDLT), which took effect without consultation or notice in December 2014, effectively brought the structure of taxation of residential property purchases elsewhere in the UK into line with Scottish proposals. I welcome the UK Government's decision to follow the lead given by Scotland in adopting a progressive tax structure.

The debate on LBTT rates and bands gave Scotland and the Scottish Parliament a new opportunity to be involved in revenue-raising decisions. I also welcome the contribution for the first time of the Scottish Fiscal Commission. The Commission provided independent scrutiny of and commentary on the Scottish Government's revenue forecasts for the devolved taxes, and for non-domestic rates.

In January 2015, I confirmed that Revenue Scotland was ready to start to collect devolved taxes from 1 April 2015. Progress over the past year has been notable, reflecting a great deal of work in planning and implementation. There has been considerable public and Parliamentary interest in preparations for the new body. I am confident that the Board, formally appointed in January, will ensure that Revenue Scotland operates consistently with our approach to taxation, engaging with taxpayers and their agents to minimise costs and ensure efficiency and effectiveness. This will be combined with a rigorous approach to ensure that any tax due is collected, with vigilant scrutiny to counter any tax avoidance activity.

As we approach the go-live date for devolved taxes, we therefore are on track to deliver the financial provisions of the Scotland Act on time and to budget. Through this process, we have developed experience and capacity in tax policy, legislation and systems, providing a solid platform for more revenue responsibilities flowing from the work of the Smith Commission.

The remaining key taxation provision – the Scottish Rate of Income Tax (SRIT) – is of course the administrative responsibility of the UK Government. However all administrative costs fall on the Scottish budget. We continue to track Her Majesty's Revenue and Customs' (HMRC's) progress closely, including its efforts to identify Scottish taxpayers, and further details are provided in this report.

Also in the coming year, we expect to exercise our limited borrowing powers to fund around 10% of our capital programme, as set out in the draft Budget in October 2014.

Finally, I welcome the Scottish Parliament's scrutiny of and interest in the programme of work to implement the financial provisions of the Scotland Act 2012. This forms an important part of the Scottish approach to the business of government. The Scottish Government will continue to do all it can to ensure that the Parliament and people of Scotland are engaged in the remaining aspects of this programme, and in further work on implementing the Smith Commission's proposals.

JOHN SWINNEY

Chapter 1 - Devolved Taxes and Revenue Scotland

1. Throughout the parliamentary passage of the three tax Bills to establish LBTT and SLfT and to set up Revenue Scotland, and in bringing forward the subsequent package of subordinate legislation, the Scottish Government has continued to work closely and collaboratively with a wide range of Scottish tax and legal practitioners to help shape and develop our policy proposals.

2. The Government has also worked closely with Revenue Scotland, Registers of Scotland (RoS), the Scottish Environment Protection Agency (SEPA) and the Crown Office and Procurator Fiscal Service amongst others to ensure that effective operational arrangements are in place when the devolved taxes come into effect on 1 April 2015.

Legislation

3. The Land and Buildings Transaction Tax (Scotland) Act 2013 (the LBTT Act) received Royal Assent in July 2013. As part of the legislative development process, the Scottish Government published a consultation paper[1] in May 2014 inviting views on draft secondary legislation covering a range of issues including transitional arrangements and the addition and modification of certain tax reliefs.

4. The Scottish Government received 20 responses to the consultation and an analysis of the consultation responses[2] was published in December 2014. Nine Scottish Statutory Instruments were laid in Parliament between December 2014 and February 2015.

5. In June 2014, following work by a consultative group, the Scottish Government published a second consultation paper[3] proposing the introduction of a sub-sale development relief. An analysis of the consultation responses[4] was published in December 2014. Subordinate legislation providing for the relief was laid in Parliament in January 2015 taking the responses into account.

6. The Finance Committee concluded its consideration of the LBTT secondary legislation on 4 March 2015. All of the legislation for the introduction of LBTT is now in place, as are transitional arrangements to ensure correct tax treatment of transactions made immediately before and after 1 April.

7. A Bill establishing the Scottish Landfill Tax (SLfT) was passed by Parliament in December 2013 and received Royal Assent in January 2014. A consultation paper[5] was published in May 2014 inviting views on draft secondary legislation. The Scottish Government received 48 responses to the consultation and an analysis was published[6] in October 2014.

