Article by Liz Lathwood, Technical Officer, Chartered Institute of Taxation.
This article appeared in the February 2003 issue of Tax Adviser.
Articles on tax credits appear virtually every other month – in this journal at least. This must be a good thing as the ‘change’ to a new system of tax credits looms nearer. Before you move on, consider how many clients will be expecting informed advice on these rules effective from April 2003. Even if they do not want you to help with filling in the forms they may be looking for information on how the credits work and they will almost certainly complain if you have not kept them informed of a possible claim.
The new system offers tax-based support for low-income workers and higher income working families with thresholds generous enough to allow well over 90 per cent of families to make a claim.
Kate Upcraft wrote in Tax Adviser, December 2002, on some of the implications for employers. Other articles have dealt with the complexities of the regime. However, the legislation and related regulations have been slow in coming, therefore this article aims to clarify some of the areas where members may have received a mixed message. It also looks at some of the practicalities of the new rules and what the Chartered Institute of Taxation (CIOT) has been doing (through consultation), to highlight these unclear areas to the Inland Revenue and the government.
On 5 December 2002 the Public Accounts Committee (PAC) issued a report on Tax Credits (see http://www.publications.parliament.uk/pa/cm200102/cmselect/cmpubacc/cmpubacc.htm ). It features ‘old’ tax credits (primarily the audit role of the Revenue and the National Audit Office where old credits were paid by employers), but contains some useful information on new credits:
- The computer system for new tax credits is eight times bigger (or ‘more complicated or whatever’) than the self-assessment computer system (Ev. 11).
- The costs of setting up and administering new tax credits is estimated at £1billion over four years (Ev. 11)
- The Revenue has a data warehouse to enable it to review the details of living arrangements such as who lives in a household (Ev. 12). It describes its work in this area (and the need to become more intrusive on personal circumstances) as not entirely new – ‘when an additional personal allowance was paid to a single parent we needed to be sure that the person who was claiming the allowance was not living with somebody as a partner’ (Ev. 11,12)
In submitting evidence to the committee the Revenue were unable to be precise about the likely numbers of individuals eligible for new tax credits, but another recent report from the Institute for Fiscal Studies (The Benefits of Parenting, Commentary 91, November 2002) suggests:
- almost all of the seven million families in the United Kingdom (UK) will receive some form of new child tax credit;
- total government child contingent support in 2003 is estimated to be in the order of £21billion (old tax credits were £4.7billion, in 2000–01, according to the PAC report);
- ‘there should be no doubting of the scale or importance of the new child tax credit’ (p. 47).
Any members who are still thinking that new tax credits can be ignored may have to think again!
What is income for tax credit purposes?
The definition of ‘income’ for tax credit purposes has been a confusing issue, but with the regulations now laid the following are clear:
- employee benefits to be included are cars, fuel, taxable mileage allowances, value of second-hand goods (where the higher measure of cost will be used if the employee is remunerated at £8,500 or more or is a director), employee’s bills paid by the employer; cash and non-cash vouchers and credit tokens (but not those provided for childcare). Employer owned living accommodation is not included;
- pension income is included;
- full relief is given for tax-relievable pension contributions, give-as-you-earn (GAYE) payments and Gift Aid, but only for payments made in the year; there is no provision for carry backs. There is a problem in that the claim forms do not include a space for claiming Gift Aid, but the position is to be rectified in future editions. Claimants who made Gift Aid payments in 2001–02 can phone the Tax Credits Helpline in case the payments make a difference to their 2003–04 initial award. For Gift Aid payers on higher incomes the payment may make no difference because they will only be entitled to the family element of Child Tax Credit i.e. their tax credit award in not so ‘income sensitive’ (see below);
- no relief is given for tax-deductible payments by the employee to a share incentive plan (SIP);
- the £300 de minimis exception for ‘other income’ applies to the joint income from pensions, investments, property, foreign sources and any notional income. Employment income, self-employment income, social security income, student income and miscellaneous income are calculated separately and added to the surplus ‘other income’ over £300.
