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3rd Report, 2011 (Session 3)

The Scottish Variable Rate of Income Tax

CONTENTS


Remit and membership

Report
Introduction

The Scottish Parliament’s tax-varying powers

The decision-making process: 1999-2011

The state of readiness
The state of readiness after the 2003 election
The state of readiness prior to the 2007 election
The state of readiness after the 2007 election
The state of readiness after the 2011 election
The SVR in the next parliamentary session

Annexe A: extracts from the minutes of the Finance Committee

Annexe B: Government papers and oral evidence taken by the Committee

The Scottish Government published all relevant papers on the SVR on 10 January 2011 and provided the Committee with a timeline of events.

SVR - Government papers (link to Government website)
SVR - timeline (116 KB pdf posted 11.01.2011)

Please note that all oral evidence and correspondence received by the Committee is published electronically only, and can be accessed via the Finance Committee’s webpages, at:
http://www.scottish.parliament.uk/s3/committees/finance/inquiries/svr.htm

1st Meeting, 2011 (Session 3), Tuesday 11 January 2011

ORAL EVIDENCE

Sarah Walker, Director, PAYE, Self Assessment and NI Contributions; and
Janet Clayton, Assistant Director, PAYE, Self Assessment and NI Contributions, HM Revenue and Customs.

3rd Meeting, 2011 (Session 3), Thursday 20 January 2011

ORAL EVIDENCE

Rt Hon Michael Moore MP, Secretary of State for Scotland; and
Robin Haynes, Senior Economist, Scotland Office, UK Government.

4th Meeting, 2011 (Session 3), Tuesday 25 January 2011

ORAL EVIDENCE

Andy Kerr MSP;
Tom McCabe MSP; and
Jack McConnell MSP, former Finance Ministers;
John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth; and
Richard Dennis, Head of Civil Law Division, Scottish Government.

Remit and membership

Remit:

1. The remit of the Finance Committee is to consider and report on-

(a) any report or other document laid before the Parliament by members of the Scottish Executive containing proposals for, or budgets of, public expenditure or proposals for the making of a tax-varying resolution, taking into account any report or recommendations concerning such documents made to them by any other committee with power to consider such documents or any part of them;

(b) any report made by a committee setting out proposals concerning public expenditure;

(c) Budget Bills; and

(d) any other matter relating to or affecting the expenditure of the Scottish Administration or other expenditure payable out of the Scottish Consolidated Fund.

2. The Committee may also consider and, where it sees fit, report to the Parliament on the timetable for the Stages of Budget Bills and on the handling of financial business.

3. In these Rules, "public expenditure" means expenditure of the Scottish Administration, other expenditure payable out of the Scottish Consolidated Fund and any other expenditure met out of taxes, charges and other public revenue.

(Standing Orders of the Scottish Parliament, Rule 6.6)

Membership:

Derek Brownlee
Malcolm Chisholm
Linda Fabiani
Joe Fitzpatrick
Tom McCabe (Deputy Convener)
Jeremy Purvis
Andrew Welsh (Convener)
David Whitton

Committee Clerking Team:

Clerk to the Committee
Jim Johnston

Senior Assistant Clerk
Terry Shevlin

Assistant Clerk
Allan Campbell

Committee Assistant
Jennifer Bell

The Scottish Variable Rate of Income Tax

The Committee reports to the Parliament as follows—

introduction

1. On 18 November 2010 the Secretary of State for Scotland, the Rt Hon Michael Moore MP, wrote to the First Minister, the Rt Hon Alex Salmond MSP, about the operation of the Scottish Variable Rate of Income Tax (“SVR”). In particular, he stated that “a new Scottish Parliament, elected at the May 2011 election, would not be able to invoke the SVR until at least the 2013-14 tax year”.

2. The First Minister responded on 19 November, while the Cabinet Secretary for Finance and Sustainable Growth, John Swinney MSP, also wrote to the Secretary of State on 22 November.

3. On 23 November 2010 the Finance Committee took oral evidence from the Cabinet Secretary on the 2010 Autumn Budget Revision, which included a brief discussion of issues relating to the SVR. The Cabinet Secretary said that he would make a full statement on this matter to the Parliament the following day. A chamber debate on the SVR was held on 24 November 2010. Following this debate, the Finance Committee decided at its meeting on 14 December to undertake an inquiry into the SVR, and agreed the following remit—

To consider the substance, context and decisions of the Scottish Government relating to the Scottish Parliament's revenue raising powers through the Scottish Variable Rate.

4. The main aims of the inquiry are—

  • to facilitate transparency in relation to the decision making processes of both the current and previous administrations in relation to the operation of the SVR; and
  • to identify what lessons can be learned with regard to informing the operation of the SVR in the next parliamentary session.

