Tax credits - calculation of income rules

The relevant legislation is the Tax Credits (Definition and Calculation of Income) Regulations 2002, as subsequently amended. The legislation was amended in late 2003 to reflect some of the problems in dealing with the self employed claimant, and in particular to deal with losses brought forwards and carried forwards.

The income of the claimant, or joint claimant is calculated for the tax year as follows.

Step 1

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Comments

Employment income

Anonymous | | Permalink

The employment income is not straight forward. Some benefits included for tax are not included for tax credits. For example medical insurance and interest free loans.
The notes on how to renew a tax credit claim http://www.hmrc.gov.uk/forms/tc603rd-notes.pdf only request details of certain benefits from the P11D (see page 24 and 25).

It just makes it more confusing and complicated than it already is.

Mister E.

davidwinch's picture

In contrast with Social Security Benefits

davidwinch | | Permalink

I appreciate that this is a statement of the absolutely obvious, but the claimant's ownership of assets and savings has no impact on Tax Credits. (Income earned from savings does - but not the savings themselves.)

So it will often be the case that a person might be refused, say, Income Support, on the grounds that they have savings in excess of the permitted maximum for eligibility, but they would still be eligible for Tax Credits.

I am dealing with a steady stream of cases in which individuals are being prosecuted for fraudulent claims by the DWP in circumstances in which they were eligible for Tax Credits but did not claim them. Typically the fraud consists of failing to disclose savings or failing to disclose that a member of the household (typically a boyfriend who has moved in) is in employment.

On occasion the Tax Credits not claimed can actually exceed the DWP Benefits claimed fraudulently! However this does not prevent a conviction and a requirement to repay the Benefit obtained (even though it is no longer possible to claim the Tax Credit entitlement).

So if you have an involvement with those on low incomes and claiming benefits from the DWP do advise them to claim Tax Credits (and reasonably promptly) if they may be entitled to them.

David Winch

nogammonsinanundoubledgame's picture

Foreign Income

nogammonsinanun... | | Permalink

Rebecca, no doubt I could find it if I were not being lazy, but you say that employment, trading and investment income should be excluded from the category "foreign income". What, pray, is left? Casual earnings? No doubt the coin will land on its edge before it crops up in practice.

Incidentally, I do hope you intend at some time to do a similar series on Pension Credit. I was reminded by David's comment about capital savings being excluded from the means testing, which of course applies to the tax credits of the subject matter of this thread, but not I understand for Pension Credit.

With kind regards

Clint Westwood

Fiasco

The Black Knight | | Permalink

Unfortunately the system is too complicated for mere mortals who cannot afford accountants to ensure the claims are correct.
The average intelligence level is well below that attributed to the man on the clapham omnibus, after all if MP's get confused about much simpler rules, what chance does a single mum with a Gcse in childcare stand.

bzalcs-c184's picture

Tax credits

bzalcs-c184 | | Permalink

This is an excellent article and certainly clarifies some issues.

Where we always have trouble is to know if Capital gains should be declared or not. Does this go in Miscellaneous income. Or is it left out completely?

Capital gains are not included

Anonymous | | Permalink

I certainly have never included Capital Gains in the tax credit claims.

Mister E

Tax Credits Calculation

GeorgeBenson | | Permalink

Dear Rebecca,

Please could you add an example of doing the calculation to the article?

Regards,
George

nogammonsinanundoubledgame's picture

Capital gains, and other issues

nogammonsinanun... | | Permalink

Just to confirm the response to the earlier questioner, capital gains are excluded from the means test. Not to be confused with chargeable event gains, which are an income tax charge and, I understand, not subject to any kind of "top slicing" for tax credit purposes as they are for income tax purposes, despite that the gain accrues over several years. How iniquitous is that?

But I have another question for the gallery:

Is there any circumstance, in your opinion, in which a trader whose income is at the bottom end of a marginal taper band, might partially disclaim capital allowances and NOT be required to include the amount disclaimed as notional income in the tax credit declaration?

With kind regards

Clint Westwood

RebeccaBenneyworth's picture

Replies, replies

RebeccaBenneyworth | | Permalink

Sorry all, I've been standing up lecturing non stop recently. Tonight finds me in the delights of Premier Inn Taunton with a pub that stops serving food at 9.30 ( I arrived at 9.32 expecting it to be 10.... Kit Kat for main meal of the day, yummy)

Thanks for positive feedback. As many answers as I can.
Foreign income - I hadn't really thought about this, Clint but you must be right - how may claimants have casual foreign income?
Yes, capital gain (as in CGT) excluded (as Clint says)
Examples - I'll try to get an innovative way of presenting this - work in progress for the end of the week! (Finish lecturing until September on Thursday afternoon!)
Pension credit....yes, I'll take on holiday with me this summer and read on the beach then do some in the autumn... there's something to look forward to!
Disclaiming capital allowances... I think the issue would be that income after CA's is below £6,420 so you disclaim to bring you up to that amount. The balance remains in the pool and enhances claim next year, so that one has improved tax credit claim in future years by reducing capital allowances. But not by reducing income which is what the legislation requires so it isn't notional income. If I understood the question correctly? What an interesting outcome!
I'm working on something as clear as I can on the entitlement issue and minimum wage / employment contracts for next week.