8. The Scottish Government also engaged with landfill operators and those with an interest in landfill tax at a series of events. The Landfill Tax Working Group, which includes representation from each major stakeholder group, also provided feedback on the proposals. This consultation process helped to inform the development of the secondary legislation subsequently laid in Parliament.

9. All of the legislation for the introduction of SLfT- on 1 April 2015 is now in place. This includes regulations establishing the Scottish Landfill Communities Fund, enabling landfill operators to obtain a tax credit for 90% of the value of contributions made to environmental projects and local good causes, subject to a cap of 5.6% of total tax due.

10. The Revenue Scotland and Tax Powers Act 2014 (RSTPA) completed its Parliamentary passage in August 2014 and received Royal Assent in September 2014. The Act establishes Revenue Scotland as the tax authority for the devolved taxes and puts in place a statutory framework for the collection and management of those devolved taxes. It also establishes the Scottish Tax Tribunals to hear appeals against decisions taken by Revenue Scotland.

11. In October 2014 the Scottish Government published two consultations flowing from the RSTPA, the first of which[7] attached drafts of the subordinate legislation which the Government proposed to bring forward under the RSTPA and the second[8] set out draft rules of procedure for the Scottish Tax Tribunals. Both consultations closed in January 2015 and the Scottish Government has since laid 10 statutory instruments before the Scottish Parliament which reflected the responses to the consultations.

12. Under the RSTPA, Revenue Scotland was brought into being on 1 January 2015. All of the provisions of the RSTPA not already in force will come fully into force on 1 April 2015, together with the subordinate legislation described above.

13. Both the President of the Scottish Tax Tribunals and the members of the First-tier and Upper Tax Tribunals have been appointed with effect from 1 April 2015, when the Scottish Tax Tribunals will come into being.

Tax rates and bands

14. The proposed rates and bands for LBTT and SLfT were published in the 2015-16 Draft Budget on 9 October 2014.[9] On the same day, the Scottish Government published online LBTT calculators and a forecasting methodology paper[10] to aid transparency of the approach taken in preparing the revenue forecasts presented in the Draft Budget. The forecasts were "endorsed as reasonable" by the independent Scottish Fiscal Commission[11]. The Equality Budget Statement[12] included an overview of how equality impacts have been considered in developing new Scottish taxes and in establishing Revenue Scotland.

15. As part of the Stage 1 debate on the Budget Bill in January 2015 the Deputy First Minister presented updated proposals for rates and bands for residential LBTT, and confirmed his proposals for non-residential LBTT rates and for SLfT rates. Rate-setting Orders for LBTT and SLfT were laid before the Scottish Parliament on 5 February 2015 and approved by the Scottish Parliament's Finance Committee on 25 February and 4 March 2015 respectively.

Scottish Fiscal Commission

16. The then Cabinet Secretary for Finance, Employment and Sustainable Growth confirmed in evidence to the Finance Committee on 7 May 2014 that Scottish Ministers would establish an independent Scottish Fiscal Commission to scrutinise the Scottish Government's forecasts of devolved tax receipts.

17. The Commission has been established initially on a non-statutory basis to provide assurance over the reasonableness of the Scottish Government's forecasts of revenue from the devolved taxes and of the economic determinants underpinning the Scottish Government's forecasts of revenues from non-domestic rates.

18. In order to secure the independence of the Commission, the Scottish Parliament was invited to approve the Scottish Government's nominations for appointment to the Commission. The Government nominated Lady Susan Rice, Professor Andrew Hughes Hallett and Professor Campbell Leith to serve on the Commission, with Lady Rice to serve as Chair. The Finance Committee held pre-appointment hearings in May and June 2014. The Committee subsequently recommended to the Scottish Parliament that the appointments should be approved. In June 2014 the Parliament endorsed the creation of the Scottish Fiscal Commission and approved the Scottish Government's nominations for appointment.

19. The Commission published its first report on 9 October 2014, in which it endorsed the Scottish Government's forecasts of devolved tax receipts. In January 2015, the Commission also reviewed and endorsed as reasonable the Scottish Government's updated forecast of revenue from residential LBTT.

20. The 2014-15 Programme for Government, published in November 2014, confirmed that the Scottish Government would bring forward legislation to put the Commission on a statutory footing.