5. The Committee took oral evidence at three meetings, from the following witnesses—

  • HM Revenue and Customs (HMRC);
  • Rt Hon Michael Moore MP, Secretary of State for Scotland;
  • Rt Hon Jack McConnell MSP, Tom McCabe MSP and Andy Kerr MSP, former Scottish Executive finance ministers;
  • John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth.

6. To assist with the Committee’s inquiry, the Scottish Government published on its website “all relevant papers on the Scottish Variable Rate”1. This documentation covers the period from December 1999 to December 2010 and amounts to over 700 pages.

The Scottish Parliament’s tax-varying powers

7. In the devolution referendum on 11 September 1997, 63% of those voting supported a Scottish Parliament with the ability to increase or decrease the basic rate of income tax by up to three pence.

The Scotland Act 1998

8. This power was subsequently enshrined in the Scotland Act 1998. Other relevant provisions in the Act can be summarised as follows—

  • the SVR can be varied by half pence multiples. Any variations apply to the taxable income of Scottish taxpayers;
  • a “Scottish taxpayer” is “a person who is resident in the UK for income tax purposes where Scotland is the part of the UK with which that person has the closest connection during the year”;
  • a tax-varying resolution of the Scottish Parliament must relate only to a single tax year and generally must be passed before the start of the tax year to which it will apply. But it cannot be passed more than 12 months in advance of that tax year;
  • there is an exception to this rule: where the UK Parliament has not determined the basic rate for a relevant tax year before 6 March in the preceding tax year, then the Scottish Parliament will have one month to pass a tax-varying resolution from the date the basic rate is determined. In such cases, the resolution would have effect from the start of that tax year;
  • only a member of the Scottish Executive may propose a tax-varying resolution;
  • where the SVR is increased for Scottish taxpayers, the Inland Revenue [now HMRC] is to pay into the Scottish Consolidated Fund (SCF) an amount equal to the estimated yield from the additional tax to be paid by Scottish taxpayers.
  • HMRC is to make and maintain appropriate arrangements to determine the amount and frequency of payments into the SCF. It has also to determine, in consultation with Scottish Ministers, the amount and timing of such payments;
  • where the SVR is decreased, payments are to be made out of the SCF to reflect the shortfall in the yield of income tax resulting from the reduced rate.

Standing Orders

9. Standing Orders amplifies some of these powers. In summary, Rule 8.10 states that a motion for a tax-varying resolution—

  • can only be moved a member of the Scottish Executive;
  • can not be amended;
  • with the exception below, may be moved no earlier than 12 months before the beginning of the year of assessment to which it relates;
  • can be moved after the beginning of the year of assessment to which it relates only at Stage 3 of a Budget Bill, or a Bill to amend a Budget Act, relating to that year.

10. Standing Orders Rule 9.16.7 states—

“If a Budget Bill is dependent upon the Parliament passing a tax-varying resolution which provides, in accordance with section 73, for an increase for Scottish taxpayers of the basic rate and the Parliament rejects the motion for such a resolution, the Bill falls.”

Using the SVR power

11. No member of the Scottish Executive has ever proposed that a tax-varying resolution be moved and the Scottish Parliament has, therefore, never used its power to alter the SVR.

12. The former Scottish Executive and the current Scottish Government have always made clear, whether at the start of a parliamentary session and/or in the relevant Draft Budget document, that they did not intend to use the power.

13. While the power has never been used, attempts have been made to put practical arrangements in place that would ensure that the SVR power could be used in future, should the Scottish Parliament so decide. The key issue discussed in this inquiry is the extent to which the Parliament’s ability to vary the SVR has been affected by these practical arrangements and associated political decisions.

The decision-making process: 1999-2011

14. While the Secretary of State’s letter commented on the current Scottish Government’s actions, this section provides a chronological summary of the key decisions made by all Administrations since 1999.

