The Scottish Government

Box 4.1: Income Tax

Income tax is a tax payable on income. Taxpayers' income is assessed for income tax according to a prescribed order; (i) non-savings income, (ii) savings income (not dividends) and (iii) dividends. Each individual is entitled to a 'personal tax allowance' on which no income tax is liable.

There are two apportionment methodologies that can be used to estimate income tax revenue for Scotland:

• Residence based - this approach apportions income tax to the region in which an individual lives.
• Workplace based - this approach apportions income tax to the region in which an individual works.

GERS adopts the residence based approach to estimate income tax receipts in Scotland. This method is considered best practice and is consistent with the guidance recommended in international standards on Regional Accounts (see ESA95 paragraph 13.11). The approach is also used by HM Revenue and Customs to assess income tax in their regional analyses. While the distinction between work and residence based measures may have important implications for income tax estimates in some UK regions, such as London and South East England, as there is only a small degree of cross-Scottish border travel from residence to employment location, the effect will not be significant.

Box 4.2: Corporation Tax

Corporation tax is a tax on a company's taxable income or profits. The rate of corporation tax is fixed for each financial year. Certain activities such as capital investment and research and development expenditure are subject to various forms of tax relief.

GERS estimates corporation tax revenue for Scotland on the basis of profits generated in Scotland and not on the basis of where companies' headquarters are located. Therefore, companies with headquarters in Scotland contribute directly to Scottish corporation tax revenue via profits collected only from operations within Scotland. Similarly, companies with headquarters outwith Scotland contribute to Scottish corporation tax revenue via the profits raised from their operations within Scotland.

In practice, corporation tax is paid to the fiscal jurisdictions within which such profits were raised. Companies operating across national boundaries are subject to double taxation relief ( DTR). Applying this methodology to regional UK fiscal accounts would imply that the profits of companies headquartered in Scotland, but deemed to have 'permanent establishments' elsewhere in the UK, would be subject to this relief. Global profits earned by Scottish companies outside the UK are typically already subject to such agreements.

GERS uses the ONS's Regional Accounts estimates of profits less holding gains of public and private corporations to apportion corporation tax revenue to Scotland (it excludes 'mixed income profits' from self-employment businesses that are classified in the household sector in National Accounts). Holding gains are an adjustment relating to the changing prices of assets held.

The Regional Accounts allocate corporations' (excluding partnerships) gross trading profits to regions according to wage and salary data used to estimate regional compensation of employees' and estimates of profits for the manufacturing industry from ONS's Annual Business Inquiry. Profits from the extraction of offshore oil and gas are considered extra-regio.

Profits data from the Regional Accounts are considered the most appropriate published source of information with which to estimate Scotland's share of corporation tax revenue. Whilst there are some considerations, detailed below, the approach is considered to be the most appropriate using national statistics, and leads to an estimate broadly consistent with Scotland's GVA share.

• Using the current methodology, non- UK earnings taxed abroad but subject to additional top up taxation by the UK Government when repatriated are allocated across the UK according to a company's onshore local activities. It could be argued that such earnings should be allocated to company headquarters. However, information at such a disaggregated level is currently not available and would be counter to the approach taken to estimate economic statistics such as GDP.
• The corporation tax base extends beyond operating surpluses and includes non-trading activities and capital allowances. The current methodology proxies total corporation tax revenue solely on the basis of operating surpluses.

Work is ongoing in an attempt to address these issues.

While future modifications will be adopted where appropriate, many of the issues outlined above arise as a direct consequence of the current constitutional, legal and financial framework in which the UK and Scotland currently operate. The approach adopted is considered to be robust.

Box 4.3: VAT & Excise Duty

Value Added Tax ( VAT) and excise duties are the principal elements of indirect taxation ( i.e. taxes on products) in the UK.

VAT is charged on the final consumption of certain goods and services and is levied at 17.5% of the purchase price, though a reduced rate of 5% is levied on some items. Alcohol excise duty is a flat-rate duty on alcoholic beverages while tobacco duty is a combination of flat rate duty and an ad valorem tax charged on cigarettes, cigars and loose tobacco. Any revisions to VAT and excise duties are announced during UK Budget and Pre-Budget ( PBR) reports.

Two alternative apportionment methodologies can be applied to VAT and excise duties.

• Consumption based approach - apportioning VAT and excise duty to the region in which the good was consumed.
• Production based approach - apportioning VAT and excise duty to the region in which the good was produced.

In GERS, VAT and excise duty estimates for Scotland are based on the consumption approach. This is appropriate as the burden of the duty is borne by the final consumer rather than the producer. This is considered best practice as within a system of regional fiscal accounts, the VAT liability 'sticks' when the item is purchased by the final consumer. The location of production is of no relevance.

Tobacco and alcohol duties are only collected if the product is consumed in the UK. If the product is exported, the producer receives export relief. For example, while duty is levied on Scotch Whisky when it leaves a bonded warehouse, in reality it is only collected if the whisky is consumed in the UK. Consequently, the ultimate payer of the duty is the UK consumer of the product.

Therefore, GERS estimates duty collected from Scotch Whisky based upon the level of whisky consumption in Scotland, even though Scotch Whisky is only produced in Scotland. Similarly, the estimate of tobacco duty collected in Scotland is based upon the level of consumption of tobacco products in Scotland, even though most tobacco goods are produced outside Scotland.

Box 4.4: Scottish Water

One of the largest contributors to UK public corporations' gross operating surplus ( GOS) is Scottish Water. The equivalent water companies in England and in Wales have been privatised. In Northern Ireland, water services are currently part of the public sector, but classified central government rather than public corporation.

In previous GERS reports, the GOS of UK public corporations was allocated to Scotland using a GVA share (excluding extra-regio). This, however, made no adjustment for the major contribution made by Scottish Water.

In this edition of GERS, the GOS for Scottish Water and other public corporations that only operate in Scotland have been fully assigned to Scotland. For those public corporations operating solely in England, Wales or Northern Ireland, Scotland has not been assigned any share of their GOS. For those that operate on a UK basis, a share of their GOS has generally been allocated to Scotland on the basis of the relevant industry GVA.

A more detailed discussion of GOS (and the other elements of GOS) is provided in the detailed revenue methodology paper on the GERS website.

Revenue Estimate of Public Corporations' Gross Operating Surplus: Scotland 2002-03 to 2006-07