Revenue Scotland Implementation

21. The Tax Administration Programme, to establish Revenue Scotland, is at an advanced stage of delivery.

22. As noted above, Revenue Scotland was brought into being as a body corporate and an office-holder in the Scottish Administration on 1 January 2015, on which date its Chair, Chief Executive and board members took up post. Scottish Ministers appointed Dr Eleanor Emberson as the first Chief Executive of Revenue Scotland in December 2014. Also in December 2014, the Deputy First Minister announced the appointments of Dr Keith Nicholson (Chair), Lynne Bradley, Jane Ryder OBE, Ian Tait and John Whiting OBE to Revenue Scotland's Board. The Board held its first meetings in January and February 2015.

23. A staffing structure for Revenue Scotland comprising the Chief Executive and 40 operational staff has been agreed. A two-phased recruitment strategy is reaching completion with 38 of the posts already filled. The entire senior management team is now in place with essential tax specialists, financial, legal, IT and corporate service posts also filled. A training programme for all staff is being delivered in preparation for the administration of LBTT and SLfT.

24. Revenue Scotland launched its website – www.revenue.scot – in November 2014. Registration for SLfT and sign-up to the Scottish Electronic Tax System (SETS) for both devolved taxes was opened on 16 February 2015. This allows external users – principally solicitors and landfill operators – to set up accounts on SETS so that from 1 April, they will be able to submit tax returns online. On the same day, Revenue Scotland published guidance covering the devolved taxes and the operation of the RSTPA, and also opened its support desk.

25. Joint working has continued with Registers of Scotland (RoS) and the Scottish Environmental Protection Agency (SEPA) to define the relative roles and responsibilities of each organisation. These relationships will be set out in Memoranda of Understanding (MoUs). The delegation of statutory functions from Revenue Scotland to RoS and SEPA will formally be given effect by Schedules of Delegation. Information about those Schedules will be laid in the Scottish Parliament prior to 31 March 2015.

26. In October 2014, the Scottish Parliament's Finance Committee was provided with a revised estimate of the costs for setting up arrangements for collecting the Scottish taxes and operating these for the first five years.[13] The latest projected cost is £21.2m. This takes into account the recommendations of an external Gateway Review carried out in 2014, with increased resources in 2014-15 for overall programme management and the development of key processes, as well as an increase in operational and implementation staffing for year one.

27. As part of an ongoing commitment to engagement, during February 2015, a series of 7 roadshows on LBTT was held across Scotland. These were designed to give key information to those who will be involved in submitting tax returns and were attended by almost 600 solicitors and tax professionals. In addition, a public consultation on Revenue Scotland's draft Charter of Standards and Values closed on 6 March 2015. The final Charter will be laid before the Scottish Parliament before being published on Revenue Scotland's website.

28. The Devolved Tax Collaborative, which was established by the Scottish Government in 2013 to brings the tax advisory community and others with an interest in tax issues together with the Scottish Government and Revenue Scotland officials, continues to meet and was addressed by the then Cabinet Secretary for Finance, Employment and Sustainable Growth in May 2014. At its most recent meeting in November 2014, there was a clear message that Revenue Scotland should continue to provide such a forum for engagement beyond the launch of the taxes on 1 April. Consideration is now being given to the creation of two subgroups, one for LBTT and one for SLfT, which would focus on detailed issues on the operation of each tax and keep technical guidance under review.

Chapter 2 - Borrowing Powers

Capital Borrowing

29. The Scotland Act 2012 allows Scottish Ministers to undertake borrowing to fund capital expenditure subject to a statutory aggregate cap of £2.2 billion. HM Treasury has set out administrative rules, which would limit borrowing in any one year to 10 per cent of the capital budget with effect from April 2015. This gives a limit of £304 million in 2015-16. The Scottish Government set out its plans to borrow up to this limit in the 2015-16 Draft Budget, in order to support infrastructure investment plans.

30. In February 2014 the UK Government set out its intention to enable Scottish Ministers to issue bonds. The UK Parliament approved the relevant Order in March 2015. Scottish Ministers are evaluating the methods of borrowing which will be available to them and will in due course take a decision on which method or methods to use.

Revenue Borrowing

31. The Scotland Act also enables the Scottish Government to borrow for certain revenue purposes up to a maximum of £500 million. Treasury have indicated that they would apply an administrative limit in any one year of £200 million, and that they would require such loans to be repaid within 4 years.