15. The Scottish Government provided the following timeline of key dates—

1997 Devolution White PaperYes vote to tax-varying powers
1997-99 Inter-departmental Working Group aims to get SVR operational for 1 April 2000 (start of first tax year after devolution).
24 June 1999 Statement by Jack McConnell rules out use of SVR for life of Parliament.
1999-2000 Working Group takes work forward to “10 month state of readiness” so that SVR could be operational for 1 April 2004 (start of first tax year after 2nd Holyrood elections). SLA and MoU agreed [Service Level Agreement and Memorandum of Understanding]. Total cost of work - £12m
15 May 2003 Partnership Agreement rules out use of SVR for life of ParliamentSG Officials agree with Inland Revenue to maintain SVR in 10 month state of readiness at annual maintenance cost of £50,000.SLA runs to 31 July 2007
Feb 2007 Officials meet to consider preparations for election, and ensuring SVR in readiness for potential use from 1 April 2008.
March 2007 HMRC report IT suppliers’ view that £3.4m investment needed immediately to ensure readiness. SG unable to commit to spending.
May 2007 Briefing note to new Ministers (released) summarises options to bring SVR to readiness for 1 April 2008 (but not fully) and 1 April 2009.Ministers rule out use of SVR for life of the Parliament, and ask officials to explore options for returning SVR to readiness by next election for implementation from 1 April 2012 at estimated cost of £1.2m.
2008-09 HMRC major IT Upgrade, largely to PAYE systems, puts work on SVR on hold. HMRC turn back to SVR in October 2009, once PAYE systems complete.
28 July 2010 HMRC advise SG officials that to bring SVR to readiness for use from 1 April 2012 requires immediate investment of £7m, and set 20th August for decision.
20 August 2010 SG officials reply to say cannot commit to spend without discussing significant issues arising.
18 November 2010 Secretary of State letter to First Minister

The state of readiness

16. Mr McConnell was the first Finance Minister under devolution. In oral evidence, he explained that the United Kingdom Government had put in place an infrastructure in advance of the 1999 Scottish Parliament election “in anticipation that at least one party might propose using the tax power”. Following the election, the Scottish Executive made it clear that it did not intend to use the tax-varying power during the lifetime of the Parliament. Mr McConnell decided, however, to maintain an infrastructure for the power in recognition that a future Scottish Executive may have decided to use it. He explained that the option he chose, which was discussed with the Parliament, would have allowed the tax to be introduced in the financial year immediately following a Scottish election i.e. for an election held in May 2003 the tax could have been introduced the following April. Mr McConnell added that the option chosen “was based on advice that changes could not be introduced mid-financial year, so we had devised a system that would allow the changes to be made as quickly as possible.”2

17. In its oral evidence, HMRC explained that, following the Scottish Executive’s decision, an agreement was reached whereby the then Inland Revenue (subsequently merged into HMRC) would be able to put the SVR into “live running” within 10 months of a Scottish election on the normal cycle. Witnesses throughout this inquiry referred to this process as the “10 month state of readiness”. HMRC also referred to a memorandum of understanding between the Scottish Executive, the Inland Revenue and the Department of Work and Pensions. A key element of the memorandum was that the parties to it would review their state of readiness for the SVR, in recognition that “knowledge would dissipate over time if the SVR was not being used”. HMRC also stated that—

The terms of the memorandum of understanding are that we should be able to introduce the SVR following each Scottish election. We were not looking at maintaining that capacity continuously every year between elections.”3

18. A review of the state of readiness was undertaken before the 2003 election. HMRC confirmed that “the operational planning for the implementation of the SVR was in place” and that no additional IT was therefore necessary.

The state of readiness after the 2003 election

19. As in 1999, the Administration formed after the 2003 Scottish Parliament election did not intend to use the SVR powers. Mr Kerr, the then Finance Minister, decided to maintain the state of readiness. This entailed the Scottish Executive paying an annual sum of £50,000 to the Inland Revenue.

20. From 1999-2007 the memorandum of understanding was underpinned by two separate service level agreements (SLAs) between the Scottish Executive and the Inland Revenue/HMRC. While an SLA was operational between 2003 and 2007, it was only signed by Scottish Government officials in March 2007.

The state of readiness prior to the 2007 election

21. At the same time as the review of the state of readiness before the 2007 Scottish Parliament election, HMRC was undertaking a major computer upgrade that involved changing the IT that operated pay-as-you-earn (PAYE) across the United Kingdom. The overall cost of this was £389 million. HMRC informed the Scottish Executive in March 2007 that it would need additional expenditure in order to be able to implement the SVR within 10 months following the election—

“We identified at that point that the cost of maintaining SVR capacity in the new system would be in the range of £3.3 million to £4.9 million. At that point, in March 2007, the Scottish Executive felt that it could not commit to that money.”4

22. HMRC went on to explain the difference between the £50,000 a year mentioned by Mr Kerr and the additional costs outlined above—

“The £50,000 a year was an on-going cost to maintain our records of Scottish taxpayers. It was to ensure that we had an up-to-date record of which taxpayers on our records would potentially be liable for the Scottish rate. That is quite separate from the costs of upgrading our computers to ensure that they could operate the SVR. Although the Scottish Executive was paying the £50,000 a year and we were maintaining our database, that had no effect on the cost that would be involved in ensuring that our infrastructure was capable of operating the SVR. Given the changes to our infrastructure that we were planning in 2007, a cost had arisen to ensure that it could operate the SVR, regardless of the £50,000 a year.”5

