An article regarding how the CTC works and who can claim it, by Anne Redston, Chairman, CIOT Personal Taxes Sub-Committee, published in the March 2001 issue of "Tax Adviser" Gordon Brown abolished the married couples allowance (MCA) in his 1999 Budget, and replaced it with the children’s tax credit (CTC). The CTC comes into operation from April 2001 – but at the last count, over a million people thought to be eligible had not registered, despite the fact that the new tax credit is worth up to £520 a year. This article summarises how the credit works and who can claim it; it also considers a number of problem areas.
The CTC is a reduction in tax, not an increased personal allowance or a cash payment. It is thus a ‘true’ tax credit, unlike the working families tax credit (WFTC), which is an earnings top-up. Enough has already been said about the misunderstandings which this dual usage is likely to cause. The interaction of the two ‘credits’ is particularly unfortunate and is discussed towards the end of this article.
Since the CTC is a reduction in tax, it operates differently depending on whether the claimant is self-employed or employed.
· The self-employed must claim the credit using their SA return. This however means that the benefit of the CTC will not be felt for some time. It is possible to accelerate relief by completing form SA303 before January 2002 so that the credit reduces payments on account. However, care is needed here because of the need to forecast accurately all other sources of taxable income.
· Employees must claim the credit using the appropriate form. For the CTC to be included in their tax codes in time for the beginning of the 2001-2 tax year, claims must be submitted by the end of February 2001. It is already clear that many people will miss this deadline. Later claims will be backdated to April 2001 and the normal six year time-limit will apply - i.e. for tax year 2001-2 claims can be made until 31 January 2008.
Entitlement – the child test
To claim the credit, the family must contain at least one child who is:
· the child of the claimant or of his/her partner, a step-child or adopted child, or a child looked after at the expense of the claimant;
· under 16 at the start of the tax year; and
· living with the claimant for at least part of the tax year.
Only one person in the family can claim the credit, so that if an individual is living with a partner, and they both have a child, they can claim only one credit between them.
If there are shared childcare responsibilities, the credit may be split. So where a separated couple who are both basic rate taxpayers have one child who spends weekends and holidays with her mother, and weekdays with her father, they will have to agree between them how to divide the credit. However, if the mother and father share responsibilities for two children, so they both can be regarded as caring for a separate child, they may each claim the credit.
The CTC has to be adjusted if responsibilities change during the year – so if a relationship breaks up and the partner who had been claiming the credit leaves and ceases to be responsible for the child, he or she will not be entitled to the credit from that date.
While this is scrupulously fair, it is surely unmanageable on a national basis. It would have been far better for the CTC, like the WFTC, to be based on the position at a point in time and to remain in place for a fixed period thereafter. The beginning of the tax year would be an obvious choice, allowing the credit to be claimed for that year.
Revenue booklet CTCR1 explains the tax credit and gives a number of useful examples, such as:
· Jack and Jill (reproduced as Example A below) which deals with the situation when a couple split up, and the children stay with one parent and the other no longer contributes;
· Peter and Alison (Example B), looks at the position where the parents continue to share responsibility for the child after the relationship has broken down;
· The complexity becomes even greater when there are children from a number of different relationships being looked after by more than two people (Example C).
It should be noted that these examples all use the figure of £442 for the value of the credit, but in the November 2000 PBR the Chancellor raised it to £520.
Example A: Jack and Jill
Jack and Jill have been living together and sharing the credit equally. Both are basic rate taxpayers. They separate on 21 August 2001 and the children go and live with Jill.
The year is then split into two parts.
For the first part of the tax year, from 6 April to 20 August 2001, (137 days) the couple live together. The credit is worth £442 for a full year. So for this period it is worth up to
£442 x 137 = £166
which means for this part of the year it is worth up to £83 for Jack and £83 for Jill.
For the second part of the tax year, from 21 August 2001 to 5 April 2002, (228 days) the children live with Jill. For this period the credit is worth up to
£442 x 228 = £276
for Jill only. Therefore, over the whole year it is worth up to £83 for Jack and £359 for Jill (£83 + £276)
Example B: Peter and Alison
Peter is married to Alison and they have one child. They are both basic rate taxpayers and are sharing the children’s tax credit equally. On 10 September 2001, Alison leaves Peter to live with her new partner Anthony and takes the child with her. Anthony contributes at least half of the total cost of maintaining the child from 10 September. Anthony is a basic rate taxpayer and he and Alison decide to share the tax credit.
For the first part of the year, 6 April 2001 to 9 September 2001 (157 days), Alison is living with Peter.
The credit for this part of year is worth up to £442 x 157 = £190
which is worth up to £95 for Alison and £95 for Peter.
For the second part of the year, 10 September 2001 to 5 April 2002 (208 days), Alison and the child are living with Anthony.
The credit for this part of the year is worth up to £442 x 208 = £252
which is worth up to £126 for Alison £126 for Anthony.
Therefore, over the year the credit is worth up to £221 (£ 95+£ 126) for Alison £95 for Peter £126 for Anthony.