Fuller details on what is income for tax credit purposes are in the final version of The Tax Credits (Definition and Calculation of Income) Regulations 2002, No. 2006 available at http://www.legislation.hmso.gov.uk/si/si2002/20022006.htm.
Changes in income?
This area also needs careful thought. The new tax credits system is designed to be responsive, but is more responsive to in-year changes in circumstances than in-year changes in income. It can respond to changes in income but only has to at the year-end. There is no three-month rule to notify a change in income.
Claimants make their first claim based on their previous year’s income (for 2003/04 this is the ‘previous previous year’s’ (PPY) income, to get the system up and running for April 2003 – see the article on Keep those 2001/02 P60s, Tax Adviser, May 2002). For example, those making a claim beginning in April 2003 will have to provide income details for 6 April 2001 to 5 April 2002 as this will be the last complete tax year for which details will be readily available.
The claimant will then get an award notice detailing the credits they are due based on this previous year figure. If the real figure for income is different, they do not have to notify the Revenue in-year, but may do so if they choose. If they do not tell the Revenue in-year the reconciliation with their real income is made at the year-end.
Falls in income may result in an increase in credits, but only if the change, looking at the tax year as a whole, is large enough in the particular circumstances of the claimant, and/or will not be eradicated by a later rise in the same year.
For example, a couple may be earning £30,000 a year in 2001–02 and continue on this income level until September 2003. One member of the couple then loses his or her job and the joint income drops to £10,000 a year. The rate of tax credits they are entitled to is such that an income change of this size is large enough to make a difference to their claim. On an income of £30,000 they are only getting the family element of the child tax credit (CTC), but with an income of £10,000 they will get some child elements also, which will entitle them to higher tax credits. But because the measure of income is based on the tax year, their tax credits’ income for 2003–04 is £20,000 (30,000 x 6/12 plus 10,000 x 6/12). This is still too high an income for them to get the child elements of CTC and boost their tax credit claim. They must wait until 6 April 2004 when they will have a complete tax year on an income of £10,000 to be entitled to the low-income, more ‘income sensitive’ credits.
Likewise if an individual with an income of £10,000 a year, drops to £8,000 a year six months into the tax year (September 2003), but then gets a rise to £12,000 (January 2004) for the last three months of the year, his/her income over the year as a whole will still be £10,000 and the rate of tax credit remains unaltered.
What if such an individual notified the Revenue of a change of income in September 2003 and had their tax credit claim revised? (On these lower incomes, the tax credit award may be fully ‘income sensitive’. This means that his/her income and maximum credits are sufficiently matched so that every £1 drop in income results in an increase in credits of 37 pence). In this case the claimant could end up with an overpayment of tax credits by the year-end. The solution would be to ensure that the Revenue is told of the rise in income in January 2004.
There is a rule that if a claimant expects his/her income for a year to be no more than £2,500 above the income for the previous year there is no need to inform the Revenue. However, in the example above the £2,500 de minimis limit on increases in income will not operate because it only applies to increases in income from the base-line figure of £10,000 a year when the tax credit claim is made. It will not operate when the income increases from £8,000 to £12,000 as over the year as a whole the total income remains £10,000.
The CIOT has been actively involved in the discussions on tax credits, seeking to ensure that the rules operate as fairly and as sensibly as possible. This has led to a number of changes from the original drafts of the rules.
The Institute has raised the matter of income changes through the consultation process and there was debate on some of the issues in the House of Lords during the procedures on some of the tax credit regulations (see http://www.publications.parliament.uk/pa/ld199900/ldhansrd/pdvn/lds02/text/20729-21.htm#20729-21_dl0 and following). From these it can be seen that the government regards anomalous results, such as those shown above, as an inevitable consequence of integration with the tax system and alignment with the tax year. But they are consequences which may not be familiar to those used to claiming ‘old’ tax credits (Working Families’ Tax Credit and Disabled Person’s Tax Credit).