23. HMRC continued—

“We told the Scottish Executive before the 2007 election that, in order to have the full functionality to implement the SVR in April 2008, it would need to commit to the £3.4 million figure before the 2007 election. The option of spending that money after the election did not arise because it was then too late. We said to the Scottish Executive following the 2007 election that we would see what we could do, if you like. We said that, if the new Government wanted to implement the SVR, we would see whether there was some way in which we could implement it from April 2008, but it would be sub-optimal and would not have the full operation that we would expect to be able to provide.”6

24. In response to further questioning, HMRC confirmed that it would have been possible to implement the system for tax year 2008-09 “but not with full functionality”.7

25. Mr McCabe, giving oral evidence in his capacity as a former finance minister, stated—

“Papers that have been released show that Scottish Government officials were in discussions with HM Revenue and Customs officials in March and April 2007. The papers clearly show that officials believed that those discussions had not reached a stage at which they could or would brief ministers. As members know, I was the Minister for Finance and Public Service Reform at that time, when I was aware that the discussions were on-going. I inquired whether an incoming Administration would be able to implement the SVR at the first opportunity, to which the answer was yes, with at least 90 per cent collection in the first year and full collection in subsequent years”.8

26. He later added—

“…everyone is aware that substantial powers are available to HMRC to collect unpaid taxes in subsequent years. On that basis, it was acknowledged that an incoming Administration, if it wished to, could implement the SVR and achieve a collection rate of 90 per cent, and that the missing money could be recouped by HMRC. There was never any question about the ability of the SVR to be fully implemented in subsequent years, had the decision to do that been taken before 7 June 2007.”9

The state of readiness after the 2007 election

27. In his oral evidence, the Cabinet Secretary reasserted the opinion he previously gave to the Parliament, that he did not inherit a functional IT system that was capable of delivering the tax power at 10 months' notice. He said that one of the first briefings he received as a new minister, in May 2007, presented three options in relation to the SVR—

“Option 1 said that if the Scottish variable rate were applied from April 2008, implementation would be sub-optimal. Yield to Scotland from the SVR would be between £10 million and £26 million short and we would be required to pay further IT costs of £3.4 million to upgrade the system.

Option 2 stated that if the Scottish variable rate were applied from April 2009—the first reliable date for implementation—we would be asked to meet IT costs of £2.9 million for system upgrades.

Option 3—the option that I asked my officials to pursue with Her Majesty's Revenue and Customs—recognised that if the SVR were not applied during this parliamentary session, IT costs of £1.2 million would be incurred to ensure a 10-month state of readiness thereafter. Given that the Government, like all the main parties that are represented in the Parliament, had made a commitment not to invoke the tax powers, we considered that the work could be undertaken over the lifetime of this parliamentary session, enabling political choices to be made in the next session.”10

28. HMRC clarified that the £1.2 million cost of the Cabinet Secretary’s preferred option was—

“… a minimum expenditure that was part of the total cost and which related only to the PAYE elements and not to the other tax elements on which money would need to be spent. That was the minimum that needed to be done to ensure that we could keep the 10-month implementation in play ….

“The £1.2 million would have been a capital cost. It is the cost of a particular upgrade rather than a cost over a period of time. The proposition was that it could be spent in order to ensure that the first part of the upgrade was done in time so that a decision could be taken at the subsequent election on whether to invoke the SVR within 10 months.”11

29. The Committee asked the Cabinet Secretary whether, following the initial briefing he received on the SVR in May 2007, HMRC was formally informed of the Scottish Government’s preferred option. Mr Swinney stated that discussions on progressing his preferred option were taken forward on behalf of ministers by officials. The Committee asked where the Cabinet Secretary’s decision to delegate this matter to officials was minuted. Mr Swinney responded—

“That request would have been conveyed to the director of finance in response to the original briefing that I was given in May 2007.”12

30. The Cabinet Secretary set out why there had been a delay in the Scottish Government communicating its preferred option to HMRC—

“That is explained by two factors. One is that the Scottish Government had decided that it was not going to utilise the Scottish variable rate for the four years of the session of Parliament, so there was no necessity for us to take a decision or to take particular steps as an immediate priority. The question that I was asked was whether I wanted to make an investment, or to pay a fee, by early June 2007, if I recall correctly. I obviously was not going to take that decision, so there was no necessity to communicate that to the Inland Revenue. The second factor is essentially about the priorities of my officials, who worked over that entire summer and into the next spring on the comprehensive spending review that the Government undertook when it came into office, and on the formulation of the budget bill and the pursuing of that bill, which of course concluded in February 2008.”13

State of readiness negotiations from 2008 onwards

31. The Cabinet Secretary also summarised some of the reasons for the delay in progressing his preferred option in the period after 2008—