Example C: Jenny and Andrew
Jenny is married to Andrew. She has a son, Phillip, from her first marriage to James. Phillip lives with Jenny and Andrew for nine months of the year and for three months of the year he lives with James. All the adults are basic rate taxpayers.
As Phillip lives with James for three months of the year, Jenny and James agree that James should claim a quarter of the children’s tax credit
£442 = £110.50
Jenny and Andrew claim three quarters of the tax credit £442 x 3/4 = £331.50. Jenny and Andrew agree to share the credit so this is worth £165.75 to each of them.
However, if the problems arising from shared childcare responsibilities were not enough, layered over them is the income test.
Entitlement – the income test
The CTC is reduced as soon as one of the individuals is a higher rate taxpayer. The credit is tapered away at the rate of £1 of income for every £15 of income taxed at the higher rate. Therefore those couples who have £7,800 of income or more taxed at the higher rate will not receive any CTC.
This might be reasonably straightforward if we were talking about an individual allowance. But once this tapering threshold is combined with the other elements of the CTC, the whole scheme becomes positively byzantine.
The rules require that if there are two or more possible claimants in respect of the child or children, and one of them is a higher rate taxpayer, he or she must claim the allowance; it cannot be claimed by the partner on the lower income. This relatively simple situation is illustrated at Example D below.
Jeremy and Louise have 2 children under 16. Louise earns £36,010 and Jeremy earns £25,000. Louise has to claim the children’s tax credit as she is the higher rate taxpayer. Louise is taxed as follows (using 2000/01 rate bands and personal allowance)
· 0 per cent on the first £4,385 of her income (the limit of her personal allowance)
· 10per cent on the next £1,520 of her income (i.e. at the starting rate up to £5,905)
· 22 per cent on the next £26,880 of her income (i.e. at the basic rate up to £32,785)
· 40 per cent on the remaining £3,225 of her income (i.e. at the higher rate up to £36,010)
The credit is reduced by: £3,225 = £215
Therefore the credit is worth £442 - £215 = £227 off the tax that Louise has to pay.
If neither partner is a higher rate taxpayer, they can agree to split the allowance between them. This is one of the principles operating in examples A-C above. But the credit cannot be split in this way if one of the individuals is a higher rate taxpayer. This means that no part of the tax relief can be given to the parent who is spending the greater part of his or her time looking after the children, if the other parent pays tax at the higher rate.
Furthermore, as the credit is claimed in advance of the tax year, and paid in-year to employees, the couple must estimate in advance whether one of them will be a higher rate taxpayer in the next tax year, and if so, which of them it will be; if they are wrong they must tell the tax office ‘as soon as possible’, and their credit will be adjusted. One is driven to ask whether this fine-tuning was really necessary - surely there was room for a common-sense shortcut or assumption, such as basing the relief on the previous year’s income.
Exactly how easy this estimate of the following year’s income will be for a couple who change jobs in the year, have a number of part-time employments, or are on variable earnings such as commission remains to be seen!
Single v dual earner households
One of the main complaints about the CTC is that it disadvantages the traditional family where one person earns the money and the other cares for the children, as compared to the family where both adults work. In the latter case, both can earn just short of the higher rate tax threshold, and still qualify for the relief in full, despite having a total household income in excess of £65,000. But a single earner household on £20,000 less than this will not get any CTC at all.
The rules for sharing of the credit and the higher rate test apply not only to married couples but to unmarried partners of the opposite sex. The legislation (FA 1999, Sch. 3, para. 1(a)) applies to ‘a husband and wife…living together or a man and a woman (who) are living together as husband and wife’.
This adds further elements of instability to the situation. Girlfriends, boyfriends and partners tend to be less permanent than spouses, even given the modern more relaxed attitude to divorce. Working out next year’s CTC based on this year’s romantic entanglements will be a real challenge.
And how are the Revenue to know the true position? They do not have information about lovers, only spouses. Surely designing the CTC in this way positively encourages the suppression of information, and creates a climate of voluntary non-compliance.
Interaction with WFTC/DPTC.
One of the worst aspects of the CTC is that its value to the poorest is much less than the headline figure of £520. This is because:
· the WFTC/DPTC is calculated based on after-tax income;
· the CTC reduces tax and so increases after-tax income;
· this therefore restricts the amount of WFTC/DPTC which can be paid to the worker.
The article ‘When is a Tax Credit a Tax Reducer’ by Elizabeth Lathwood (Taxation, 6 July 2000) explores this interaction in detail. In brief, those on WFTC/DPTC are likely to receive a net benefit of around £200 a year – rather a disappointing result. The only comfort for the government is that few of the electorate will have the faintest idea what has happened.
Far more complex scenarios will arise in practice than those discussed in this article, and it is astonishing that such a low value relief should be so very complex to apply. In short, the CTC is an over-targeted tax relief. The Low Incomes Tax Reform Group, of which I am a member, made representations to this effect last year. We suggested that ‘a similar result could have been achieved by a flat rate allowance and a slight shift in the higher rate threshold.’
It is to be hoped that the new integrated child credit, due to be introduced in 2003, will eliminate many of the complexities highlighted in this article. In the meantime, advisers should be aware of the rules and ensure clients do not fail to claim where appropriate.
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March 2001 by