Aegon’s contribution to the Smith Commission
on further devolved powers for Scotland
31 October 2014
Introduction and high level comments
Aegon welcomes the opportunity to provide input to the Smith Commission as it considers further devolved powers for the Scottish Parliament.
Aegon is a financial services company offering pensions, savings and protection products to customers across the UK. Our life company is currently registered in Scotland although around 90% of our UK customers are resident outside of Scotland.
We appreciate that the Smith Commission’s focus is on delivering heads of agreement for further devolved powers which will focus on principles.
However, as part of that process, we believe that it is important to give some consideration to the ‘next level’ consequences of devolving any particular power. Without this, there is the potential for unintended and negative consequences to emerge after powers have been devolved.
We welcome the agreement already reached that changes should avoid being detrimental to other parts of the UK.
We recommend that this be extended to avoid any changes which would be detrimental to either Scotland alone, the rest of the UK (rUK) alone, or the UK in totality.
From a financial services perspective, we believe the loss of the single UK-wide market in financial services would be detrimental to the UK as a whole.
In view of the importance of financial services to the Scottish economy, we also believe damaging that sector would be damaging to Scotland’s future prosperity.
To retain a single UK-wide market in financial services, it is essential that any devolved powers do not result in either having to offer two distinct product sets to customers in Scotland and rUK or to have to ‘divide’ the financial services company into two because of the taxation of the financial services company.
Many financial services products have strong interfaces with various personal taxes and at times corporation tax. Certain product types like pensions have a very distinct and complex set of tax rules within which they operate. This controls how much can be paid in by individuals and employers, tax relief on contributions, investment growth within the pension, when and through which routes income can be taken and the tax treatment thereof, and the tax treatment on death.
At times, our products also have links to various social security benefits.
The way in which life companies such as Aegon are taxed (which considers
investment returns less expenses, often referred to as the ‘I minus E’
approach) links to both corporation and personal tax rates.
In light of the above, devolving powers around tax or benefits which led to different rates of tax or benefits in different jurisdictions would have consequential implications for financial services providers, their existing and future products, their customers and potentially their ability to serve the whole UK from a single base (whether in Scotland or elsewhere in the UK).
We can envisage different ways in which devolved powers around tax (or benefits) could be extended:
The power to change the level or rate of a preexisting tax (e.g. income or corporation tax).
The power to change the boundary points for a tax being payable at a particular rate by an individual or firm (e.g. bands of earnings within which different rates apply)
The power to introduce a new tax or tax relief.
The power to change the tax rules for a particular form of product (such as pensions).
The power to change state benefits.
All of the above would have consequential implications for financial services firms, their customers and their ability to serve the current UK market. We understand that a degree of 1 and 2 is a likely outcome of the devolution debate. We want to stress that as evidenced by the Scotland Act 2012, the costs can be significant, for example in facilitating the correct rate of pension tax relief based on residence.
For each of 1, 2 and 5, we accept that financial services considerations will be secondary. However any such changes could still be detrimental to financial services companies operating out of Scotland or those registered in rUK with customers in Scotland.
Under 4, the financial services considerations become primary. They could also be primary under 3 if the tax was specific to financial services.
We do not believe financial services-specific tax changes are required to meet the broader aims of devolution. Indeed, we believe they would fail the test of administrative efficiency and more importantly severely damage the single UK-wide market.
Even if the Scottish Parliament did not initially exercise any powers given to make such changes, financial services companies would need to prepare for the potential for them to do so at some future date. This would be unsettling for firms serving Scottish customers and / or operating in Scotland and for those considering doing so in future.
We would strongly oppose financial services-specific devolved tax powers on the grounds that these could be highly damaging to the operation of a single UK market in financial services and detrimental to its customers.
In Section 2, we have provided more detail on the different taxes which affect Aegon as a financial services firm and our customers. We hope this will allow ‘next level’ implications to be assessed including ease of implementation and associated cost considerations.
Retaining a UK-wide market in financial services also means there is no need to have separate financial services regulatory regimes or to have separate organisations or mechanisms to offer consumers protection. This delivers further cost benefits.
Extending devolved powers could of course have wider implications for Aegon as a company and employer based in Scotland. Here we have focused on those aspects specific to financial services.
Detailed implications 2.1 Income tax
Already enacted by the Scotland Act 2012, from 6/4/2016 the rate paid by Scottish taxpayers will be calculated by reducing the basic (20%), higher (40%) and additional (45%) rates of UK income tax by 10 pence in the pound and adding a new Scottish rate (SRIT) set by the Scottish Parliament.
Scottish tax payers will need to first be tax residents of the UK, but will then generally be defined by their main place of residence (in or out of Scotland) with a day based decider, should their main residence not give sufficient indication.
In addition to impacting employee payrolls, this will impact tax relief on pensions (including operation of PAYE deducted from annuity payments).
HMRC confirmed in 2012 that Scottish taxpayers should receive tax relief on their pension contributions at the Scottish rates. Pension scheme members who are Scottish taxpayers, who pay contributions to their employer’s pension scheme under the net pay arrangement, will automatically receive tax relief on their contributions at the Scottish rates. However, the system for giving relief at source (RAS) will not automatically provide the correct relief for Scottish taxpayers.
HMRC has been working with the pensions industry and has decided that RAS will be at Scottish rates for Scottish taxpayers. This requires pension firms to be able to differentiate between Scottish and rUK taxpayers in their records and make RAS claims at both the Scottish basic rate and the basic rate applicable to rUK. HMRC intends to provide information to pension scheme administrators to allow them to identify which of their members are Scottish taxpayers.