“Scottish Government officials undertook to work with HMRC to ensure that the upgrades could be made. In early 2009, there were further discussions about the option that I wished to pursue—that of paying £1.2 million to achieve a working system for the next parliamentary session. Officials sought clarity from HMRC on costs and timescales for making the necessary changes. On 28 May 2008, HMRC advised Scottish Government officials that the process was progressing, but more slowly than had been expected. That sparked a prolonged period of communication by my officials to obtain answers. As HMRC officials explained to the committee, they were busy during much of the time implementing a major upgrade to the pay-as-you-earn systems.”14

32. HMRC confirmed that it was in the process of a major computer upgrade between early 2008 and 2010 meaning that it “became difficult for us to isolate the cost of the SVR aspects from the overall HMRC PAYE project”. For example, in February 2008 the Scottish Government asked HMRC for more detail about the expenditure involved in its preferred option. HMRC admitted that—

“… we were in a process whereby we were aiming at a moving target. The SVR aspects got swept up in the overall project. We continued to keep in touch with the Scottish Government. We told it that we would reassess the costs involved. I think that on two occasions we offered to meet to update it but, in practice, until last summer [2010] it was difficult for us to give it the details of the phases of the project that we were talking about in that February e-mail, what the work would cost and what it would involve. That accounts for some of the time that was taken between the start of that conversation and the results being produced last summer.”15

33. A briefing released by the Scottish Government in relation to this inquiry shows that, in November 2008, the Scottish Government’s Director of Finance suggested to the Cabinet Secretary that HMRC be formally minuted to ask for clarification about the current state of readiness and possible costs to the Scottish Government. The briefing continues: “The Cabinet Secretary advised that since there were no plans to implement the SVR in the lifetime of the Parliament no formal correspondence with HMRC was necessary. However he asked that Finance officials continue to maintain informal contact with HMRC”.

2010 deadline

34. The Committee asked HMRC when it first told the Scottish Government that there would be a deadline in 2010, which would be the last point at which SVR readiness would be available to an incoming Government after the 2011 election. HMRC said that it sent Scottish Government officials an email on 6 April 2010 saying that—

“… we were going to have to do another costing exercise to get another estimate from our IT suppliers, that that would be available in the summer and that we would need fairly quick decisions from the Scottish Government to be able to implement it. I think that at point we also gave it to understand that the cost was likely to be significantly higher than the £1.2 million that we had been discussing previously.”16

35. In his oral evidence, the Cabinet Secretary told the Committee that—

“… on 28 July 2010, HMRC set out a proposition for further IT work at an indicative cost of £7 million to enable the SVR to be exercised by the beginning of 2012-13. Were we not to agree to that approach, the earliest that the SVR arrangements would be available to us would be the following year—2013-14. My officials wrote back on 20 August to say that we could not commit to the investment without further details, and we heard nothing further until the letter from the Secretary of State for Scotland to the First Minister on 18 November.”17

36. In relation to the Cabinet Secretary’s reference above to a communication of 20 August from Scottish Government officials, the email in question states—

“We are not in a position to commit to this work, with the associated funding requirement you have asked for, at this time. We realise that the implication of not making a commitment at this point is that we may not be able to maintain the previously agreed 10 month state of readiness.”

37. HMRC confirmed that—

The response that we received in August was that they [the Scottish Government] had decided that, at that point, they could not commit to the expenditure and recognised that that would not allow us to fulfil our obligation to implement the SVR within 10 months.”18

38. The letter from the Secretary of State also said—

“… I do know that the Scottish Government confirmed in August this year [2010] that it was not able to commit the necessary resources to enable HMRC to proceed with work on PAYE systems to allow the SVR to be available in the first tax year after the 2011 election.”

39. The Committee asked the Cabinet Secretary when he first became aware of the deadline set by HMRC, for allowing the SVR power to be available after the 2011 election.

40. Mr Swinney said that a Scottish Government official discussed the matter with him on 4 or 5 August 2010, and that he instructed officials to “find out some more information, because I was not committing to £7 million without more detail about how it had suddenly become £7 million”19.

41. HMRC explained why the estimated costs for maintaining the state of readiness increased to £7 million between 2007 and 2010—

“The quote that was given in 2007 was of up to £4.9million. There was a central figure of £3.4million, but £4.9million was the upper bound of the likely cost. That has now gone up to around £7million.

