Tax shocks for Jocks

Opinion: How will Labour's tartan tax work out in practice? Will England become a lucrative on-shore haven? Alasdair Douglas takes a wry look at the chances of Scots getting their sporrans in a twist

Gordon Brown and his friends in the Scottish Labour Party may believe that the greatest advantage in life is to be born a Scotsman - if only for the unconditional hospitality and economic support of the nearest neighbour - and that Jocks will volunteer to pay an extra 3 per cent tax for the privilege if they choose to have their own parliament under Labour's devolution plans. But what about the practicalities?

Since unification, Westminster has sought to impose full integration on the Scots, most infamously in 1747 when to appear distinctly Scots was proscribed by law. Wearing tartan and possessing bagpipes ("warlike weapons" according to the Disarming Act) were punishable by deportation for up to seven years. But, so far, laws have failed to extinguish the Scots' identity. Perhaps 250 years on, a Scottish-dominated Labour government will finish the job by levying the promised tartan tax on anyone who claims to be Scots, for how better could a Labour administration collect a tax which the Scottish electorate votes upon itself?

In international tax, state borders provide the touchstone for separating the taxing rights of one fiscal regime from another but, where the border is, in essence, not real, the imposition of tax by reference to the familiar tests of residence, domicile, source of income and location of trading operations is likely to be, at best, complex and expensive, and, at worst, unfair and a major brake on doing business in Scotland.

Save for the wholly arbitrary exemption for companies, Labour has said little about how it will impose a special tax on Scottish taxpayers, but it might be supposed that it will try existing UK principles as a starting point. The most obvious rule would be to tax those resident in Scotland. This would catch most ordinary Jocks, but would have potential for unfairness round the edges. Peripatetic pop stars and politicians who spend more than half the year outside Scotland would not be resident there under the basic rule and so would avoid the charge. Looked at from this side of Hadrian's Wall, the Englishman on temporary secondment to Scotland for six months would be treated as resident there for the whole tax year and pay Scottish Higher Income Tax on his English income.

Another internationally recognised principle is to tax income whose source is in a particular state, irrespective of the residence of the recipient. Interest arising in the UK is subject to withholding tax when it is paid to a non-resident, income from trading activities carried on by a non- resident in the UK is taxable, etc. Would this source principle be of any use in imposing the new Scottish tax? The ease of administration would appeal to the Treasury if say, banks and other companies were to be obliged to withhold the extra 3 per cent tax from interest and charge an extra 3 per cent advance corporation tax on dividend payments as this would fit easily with the existing regime, but its efficacy would last only for the 24 hours or so that it would take to switch deposits to banks south of the Tweed and divest of shareholdings in Scottish companies.

Taxing the Scottish trading operations of English or other foreign residents would likewise be no simple matter to include in the new regime. Individuals and partnerships currently doing business in Scotland would be discouraged from investing further resources there if the alternative was to invest a few miles south and increase the post-tax earnings by 3 per cent. Sportsmen, musicians and other performers would be reluctant to add the extra appearance farther north if the net profit for performing in Newcastle was that much greater.

But surely the problems are capable of solution. After all, the US has a system under which states charge tax in parallel with the federal system. Each state manages to collect its own tax but the overall structure is far from simple or cheap to administer. Taxpayers in one state pay tax in another if they do business there, subject to a minimum level of activity and determined by reference to property, payroll and receipts in the other state. A permanent residence test is applied if an individual has homes in two states and imperfect tax credits are given across state lines where income is subject to double tax. The US state arrangements are complex enough to apply but, most importantly, are workable because they sit within a countrywide framework where every neighbouring state collects its dues. In the UK, a new Labour Scottish tax would be working against the framework of there being a tax haven next door.

So what would be best? A Scottish Higher Income Tax on the worldwide income of those who claim to be Scots - self-assessed and paid voluntarily - might be the answer. Three per cent of income with no allowances would be payable each year and, in return, the Queen (or, more appositely, the Duke of Edinburgh?) would send a certificate to the taxpayer confirming that he or she was recognised officially as a Jock. And the sanction for non-payment? Those who failed to pay would be deemed to be English. Surely no Scot worth his porridge would risk such a penalty to avoid the Scottish Higher Income Tax?

The writer is head of corporate tax at UK corporate lawyers Travers Smith Braithwaite, and a Scot.