32. Use of revenue borrowing would not, because of its nature, be planned in advance of the need arising.

Chapter 3 - Scottish Rate of Income Tax

33. Scottish rate of income tax (SRIT) is scheduled to begin in April 2016. HMRC is responsible for implementing and operating the tax. SRIT is not a devolved tax. The tax base and any changes to it, along with tax bands and thresholds, will remain under the control of the UK Government.

34. The Scottish Parliament will set a single Scottish rate by Resolution each year. The same rate will apply across all three tax bands. The Scottish Government is meeting all start-up and running costs of SRIT.

35. The Scottish Government continues to be represented on the relevant HMRC programme and project boards, with access to all project papers and background information. HMRC consults the Scottish Government on options and decisions that have a potential impact on Scottish taxpayers and employers, and/or on the costs of the project.

36. HMRC has reviewed its estimate of total costs of implementing SRIT and has reduced these from a range of £35m to £40m (published in last year's UK Government's implementation report) to a range of £30m to £35m. HMRC expects that the IT costs of implementing SRIT will be unchanged at between £10m and £15m, but that non-IT costs will be £5m lower, at approximately £20m. HMRC is currently updating its expected profile of costs.

37. The provision for SRIT costs included in the Scottish budget for 2015-16 is £25.7m. Implementation costs totalling approximately £10m are expected to be incurred in 2016-17 and 2017-18. This will be taken into account in the Scottish Spending Review this year. Approximately £2m of SRIT costs have been met by SG so far.

38. Accurately identifying Scottish taxpayers is key to successfully implementing SRIT. HMRC have continued to work on the strategy, including by carrying out work to test the association between taxpayers and postcode addresses held on their database.

39. HMRC has also asked for access to administrative data held in Scotland on the NHS Central Register to cross-check against its taxpayer database and so help to improve the integrity and accuracy of the identification of Scottish taxpayers. The Scottish Government has just completed a consultation on widening access to administrative data in NHS-CR, including giving access to HMRC. Scottish Ministers are considering the wider access proposals in the light of responses to the consultation.

40. HMRC has been preparing its approach to communicating with employers to help ensure that they are ready to implement SRIT from April 2016; and is also planning for communications with Scottish taxpayers. Work has also been done on specifying the management information required to support performance reporting and forecasting once SRIT is in operation.

41. Discussions have taken place between HMRC and the National Audit Office (NAO) on how best to satisfy the requirements of financial reporting to the Scottish Parliament. The NAO is also in the process of agreeing a Memorandum of Understanding with Audit Scotland on arrangements for planning and reporting the audit of SRIT. The Scottish Government welcomes and supports the inclusion of Audit Scotland in this work.

Chapter 4 - Block Grant Adjustments

42. Scotland receives most of its public funding directly via the Block Grant. When taxes are devolved, receipts are paid into the Scottish Consolidated Fund and are no longer available to the UK Government. In recognition of this, the Scottish Block Grant will be adjusted on the basis of calculations agreed between the Scottish and the UK Governments.

43. Implementing the financial provisions for the Scotland Act 2012 has focussed on two Block Grant adjustments mechanisms – in respect of SRIT and in respect of the two fully devolved taxes.

Block Grant in Respect of SRIT

44. An approach was agreed between Ministers and confirmed in an exchange of letters in 2012. Additional information was provided by the UK Government in its previous implementation report in May 2014. The mechanism that will be applied indexes the Block Grant adjustment to movements in the UK tax base. Consequently, the net effect on the Scottish budget of the operation of SRIT once fully implemented will be determined by whether the Scottish non-savings, non-dividend tax base grows more or less quickly than the UK tax base. Faster Scottish growth in comparison with the UK as a whole would mean a net addition to the Scottish budget. If the tax base in Scotland grows more slowly, there would be a net reduction.

Block Grant adjustment in respect of the devolved taxes

45. On 14 January 2015, the Deputy First Minister wrote to the Scottish Parliament Finance Committee, confirming that agreement had been reached on the Block Grant adjustment in respect of the fully devolved taxes for 2015-16 only. The adjustment was £494m, based on a comparison of forecasts prepared by the Office for Budget Responsibility (OBR) and by the Scottish Government of receipts that would have been expected from SDLT and from the UK Landfill Tax in Scotland in 2015-16 – and therefore the amount foregone by HM Treasury as a result of devolution of these taxes.