The costs are quite confusing. The reason why the figure increased from something like £5million in 2007 to something like £7million in the summer of 2010 was partly the change in the costs of our major PAYE programme upgrade. Other things also happened, such as the loss of child benefit data disks in late 2008, which led us to increase significantly the data security requirements of a number of our programmes. That added to the cost of all our programmes and would have had some effect on the cost of SVR implementation. I need to point out that SVR implementation is a small aspect of a large programme—the overall cost of £7million is a fairly small part of a programme that is worth over £380million. Perhaps the variability is, therefore, not so surprising.”20

42. HMRC also confirmed, in accordance with the letter from the Secretary of State for Scotland, that it could not deliver the SVR for tax year 2012-13 i.e. the first financial year after the forthcoming Scottish Parliament election. The Cabinet Secretary stated that he had made a mistake in not communicating to the Parliament that the SVR is not operable for 2012-13 and that discussions with HMRC were ongoing.

43. The Committee emphasises that the power to alter the SVR belongs to the Scottish Parliament and not to the Scottish Government. The Parliament should therefore have been kept informed throughout this session about the Scottish Government’s position on the SVR, the ongoing dispute with HMRC and the threat to the state of readiness for 2012-13.

44. In particular, the Committee highlights that the Scottish Government decided in August 2010 not to commit to further IT work being undertaken on the SVR. This decision was made in the knowledge that it may result in the SVR power for 2012-13 being lost. The Committee considers that this matter should, at the very least, have been communicated immediately to the Parliament.

Wording of budget documents

45. There is a further, specific matter that the Committee wishes to highlight in this section, which concerns the wording used about the SVR in previous Scottish Government and UK Government budget documents.

46. The Committee questioned the Cabinet Secretary about the wording used in various Draft Budgets this session regarding whether the SVR would be used. The Committee pointed out that the Cabinet Secretary had said that the wording in the 2011-12 draft budget was the same as the wording used since the 2005-06 budget.

47. Both the 2005-06 and the 2006-07 Draft Budgets (i.e. the last two Draft Budgets of the previous Administration) stated—

"In order to avoid pre-empting decisions on this issue by any subsequent administration, the Executive has agreed with the Inland Revenue that the infrastructure necessary to use the tax-varying powers will be kept in a condition where, after a May election, the powers could be introduced from the start of the new financial year the next April. Following the initial investment made during the last Parliament to bring the infrastructure to this condition, the cost of maintaining this state of readiness is £50,000 a year."21

48. The current Scottish Government’s first Draft Budget, for 2008-09, stated—

"In accordance with the agreement between the Scottish Government and the Parliament's Finance Committee on the budget process, the Scottish Government confirms that it will not use the existing tax-varying powers in 2008-09."22

49. In response to the question of whether he had knowingly changed the language used in the budget documents, the Cabinet Secretary stated—

“Perhaps I did not use exactly the same words, but I confirmed the same point … If that has created confusion in the minds of the committee, that was not my intention. I was simply confirming the point that a convention exists between the Finance Committee and the Government that requires the Government to confirm whether it will use the tax-varying powers.”23

50. On a separate note, the Committee raised with the Secretary of State the point that UK budget documents for 2007-2010, but not the June 2010 budget document, included a paragraph on the effects of the Scottish Parliament’s SVR powers. The paragraphs stated that a one penny change in the SVR in 2007-8 would be worth approximately £300 million. The Committee also asked why the Treasury’s Statement of Funding Policy, published in October 2010, referred to the SVR. The Secretary of State advised that the Committee should raise both these matters with the Treasury. Having done so, the Chief Secretary to the Treasury’s response clarified that Section 76 of the Scotland Act 1998 requires the Treasury to make a statement where it appears to the Treasury that the proposed modification to any provision of the Income Tax Acts “would have a significant effect on the practical extent for any year of assessment of the Scottish Parliament’s tax-varying powers”.

51. The Committee highlights that its current written agreement on the budget process with the Scottish Government does not actually discuss the SVR at all; the convention to which the Cabinet Secretary refers above stems from a previous written agreement, which was revised in 2005. The Committee recommends that the new Finance Committee considers what information relating to the SVR should be included in a further revised written agreement, following the 2011 election.

The state of readiness after the 2011 election

52. Currently, there is no Service Level Agreement (SLA) in operation between the Scottish Government and HMRC, while the dispute between the Scottish Government and the UK Government about paying for costs associated with the SVR has not been resolved. The Committee explored these issues in evidence with the Cabinet Secretary.

Service Level Agreement

53. In relation to why there has been no SLA this session, the Cabinet Secretary explained that—

“I came in to office and was faced with three options, which I have rehearsed with the committee. What would we write a service level agreement about: the £1.2million option, the £2.9million option or the £3.4million option? We could not write a service level agreement until we had some concept of what the service that would be delivered was going to be about. So, there was no service level agreement because it would inevitably follow the route that we decided to take as a consequence of the decisions that were arrived at. That is the subject of the file of correspondence that the committee has in front of it."24

Costs associated with the SVR

54. In terms of the dispute over paying for costs associated with the SVR, the Secretary of State for Scotland’s letter stated—

“Section 80 of the Scotland Act allows for any administrative costs incurred by HMRC in relation to the Scottish Parliament’s tax varying power to be met by Scottish Ministers. It is an established principle that the costs of devolution should be met from the Scottish budget.”

