Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Emergency Budget: Tax credits - how it bites

by
23rd Jun 2010
Save content
Have you found this content useful? Use the button above to save it to your profile.

Rebecca Benneyworth offers a technical summary of the tax credits changes and how they apply.

There were cries of “shame” in the House when the chancellor gave the lowdown on tax credits for high earners. Known fairly widely in the tax profession, but possibly not to the general public, the combined impact of the £50,000 income limit for the family element of tax credit, and the income disregard of £25,000 per annum conspire to allow some people with income of up to £83,000 to claim tax credits.

Osborne has stopped the rot with a wide range of change to the tax credit system, but has stopped short of massive change, relying on tinkering with rates and thresholds to achieve the effect he wants - to stop wealthy families gaining entitlement to this benefit and to reduce the cost of tax credits, albeit by a small margin on the £30bn a year they currently cost.

The changes
The following changes to the existing tax credit regime have been announced:

  • The taper rates will be aligned at 41% each – up from 39% for the main tax credit benefit and from 6.7% for the family element. This will focus the payments on the lower paid and remove benefits from higher income recipients. The main taper rate will change in 2011, and the family element rate from 2012.
  • The baby addition for the family element will be withdrawn from April 2011, reducing the family element to £545.
  • The family element threshold will reduce from £50,000 to £40,000 from April 2011.
  • Backdating of tax credits is currently available for three months – by request – backdating is not automatic. This will be reduced to one month with effect from April 2012.
  • The income disregard for income increases will be reduced from April 2011 from £25,000 to £10,000; from April 2012 this will reduce to £5,000. This once again raises the spectre of tax credit debt for those who see their income increase in the award period, which is the reason the limit was increased.
  • There will be a new income disregard for income decreases which will mean that a reduction in income of less than £2,500 will be ignored for tax credit purposes, potentially denying additional claims of up to £1,025 per annum. This will commence in April 2012.
  • The 50+ return to work additional element of working tax credits will be abolished from April 2012.

The effects
Ignoring the impact of inflationary changes, the changes in the thresholds and taper rates would have the following impact over the next two years:

For families with two children and full time working parent, with income of £20,000 per annum:

  • Current year net award £4,449
  • 2011 net award £4,177
  • 2012 net award £4,177

For families with two children and full time working parent with income of £41,000 per annum:

  • Current year net award £545
  • 2011 net award £478
  • 2012 net award £135

For families of two children with maximum childcare claim for both with income of £48,000:

  • Current year net award £6,009
  • 2011 net award £5,464
  • 2012 net award £4,632

Income disregards
Clearly, however, some of the worst excesses of the tax credit system will be eliminated by the reduction in the income disregard. The following example may suffice:

John has two children and the family’s normal income is £30,000. John plans to invest £25,000 in a new zero emissions vehicle on which he will receive 100% first year allowances, thus reducing his income for tax credit purposes to £5,000. His tax credit claims are as follows (under the current system):

2010/11 Provisional award based on income of £30,000 £550
  Final award based on actual income of £5,000 £9,745
     
2011/12 Provisional award based on income of £5,000 £9,745
  Final award based on income of £30,000 (disregard increase) £9,745

The total value of additional tax credit award towards the purchase of vehicle is £18,390 (as the family element would have been available in any event)

Under the new rules, the following awards would be made (ignoring the change to the taper rate):

2010/11 Provisional award based on income of £30,000 £550
  Final award based on actual income of £5,000 £9,745
     
2011/12 Provisional award based on income of £5,000 £9,745
  Final award based on income of £30,000 (disregard £10,000 of increase) £4,449
OR (2012/13) Final award based on income of £30,000 (disregard £5,000 of increase) £2,499

Therefore, the tax credit contribution to the purchase of the vehicle is £12,673 when the income disregard reduces to £10,000 and £10,723 when it reduces to £5,000. The income reduction disregard has minimal effect here as the net income after the reduction is below the taper threshold of £6,420.
 

Replies (2)

Please login or register to join the discussion.

avatar
By steve marsland
28th Jun 2010 14:09

Tax Credits

Good article written by Rebecca but I would like to mention a couple of points and I am more than happy to be corrected as this is such an important area for our clients as in 2012/13 I can see our clients being the position whereby they end up being overpaid tax credits because of the reduction in the income disregard.

The first point is the calculations that Rebecca prepared for 2011/12.  Just a minor point, but the reduction is at 41% and not 39%.  Or should we read this as an effective tax rise of 2% for those receiving tax credits who are on very low incomes!!

Secondly, from my review of the budget notice headed 'Benefits and Tax Credits' (see link below) it would appear to indicate that from 6 April 2011 the second withdrawal rate, which currently is 6.67%, is being increased to 41%.  This would mean that the for those individuals entitled to the family element only of £545, their household income would only have to be £41,330 (£545/41% + £40,000) to lose out on tax credits altogether.

This notice also refers to the fact that from 6 April 2012 the tapering of the family element will begin immediately after the tapering of the child element which if I am reading it correctly means that a family with 1 child (currently entitled to a maximum tax credits of £7445 assuming no disabilities and child care etc) would lose all entitlement to tax credits at a household income of £24,578 (£7445/41% + £6420).  Can this be right or am I missing something!!!!!!!!!!!!

Please correct me if I have read the article incorrectly (www.hmrc.gov.uk/budget2010/bens-creds-all.pdf)

Steve Marsland 

 

 

Thanks (0)
avatar
By keith_j
01st Jul 2010 17:41

Tax credits

Steve, my reading of Rebecca's article and the budget guidance is broadly the same as yours. My only comment on your calculations is that the Chancellor announced an increase in the child element of Child Tax Credit of £150 per child from April 2011 so the current maximum amount of £7445 will increase to £7595. Thus a family with 1 child will lose all their tax credits at an income of £24,944.

Your basic conclusion is correct that many families on modest incomes will cease to be eligible for tax credits. Thus the changes have gone further than either the Lib Dems or the Tories put in their manifestos.

Like you I am worried about the reduction in the income disregard. We have many self employed clients who are eligible for tax credits who are likely to end up with overpayments through no fault of their own. I appreciate that the £25,000 income disregard was open to abuse but a reduction to £5,000 is going too far in the other direction .

Thanks (0)