Regards
Rebecca Benneyworth

Tax credits - a solution for accountants

steve marsland | | Permalink

Once again an excellent article from Rebecca about the calculation of income for tax credit purposes and intelligent replies from those commenting on the article. It seems that most of the replies to the articles written by Rebecca and to that matter other questions posted on Accounting Web come from the same people, but with so many people reading the articles, there must be interest out there from accountancy practices in tax credits?

As has been demonstrated in the article and from the replies the calculation of income for tax credit purposes is not entirely straightforward as is a lot of the other areas that go to make up a claimants tax credit entitlement. I think it is far to say that the vast majority of accountants in practice do not understand tax credits either! However, a lot of their clients will be within the tax credit system and those clients will be completing their annual declarations this month with no assistance at all.

Throughout the last six years of dealing with tax credits I have seen very few clients who complete their own tax credit annual declaration forms get it right. This is not surprising as although the annual declaration form requires in most cases the completion of 5 boxes for a sole claim or 9 boxes for a joint claim, the information required to be considered is similar to that for an SA tax return which runs to at least 10 pages plus all the supplementary pages on top of that! As an accountant would you allow your clients to fill in their own SA return with no assistance? We certainly wouldn't recommend to our clients that they deal with it themselves.

There will also be accountants out there that will receive/or have received phone calls from clients asking them for their income figures so that they can complete their tax credits annual declaration form (you know who you are!!!). Although the letter of engagement that the client has signed probably has a paragraph in it saying amongst other things "we don't affer any advice on tax credits". I can tell you that after speaking to numerous accountantancy practices across the country they still give client's what they believe to be the income figures despite what is stated in their letter of engagement, which is extremely worrying as how can an accountant possibly give these figures to client's without knowing what income is taken into account for tax credit purposes? Whilst the income figures are very similar to that entered on the SA tax return, there are specific rules as to what can be deducted from income for tax credit purposes such as SMP, SAP, SPP and how you treat pension contributions, gift aid payments, certain types of income where the client may have been retired/invalided out of the the miltary/police force, foster care receipts as well as other deductions and trading losses and how they are treated for tax credit purposes.

As Rebecca mentions in her article trading losses can be offset against total household income in the year of the loss, but any surplus can be carried forward and offset against future profits of the same trade. Be aware that trading losses can be relieved for income tax purposes in the normal way and thus could achieve a tax refund at 41%, but also the losses could be utilised for tax credit purposes and thus increase entitlement at effective rate of tax at 39% and sometimes even higher depending on future profitability of the business and family circumstances. We have seen cases where the trading losses have achieved a refund of income tax and increase entitlement to tax credits of well over 100%. We have also found over the years that in the majority of cases where trading losses arise the amount received by our clients in extra tax credits is far in excess of that received from a refund of income tax. You cannot simply ignore tax credits for your clients. Whilst the tax credits legislation is in place and rules remain as they are, your clients should be making use of them where possible.

As I have mentioned above, some clients will be in the system already and will probaly be getting their tax credit affairs wrong by, in some cases, using the income figures that their accountant has given them without the accountant really understanding the rules. As advisers to our clients we all strive to understand as best as possible our extremely complex tax legislation and advise our clients on mitigating their tax liabilities as much as possible, but without considering their tax credits position we are leaving a huge hole in that advice. After all with 6 million families in the system this is not something that may only affect some of your clients, your entire client base should be reviewed. Not withstanding the fact that you don't have to have kids to be entitled to some form of tax credits or be working to be entitled either.

It is my belief that accountants should be looking at their clients tax credit position as simply ignoring it or allowing your clients to do it themselves without pointing out the complexity of the system is potentially negligent. Harsh words you may say, or utter nonsense as your letter of engagement absolves you from this. But if you are advising your client's on how to structure their affairs in such a way to mininise the amount of income tax and NI they pay (after all is what the vast majority of our clients want us to do), and by doing so your clients miss out on being able to claim tax credits that in all likelihood will be far in excess of the income tax savings you have made them, would you still like to face your client after they have been told by someone else that has a knowledge of tax credits that they could have received many thousands in tax credits? Or for you to tell them that tax credits is not something you advise on and refer them to the paragraph in your letter of engagement which states that? I know I would not want to put myself or my practice in that position.