55. The First Minister’s response challenged this interpretation, by quoting paragraph 3.2.8 of HM Treasury’s Statement of Funding Policy—

“Where decisions of United Kingdom departments or agencies lead to additional costs for any of the devolved administrations, where other arrangements do not exist automatically to adjust for such extra costs, the body whose decisions leads to the additional cost will meet that cost.”

56. In oral evidence, HMRC said—

“Our understanding of the basis on which we are funded is that the costs of maintaining and upgrading the capacity to operate the SVR are to be paid by the Scottish Government.”25

57. The Committee asked HMRC officials whether the Scottish Government had, since 2007, ever stated to HMRC that the funding policy was wrong. The Committee also asked whether the Scottish Government’s view – that the statement of funding policy says that the Scottish Government would not have to cover the increased costs because of actions that were taken by HMRC – had ever been communicated to HMRC.

58. HMRC said that neither point had been communicated at official to official level.

59. HMRC added that—

“… on each occasion on which we went formally to the Scottish Executive, or the Scottish Government, with an estimate of the costs that would be involved in the upgrade, it simply said that it is not prepared to commit to that expenditure at this time. It has not raised any issue of principle about the funding.”26

60. Given the long running and ongoing discussions between the Scottish Government and HMRC over costs, the Committee asked whether the matter could have been escalated to a dispute between the Scottish Government and HMRC. The Cabinet Secretary replied that—

“There was no mechanism that was in any way functional for the resolution of disputes between Administrations until the change of UK Government in 2010. As a matter of process, the dispute resolution procedure has been put in place only in the past few months.”27

Role of HMRC

61. The SVR powers set out in the Scotland Act do not, understandably, take full account of practical arrangements that a Scottish Administration may make in relation to the actual operation of the tax-varying power. Therefore, the Committee also discussed with the Cabinet Secretary the point that while the Parliament may agree to alter the SVR it would be dependent on HMRC IT systems for the actual implementation of this decision.

62. The Cabinet Secretary said that—

“If I had said to HMRC, "Look, I'm not paying the money under any circumstances—just you get on with doing the upgrade," I suspect that it would have said, "We are not taking this forward."”28

63. He further explained that—

“I need HMRC to operate the system and to undertake the IT development. We do not control the system; it is controlled by HMRC. HMRC had made it clear that, through the viability assessments that it had carried out, the system was not functional without further capital investment. That opened up the question of how the system was to be delivered. That is the question with which I was confronted when I came into office.”29

64. The Committee asked whether this meant that it is HMRC and not the Scottish Parliament that decides whether the SVR is implemented. Mr Swinney responded: “What I am saying is that we are dependent, as we always have been, on HMRC to operate the system.”30

65. Finally, given the ongoing discussions about costs between HMRC and the Scottish Government, it is also worth highlighting oral evidence from HMRC that there would be costs associated with introducing the SVR separate from any IT upgrade bill. HMRC confirmed that these costs are estimated to be £10 million in the first year, with an on-going cost of £4 million a year, to be met by the Scottish Government.31

The SVR in 2013-14

66. In his oral evidence, the Cabinet Secretary referred to a letter from the Exchequer Secretary to the Treasury, David Gauke MP, dated 21 December 2010. The letter, which had not previously been seen by the Committee, discusses the preparations that would have to be made in this parliamentary session to allow an incoming administration to activate the SVR for 2013-14 i.e. the second financial year after the forthcoming Scottish Parliament election. It states—

“If the Scottish Government wanted to go ahead, HMRC would need the final, definitive decision by mid-August. Before that they would need to conduct a Viability Study. In order to be sure that this is completed in time to inform the final decision, I would request that we have your decision on whether to proceed, on the basis of an agreement with the Scottish Government on funding, by late April.”

67. The letter does not attach a cost to the Viability Study.

68. The Cabinet Secretary confirmed that he hopes to report to the Parliament shortly on the steps and costs associated with reintroducing a state of readiness to deploy the SVR.

