The income tax gap either side of the border in 2024/25 - 30th December 2023

The Scottish Budget changes to tax rates for higher earners (and pensioners), which have widened the tax gap between Scotland and the rest of the UK.

The Scottish Government’s Budget for 2024/25 targeted those with earnings and/or pensions above £75,000 by:

• Creating a new advanced tax rate of 45% on income above £75,000 up to £125,140; and

• Increasing the top rate of tax on income above £125,140 to 48%.

The Scottish habit of incorporating the personal allowance into their tax bands can create confusion in this instance, as it makes it appear that the new tax band is just over £50,000 wide. It is not. The impact of the phasing out of the personal allowance above £100,000 means that the band is £62,710 wide, i.e. covering taxable income between £62,430 (£75,000 - £12,570) and £125,140.

The impact of this can be seen in the graph above, which shows how much extra income tax is payable on earnings in Scotland compared to the rest of the UK (rUK):

• Tax on earnings between £12,570 and £28,867 is lower in Scotland because of the £2,306 starter rate (19%) band. It becomes higher once income is more than £2,306 into the intermediate rate (21%) band.

• The sharp kick up at about £44,000 (£43,662, to be accurate) reflects the starting point for Scottish higher rate (42%) tax while rUK is still at 20%. The graph partially flattens £6,608 later when rUK higher rate (40%) comes into play.

• The next uptick is at £75,000 when the new advanced rate is triggered, meaning 45% tax applies rather than rUK’s 40%.

• At £100,000 the trajectory steepens again because personal allowance taper begins. In Scotland this implies an effective marginal rate of 67.5%, whereas in rUK it is 60%.

• From £125,140, the graph is less steep as the difference in marginal tax rate drops from 7.5% to 3% (Scottish top rate – rUK additional rate).

The new Scottish tax structure has an interesting effect on the bonus versus dividend calculation. Consider a director with income of £75,000, choosing whether to draw out £10,000 of gross profits in 2024/25 as bonus or dividend from a company in the 26.5% marginal corporation tax band:

In Scotland, the dividend is the winner, whereas in the rest of the UK, the bonus produces a better result. The same applies at top/additional rate and if the marginal corporation tax rate is 25%. At a 19% marginal corporation tax rate, the dividend wins in all four nations.

Source: Techlink Professional.