As some of you maybe aware if you read my previous reply to Rebecca's earlier article on tax credits, we have a solution for accountants should they decide to start looking at tax credits for their clients. We are at this moment turning the systems we use into a piece of software specifically for accountants that will allow them to offer tax credits to their clients. The complete package we have available right now is only available to members of AVN (www.avn.co.uk), but we will soon be making it available as a stand alone product. The curent package and upcoming software includes a number of tools, templates, standard documents as well as a tax credit award calculation sheet and we believe the combination of this together with a support line for accountants is unique. In basic terms it allows accountants to get up and running without having to 'reinvent the wheel'. The only requirement is the attendance at a one days training course on tax credits and the software, the next being on 29 July in London, although we can arrange in house training if necessary.

If anyone would like any further information, please feel free to email me on taxcredits@marslandnash.com.

Steve Marsland

redundancy pay

sjgriffiths1 | | Permalink

I think your explanation does answer this but just to clarify is it correct that tax free redundancy pay is not included in the employment income for tax credits purposes?

thanks

Residential letting losses

Ian Lawrence | | Permalink

I was advised last year that residential letting losses COULD be offset against other family income for the 2007/8 declaration. My client received a full award that year as a result.

Please could you clarify again on this matter

Many thanks

Ian

Redundancy Payments

steve marsland | | Permalink

The Tax Credit (definition and calculation of income) regulations 2002 Reg 4(f) is where you find details of the types of employment income that are included and excluded for tax credit puposes.

Regulation 4 (f) states 'any amount chargeable to tax under chapter 3 of Part 6 ITEPA' and this is in respect of payments in connection with the termination of a person's employment, a change in the duties of a person’s employment or a change in the earnings from a person’s employment, for example; statutory redundancy pay and compensation payments for wrongful or unfair dismissal. The amount to include as income is the amount in excess of £30,000.

This is the income tax provision. See Employment Income Manual paras EIM13760 (redundancy) and EIM12950-12970 (compensation) for further details. All payments within Chapter 3 of Part 6 of ITEPA, to the extent that they are taxable, count as income from employment for tax credit purposes.

I have lifted the above details from the tax credits technical manual at para TCTM04111 if you would like to look into it further. But basically, if they are non taxable, they aren't counted for tax credit purposes.

Steve Marsland

Residential losses

steve marsland | | Permalink

Chapter 8 of the Tax Credit (definition and calculation of income) Regs 2002 lays out the position with property income. You may also want to look at helpsheet TC825 on page 3 and I have lifted the relevant section and copied it below for you.

Note 3 – Property income
Letting property does not constitute a trade, so should not be included in any income from self-employment.

Rental property

If you have a rental property that made a loss, relief for tax credit purposes is generally given in the same way as for Income Tax. If you made a loss, include '0' in respect of this income in your calculation of 'other income' for the year.

Furnished holiday lettings

If your property income includes income from furnished holiday lettings, the rules allow losses from this source to be treated in the same way as trading losses. This means that you can set them against your other income (or if you are making a joint claim, your partner's other income) in the year the loss arises.
If your property income is from both furnished holiday lettings and other forms of property income, only the loss arising on the furnished holiday lettings should be treated this way.

Other losses on property income

Normally, the loss should be carried forward and set off against profits from the same source in the following tax year. If, however, part of the loss arises from capital allowances or from agricultural land, that part of the loss may be set against other income which you (but not your spouse or partner) may have, either in
the tax year in which the loss was made or in the following tax year. In such cases, the amount of loss relief available for tax credit purposes is based on your tax calculations. Please see the following example.

Example – James and Sarah are married. Sarah stays at home to look after the children. James has income from self-employment in 2008–09 of £50,000. He also lets several properties. The income and expenses of all the lettings are included in a single rental business. During 2008–09, James incurred allowable expenditure on his lettings business which resulted in a loss of £15,000. This loss would usually be carried forward and set against subsequent profits of the lettings business. However, James has some net capital allowances
due on his rental business, so part of the loss may be set against his general income of that tax year. For Income Tax purposes, the following items were included in arriving at the loss:
• capital allowances of £10,000
• balancing charge adjustment of £8,000
leaving net capital allowances of £2,000.

For tax credits purposes, James can claim tax credits loss relief for 2008–09 of £2,000. When completing his form TC603D Annual Declaration, giving his income for the tax year 2008–09, James may set £2,000 of his rental property loss against his self-employed income of £50,000. The balance of the loss (£13,000) is to be carried forward and set against his future profits from his lettings business (but not against his future general income).