To allow time to implement these changes, it is planned that the industry should be able to operate RAS at Scottish rates from April 2018. To ensure Scottish pension scheme members are not disadvantaged, the Government has agreed that from April 2016, pension scheme administrators can continue to claim RAS at the UK basic rate for all members and HMRC will identify Scottish taxpayers and make any adjustment (depending on the rate set by the Scottish Government), to the relief given direct with the scheme member either through self-assessment or PAYE coding.
It has taken some time and detailed negotiations for industry and HMRC to reach this agreement and we urge the Smith Commission to avoid
allowing any short-term changes which would disturb this because that would impact the full implementation timetable.
Under extended devolved powers, the Scottish Parliament might be granted control over tax rate bands (point 2 in our introduction) which would affect the Scottish marginal rate of tax relief. Provisions being put in place for the Scotland Act 2012 should be able to cope with this.
A more radical change would be to change the broader way in which pensions are taxed. This could include denying higher rate relief in Scotland but not rUK. Another example would be to reverse the changes the Chancellor announced in his Budget regarding greater flexibility in how to take proceeds from pensions from age 55. Yet more examples are changes to the lifetime allowance and annual contribution limits. Granting the Scottish Parliament these forms of power present huge challenges to financial services firms wishing to operate across the UK and we would strongly oppose this degree of devolved power.
We strongly believe the broader tax framework for pensions and other financial services products should remain a reserved matter for the UK Parliament.
2.2 Tax treatment of Investment Income
We understand that under existing proposals, savings and dividend income will be subject to UK rates rather than SRIT; payments subject to basic rate withholding tax (interest on late payment of claims for example) will be subject to UK tax rates; and the policyholder tax rate applying to non-pensions savings products taxed under I-E will also be at UK rate.
It is important this is not disturbed because any changes would require separate identification of Scottish and rUK taxpayers in life company claims systems. Similarly there could be a knock on effect to chargeable events calculations which are already highly complicated even without
differentiation by residency. Changing the policyholder tax rate would effectively mean having to run two separate life books for Scottish/ rUK customers with separate pricing calculations, creating huge additional administration and systems costs and complexities. This could cause firms (Scottish or rUK based) to withdraw from the Scottish market, leading to less competition and product availability. In addition, for Scottish firms, it is likely to result in the need to revisit contingency plans regarding the location of registration.
Likewise it will be important not to impact the taxation of investment funds as having to separately identify Scottish and rUK investors would severely harm the investment management industry, requiring it to run separate funds for Scottish and rUK investors.
We strongly support the current proposals that savings and dividend income remain subject to UK tax rates and are not devolved.
2.3 Corporation Tax
We have significant concerns over the implications of devolving corporation tax
because of the extent of integration of the UK economy. While the “simplest”
approach would be to subject companies registered or located in Scotland to Scottish corporation tax, this ignores the source location of the profits themselves.
We are aware that the OECD is currently examining the allocation of profits between country units of multinational corporations. This could have implications for a Scottish company where most of its customers are in rUK (and for rUK companies with a Scottish customer base) giving rise to potential disputes with Scottish and rUK tax authorities on the split of profits. Again, this could discourage firms from operating across the UK and is likely to result in the need to revisit contingency plans regarding the location of Scottish based life offices.
Having different Scottish/ rUK corporation tax rates would also require having to run separate Scottish/ rUK books for life assurance and annuity business (sometimes referred to as BLAGAB) for pricing purposes (which is undertaken daily for unit linked business). BLAGAB products are taxed on
I-E profits with the shareholders’ share of those profits taxed at shareholders tax rate (currently 21%) with the balance taxed at policyholder tax rate (currently 20%). Maintaining separate books would be a substantial administrative burden.
Having different Scottish/ rUK pricing would significantly complicate products and their marketing. It could also result in some funds becoming too small to be viable – for example because of overheads or because it was no longer feasible to offer asset diversification or sufficient spreading of investment risk.
It would also be necessary to identify separate Scottish/ rUK pension profits for tax purposes, albeit this shouldn’t impact the customer, being a shareholder matter.
We strongly oppose the devolution of corporation tax to the Scottish Parliament.
2.4 VAT
We understand that it would not be permitted under EU law to have different VAT rates or principles between Scotland and rUK. If this is incorrect, there would be implications for the way we price our products in reflection of our expense base.
2.5 Inheritance Tax
The financial services industry offers customers products designed specifically
to meet any IHT liability they may incur in future. If rates of IHT were to be different in Scotland, then the products would need adjusted accordingly. If the broader approach to IHT were different, the changes required would be more significant. This is not as significant an issue as differences in the pension product tax regime but would nevertheless require amendments to new and potentially existing products.
Product tax frameworks outside of pensions
By far the most important ‘product tax’ framework is that for pensions. We discuss this earlier. However, there are other tax frameworks which should also be considered. Examples include:
ISAs – these receive favourable tax treatment subject to contribution limits
Investment Bonds – these allow 5% of the initial investment to be withdrawn tax free each year
We strongly oppose devolving the power to amend tax frameworks at specific product level.
Social security benefits
It is common practice for income protection policies, which replace income in the event that an individual is (temporarily) unable to continue their / any occupation, to base the monthly claim value on a specified amount less what the individual receives from the state. If Scottish residents were entitled to a different amount of state benefit, this would need to be allowed for in policy terms and conditions and in claim calculations, leading to an increased administrative burden.
We hope our submission is helpful to the Smith Commission and would be very happy to discuss any aspect of our response further.
Steven Cameron
Regulatory Strategy Director 31 October 2014