69. Considering the Committee’s inquiry remit and the Cabinet Secretary’s apology to the Parliament for a lack of communication on the SVR, the Committee finds it unacceptable that the Exchequer Secretary’s letter was only mentioned at the very end of the Committee’s last formal evidence-taking session. The letter should have been made available to the Committee as soon as possible after receipt.32

70. The immediate issue is how the Scottish Government intends to respond to the Exchequer Secretary on the preparations to activate the SVR for 2013-14. The Committee notes that the Cabinet Secretary is seeking further information on reinstating the state of readiness and urges him to make a ministerial statement as soon as possible so that the situation can be clarified prior to dissolution. Any decision that could affect the next Parliament’s ability to exercise its SVR powers should be agreed by the current Parliament.

The SVR in the next parliamentary session

71. The Committee recognises that the next Parliament’s full SVR powers will not be clear until the Cabinet Secretary has reported to the current Parliament. The Committee also recognises that the Scottish Government is dependent on HMRC to operate the SVR system, and that previous agreements with HMRC have been based on it being able to introduce the SVR following each Scottish election, rather than maintaining that capacity continuously every year between elections. Depending on the Cabinet Secretary’s statement, the Committee recommends that the new Administration inform the new Parliament about any arrangements it intends to enter into with HMRC in terms of maintaining the state of readiness, and clarifies how any decision by the Parliament to alter the SVR would actually be implemented by HMRC.

72. The Committee also recommends that the final decision on whether to bring the SVR back to a state of readiness be taken by the Parliament.

73. The Committee is aware that the income tax powers contained in the UK Government’s Scotland Bill would, if the Bill is enacted, be implemented by 2016-17 and would supersede the current arrangements. Therefore, the next session of the Scottish Parliament, from May 2011-April 2015, will be the last under which the current SVR powers could be used.

74. The Committee recommends that the Finance Committee be fully consulted by the incoming administration on the implementation of any new financial powers resulting from the Scotland Bill. The current written agreement between the Scottish Executive and the Finance Committee should also be fully revised to ensure that the Parliament is fully consulted on the operation of these powers.

Annexe A: extracts from the minutes of the finance committee

1st Meeting, 2011 (Session 3) Tuesday 11 January 2011

Scottish Variable Rate inquiry The Committee took evidence by video conference from—

Sarah Walker, Director, PAYE, Self Assessment and NI Contributions, Janet Clayton, Assistant Director, PAYE, Self Assessment and NI Contributions, HM Revenue and Customs.

3rd Meeting, 2011 (Session 3) Thursday 20 January 2011

Scottish Variable Rate inquiry: The Committee took evidence from—

Rt Hon Michael Moore MP, Secretary of State for Scotland;

Robin Haynes, Senior Economist, Scotland Office, UK Government.

4th Meeting, 2011 (Session 3) Tuesday 25 January 2011

Scottish Variable Rate inquiry: The Committee took evidence from—

Andy Kerr MSP; Tom McCabe MSP; Jack McConnell MSP, former Finance Ministers;

John Swinney MSP, Cabinet Secretary for Finance and Sustainable Growth; and Richard Dennis, Head of Civil Law Division, Scottish Government.

6th Meeting, 2011 (Session 3), Tuesday 8 February 2011

Scottish Variable Rate inquiry (in private): The Committee considered a draft report and agreed to consider a revised draft, in private, at its next meeting.

7th Meeting, 2011 (Session 3), Tuesday 22 February 2011

Scottish Variable Rate inquiry (in private): The Committee considered and agreed a draft report.


Footnotes:

2 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2965.

3 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2929.

4 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2914.

5 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2916.

6 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2917.

7 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2918.

8 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2967.

9 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2971.

10 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2989.

11 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2921.

12 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2996.

13 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2996.

14 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2990.

15 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2922.

16 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2922.

17 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2990.

18 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2915.

19 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 3004.

20 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2926.

21 Scottish Executive. (2004) The Scottish Executive: Draft Budget 2005-06. Available at: http://www.scotland.gov.uk/Publications/2004/10/20079/45117. [Accessed 24 February 2011

Scottish Executive. (2005) The Scottish Executive: Draft Budget 2006-07. Available at: http://www.scotland.gov.uk/Publications/2005/09/06112356/23573. [Accessed 24 February 2011

22 Scottish Government. (2007) Scottish Budget Spending Review 2007. Available at: http://www.scotland.gov.uk/Publications/2007/11/13092240/0. [Accessed 24 February 2011

23 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2999.

24 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2997.

25 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2923.

26 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2924.

27 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2993.

28 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2993.

29 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2993.

30 Scottish Parliament Finance Committee. Official Report, 25 January 2011 Col 2993.

31 Scottish Parliament Finance Committee. Official Report, 11 January 2011 Col 2927.

32 Paragraph 69 was agreed to by division. For 5 (Derek Brownlee, Tom McCabe, David Whitton, Jeremy Purvis, Malcolm Chisholm), Against 3 (Andrew Welsh, Linda Fabiani, Joe FitzPatrick).