Where the property income counts as a trade, such as Hotel's, B&B's and guest houses then I would agree these losses can be offset against other income as these are considered to be trades and taxed as such.

I hope this helps

Steve Marsland

Employment Income

steve marsland | | Permalink

I have deleted my last response as after looking at it again I am not entirely convinced that benefial loans or Medical Insurance premiums should not be taken into account as employment income despite what the tax credit worksheet says.

Employment income is defined in chapter 2 of the tax credit (definition and calculation of income) Regs 2002 and states employment income means 'any earnings from an office or employment received in the tax year'. The intrepreation section of the regulations confirms that earnings shall be construed in accordance with section 62 of ITEPA.

Section 62 of ITEPA explains what is meant by earnings and in relation to employment income means

(a) any salary, wages or fee
(b) any gratuity or other profit or incidental benefit of any kind obtained by the employee if it is money or money's worth (see EIM00530)
(c) anything else that constitutes an emolument of the employment.

Section 175 of ITEPA deals with taxable cheap loans and para 1 states that 'for the purposes of this chapter an employment related loan is to be treated as earnings from the employee's employment for a tax year if the loan is taxable as a 'cheap taxable laon' in the tax year'.

Given the definition is Section 62 I can accept that it doesn't fall under part a or b, but could it be seen to be an emolument of the employment? Perhaps someone could answer that for me.

Steve Marsland

Have you tried the HMRC manuals

Anonymous | | Permalink

Steve - The HMRC Tax credits technical manual goes into detail about employment income at TCTM04100 onwards http://www.hmrc.gov.uk/manuals/tctmanual/TCTM04100.htm

Personally if that manual does not mention a benefit, or excludes it, then I will follow it and not include it as income. I do not think loan benefits are mentioned as to be included as income for tax credit purposes.

I deal with a few clients tax credit claims and found that without some sort of spreadsheet to help me I'd struggle with it. Once you get to grips with the system it does become easier as you get used to the loss rules, what income is excluded, etc. Still there must be an easier way..........!

Mister E

Benefits in Kind and tax credits

steve marsland | | Permalink

Mister E, thanks for the reply. Have just located all the information regarding what benefits to include and not include at the following:

www.hmrc.gov.uk/manuals/ntcmanual/eligibility_estincome/ntc0310030.htm

This does in fact confirm that interest free loans are not included and neither are medical insurance premiums. It also would appear that the following benefits are also ignored:

Living accommodation
Vans
Services supplied
Assets placed at the employees disposal

Steve Marsland

Very handy

Anonymous | | Permalink

Steve - That list is very handy. I always look in the technical manual as previously found the tax credit manual did not include much information. It appears it has been updated since I last looked at it.

Thanks

MisterE

gsullymorgan's picture

Pension Credit & Tax Credits

gsullymorgan | | Permalink

One of the joys of trying to advise on benefits and tax credits is the necessity to fit together two, often contradictory, systems.

An example.

Someone who is in receipt of Pension Credit - Guarantee element will, if they meet the other conditions, be passported to the maximum rate of Working Tax Credit. (Hurrah, big income increase)

... but

WTC is taken into account as income for Pension Credit purposes

... so

The claimant may now have too much income to qualify for Pension Credit

... which means that

They are no longer entitled to be passported to maximum WTC

... and thus

their income drops, to a level entitling them to Pension Credit

... which means

They are passported to maximum WTC

.... carry on singing about holes in bucket.

The relevant departments have known about this for several years but a fix has still to appear.

In terms of the question about treatment of capital for Pension Credit purposes; unlike most Income Related benefits there is no 'capital cut off', a point at which entitlement to benefit ceases, but there is the usual notional income rule which applies. For people 60 or over that means for every £500 (or part) of assessed capital over £6,000 the claimant is treated as receiving £1 a week of income which will be counted as part of their resources for assessing benefit.

Actual income from capital is ignored. Interestingly, Council Tax Benefit has a cut-off at £16,000 of capital but can be received beyond that point of the claimant continues to receive the Guarantee Element of Pension Credit as that passports to maximum eleigible CTB.

The rules on valuation and relevance of capital are, of course, very different between the tax and benefits systems.

Gareth Morgan ( gmorgan@ferret.co.uk )

Tax credits further query

Anonymous | | Permalink

Chargeable event gains are included in other income in total for tax credit purposes. Does anyone know if a life insurance pay out to a spouse on death is included in total income?

Article on Tax Crdits and Employment Contracts

Anonymous | | Permalink

'Im working on something as clear as I can on the entitlement issue and minimum wage / employment contracts for next week.'

Does anyone have a link to the article referred to please as I can't locate it.

Thanks.