46. The agreement between the Scottish and UK Governments on the Block Grant adjustment for 2015-16 does not set a precedent for the agreement of a permanent mechanism for setting and annually adjusting the Block Grant in respect of the devolved taxes in future years.

47. Discussions continue between the Scottish and UK Governments about some further, technical aspects of the Block Grant adjustment. These include the size of the allowance to be made for forestalling activity by people and businesses buying property in Scotland in the period between the announcement of rates of LBTT and its introduction. Discussions also continue on the split of the Block Grant adjustment between funding for capital and revenue expenditure, and on access to any surpluses generated by tax receipts exceeding forecasts.

Chapter 5 - Changes to systems and processes

48. Last year's report described the revised Written Agreement between the Finance Committee and the Scottish Government. The revised Agreement applied to the Draft Budget 2015-16, published in October 2014, and information was provided for the first time in the Draft Budget document about proposals on devolved taxes and on capital borrowing. Further adjustments to the Written Agreement in relation to the introduction of SRIT for 2016-17 are under discussion between the Finance Committee and the Scottish Government. In addition, the Parliament has adjusted its Standing Orders relating to the remit of the Finance Committee, to include appropriate references to public revenues.

49. Within the Scottish Government, work is well advanced on the changes to financial planning, monitoring and reporting arrangements flowing from implementation of the Scotland Act 2012. Arrangements have been put in place for financial reporting by Revenue Scotland, both for its running costs and for receipts from the devolved taxes. Work is also being done on systems to manage capital borrowing, to ensure appropriate planning, recording and reporting of transactions.

50. New and revised accounts and financial statements produced by the Scottish Government and by Revenue Scotland will be audited by the Auditor General for Scotland. The Public Audit Committee considered Audit Scotland's report 'Developing Financial Reporting' in the course of 2014. The Scottish Government remains in dialogue with Audit Scotland.

51. As noted above, accounting for and auditing of SRIT will be a matter for HMRC and the NAO, with appropriate input from Audit Scotland. From 2017, on present plans, the Public Audit Committee of the Scottish Parliament will scrutinise these accounts, along with NAO's reports on them.

Footnotes

1. 'Moving Forward with Land and Buildings Transaction Tax – A Consultation on Proposed Subordinate Legislation', published May 2014, available at: http://www.gov.scot/Resource/0044/00449463.pdf

2. 'Moving Forward with Land and Buildings Transaction Tax – A Consultation on Proposed Subordinate Legislation: an Analysis' published December 2014, available at: http://www.gov.scot/Publications/2014/12/9439

3. 'Land and Buildings Transaction Tax: A Consultation on Proposed Sub-Sale Development Relief', published June 2014, available at: http://www.gov.scot/Publications/2014/06/8803

4. 'Land and Buildings Transaction Tax: A Consultation on Proposed Sub-Sale Development Relief – an Analysis' published December 2014, available at: http://www.gov.scot/Publications/2014/12/2637

5. 'Scottish Landfill Tax, A Consultation on Subordinate Legislation', published 16 May 2014, available at: http://www.gov.scot/Resource/0045/00450678.pdf

6. 'Analysis of Responses to the Public Consultation on Proposed Landfill Tax Subordinate Legislation', published October 2014 available at: http://www.zerowastescotland.org.uk/PublicConsultation/ProposedLandfillTaxSubordinate/Responses

7. 'Revenue Scotland and Tax Powers Act: A Consultation on Subordinate Legislation', published 6 October 2014, available at: http://www.gov.scot/Publications/2014/10/4714

8. 'Revenue Scotland and Tax Powers Act 2014: A Consultation on the Scottish Tax Tribunal Rules', published 9 October 2014, available at: http://www.gov.scot/Publications/2014/10/6007

9. See the Draft Budget, Chapter 2, at http://www.gov.scot/Resource/0046/00460449.pdf

10. See the forecasting paper, available here: http://www.gov.scot/Resource/0046/00460449.pdf

11. See the Scottish Fiscal Commission's Report at: http://www.scottishfiscalcommission.org/media/media_364407_en.pdf

12. See the Equality Budget Statement at:
http://www.gov.scot/Resource/0046/00460433.pdf

13. Implementation of the Devolved Taxes – Joint Update from Revenue Scotland, Registers of Scotland and the Scottish Environment Protection Agency (171014) – http://www.scottish.parliament.uk/S4_PublicAuditCommittee/General%20Documents/17_October_2014.pdf