Marginal rates of ‘taxation’ and rates of ‘relief’
A 37 pence in the pound withdrawal rate for those claimants entitled to any credits other than the family element of CTC means that many taxpayers will suffer a marginal rate of ‘taxation’ of 70 per cent. This is made up of:
National Insurance 11 per cent (if employees)
Basic rate tax 22 per cent
Tax credit recovery rate 37 per cent
Total 70 per cent
This will be softened by the fact that the first £2,500 increase in income from the previous year will be ignored for tax credit purposes. However, the rate of ‘taxation’ will affect the next year’s claim.
Payments that can reduce income for tax credit purposes (pension contributions, Gift Aid, allowable business expenses etc.) may give a much higher than normal rate of ‘relief’, 59 per cent (22 per cent plus 37 per cent] for instance. This would occur where an individual makes an additional tax allowable payment and the tax credit claim is fully income sensitive. A retirement annuity payment for example would reduce his/her tax bill by 22 per cent of the payment and increase their tax credit claim by 37 per cent of the payment.
For many middle-income families these figures will not be important as once a claimant is within the income range which entitles them only to the full family element of CTC, only major changes in income will affect their tax credit entitlement.
The fact that new tax credits must be claimed within three months should now be common knowledge. This three-month rule percolates through various aspects of the system, such that:
- any changes in circumstances which increase the rate of credit must be notified within three months to be effective (or they will only be effective from three months previously); and
- certain changes in circumstances must be notified within three months to avoid a penalty charge.
At present examples of the latter are:
- changes in the tax-credit-claiming unit i.e. ceasing or becoming a member of a ‘couple’, and
- changes in childcare resulting in a fall in average childcare costs of £10 a week or more, lasting for at least four weeks in a row.
Apart from the complexities of averaging costs the childcare change should be easily identifiable and, providing claimants are aware of the rules, a penalty should be avoidable.
But for ceasing or becoming a member of a couple the date of change may be considerably more difficult to identify and it is in this area, particularly, that the Institute has been emphasising the compliance problems. How the Revenue handle these problems will only become apparent in time, but readers may be interested to read the current staff guidance on ‘Living Together As Husband And Wife’, abbreviated by the Revenue to LTAHAW, in their Applicant Compliance Guide written for ‘old’ tax credits. The relevant chapter can be viewed at http://www.hmrc.gov.uk/manuals/acgmanual/ch9/acg09000.htm. A look at this is slightly frustrating as much of the text is withheld under the Code of Practice on Access to Government Information.
Appeals and links with self assessment
Although the Tax Credits Bill provided for appeals to be made to the General or Special Commissioners, during the course of the parliamentary processes it was decided that, for the time being at least, appeals (other than those relating to employers) should be to an appeal tribunal and a Social Security Commissioner (see Tax Credits Act 2002 (TCA 2002), s. 63). It was felt that this appellate body would be more familiar with the rules and situations which could be relevant to new tax credits as they had considerable experience from the operation of ‘old’ tax credits.
This change has implications for CIOT members, who may be representing clients claiming new tax credits, as the rules on procedures and late appeals are very different from those under Taxes Management Act 1970 (TMA 1970) and the General and Special Commissioners’ Regulations. This area, and the matter of compliance and the interaction with self-assessment generally (see e.g. TCA 2002, s. 20 for instance), are of sufficient importance to merit a further article when more is known about the likely Revenue practice in this area.
Welcome advice for clients?
The Revenue has been targeting potential tax credit claimants by ensuring that claim forms go out to ‘old’ tax credit applicants and recipients of the tax reducing children’s tax credit. However, there is one new category of claimant who may miss out – unless well advised. Children’s tax credit stops when a child reaches the age of sixteen (Income and Corporation Taxes Act 1988 (ICTA 1988), s. 257AA(4)), but the new CTC is paid to those responsible for qualifying young persons ( of the Tax Credits Act 2002 s. 8(1)). Such a young person must be aged 16 to 18 and basically be either in full-time non-advanced education or registered with the Careers or Connexions Service. (For full qualifying conditions see the Revenue leaflet WTC1 or Regulation 5 of The Child Tax Credit Regulations 2002, No. 2007.) Clients who have older children probably still living at home and doing A-levels need to be told they may be able to get £545 a year for one, or up to, two years, by filling in a TC600. Some compensation perhaps for the joys of older teenage progeny?!
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February 2003 by