• When you fill in your tax credits claim form or your annual declaration, you need to state what your income is. In both cases the notes accompanying the form give good accurate guidance as to what figures to put, and the fact that many income definitions are the same, or very similar, for both tax and tax credit purposes means that you can often copy details across from one set of forms to the other.



• This commentary will broadly follow the order of the guidance set out in the notes to form TC600.

The four steps

The legislation, like a set of do-it-yourself carpentry instructions, prescribes a series of four steps to work out tax credit income. The form does not require this, but we set out the steps below in order to give a complete picture.

1. Add together:

   1. pension income
   
   
   
   2. investment income
   
   
   
   3. property income
   
   
   
   4. foreign income
   
   
   
   5. Notional income
   
   
   If the total is £300 or less, ignore it. If it is more than £300, subtract the first £300. Note that there is no notional capital rule as for social security benefits - only the income from savings is counted.




2. Add together:

   1. employment income
   
   
   
   2. social security income
   
   
   
   3. student income
   
   
   
   4. miscellaneous income
   
   
   
3. Add together the amounts in Step 1 and Step 2




4. Add trading income to - or if there is a loss subtract trading loss from - the total in Step 3

   Then deduct:

   • bank conversion charges or commission
   • gross gift aid, payroll giving or give as you earn donations made in current year
   • gross pension contributions

General points

• Unlike most social security benefits, for tax credits the gross income is used - that is income before tax and national insurance contributions. This will sometimes necessitate a calculation to add the tax back to income which is received, or deductions from income which are paid, net.



• This is shown in the example



• Where a joint claim is made, the joint income of the couple is taken as in the example

Specific income categories

This section follows the order of presentation in the form TC600, and the guidance notes that accompany it. The guidance notes contain much detailed information; this commentary therefore deals only in outline with topics which are covered in more depth by those notes.

• Social security income

  This category includes, broadly, taxable state benefits and excludes the non-taxable benefits. The notes to TC600 (see page 30) show which benefits to include and which to leave out.

  Note that state pensions are included not here but under 'other income' (see below) - the significance is that the other income category is broadly the Step One equivalent and therefore eligible for the £300 deduction.

• Employment income

  See page 19ff of the notes to TC600.

  Employment income, again, broadly follows employment income for tax purposes, so that most employees can use the entries on form P60 or P45. Tips and gratuities are also included.

  Employment-related share income was added half way through 2003/04.

  From 6th April 2007 any amount paid to a person serving a custodial sentence or remanded in custody awaiting trial or sentence, for work done while serving the sentence or remanded in custody has been added to employment income.

  The payment to members of the armed forces (operational allowance) is now disregarded in the calculation of employment income as is the payment made as council tax relief to the armed forces.

  The provision of one mobile phone for an employee in respect of which no liability to income tax arises under S.319 of ITEPA is disregarded for calculation of employment income.

  Taxable benefits included in employment income for tax credits are broadly the cash equivalent of company cars and fuel, taxable expenses payments and mileage allowances, cash and non-cash vouchers and credit tokens, and money's worth.

  Gross contributions to an occupational pension scheme are deducted here, along with any give-as-you earn contributions made through the payroll.

  £100 per week can be deducted from employment income for each week you received statutory maternity, paternity or adoption pay.

• Income from self-employment (or trading income)

  This is basically the business profits appearing in your self-assessment return. See the TC600 guidance notes at page 23ff.

  Note the items that you are required to deduct from the figures you entered on the self-assessment form: including gross contributions to a personal (including stakeholder) pension scheme or retirement annuity premiums, and gift aid donations.

  Note also that if you have trading losses, the relief for them is computed differently from tax - see below.

  The income categories in Step One of the main computation (above) is classified on form TC600 as Other income. Follow the guidance from page 24 onwards.

  • Savings and investment income in general follows the tax treatment - eg interest on ISAs is not counted. To work out the gross equivalent of bank interest, dividends etc, follow the notes to the example of James and Jemima shown above.
  
  
  
  • Pension income also generally mirrors the tax treatment, including taxable pensions and annuities and excluding those which are non-taxable.
  
  
  
  • Property income is, again, the same as for tax purposes. If you let rooms in your own home for £4,250 a year or less, thereby qualifying for rent-a-room relief for tax purposes, those receipts are disregarded for tax credits purposes also. If letting property is part of your business and you include the profits as part of your self-employed income in your tax return, you should do the same on the tax credit claim form.
  
  
  
  • Foreign income includes income arising from possessions and securities outside the UK, whether or not it is remitted to the UK. To this extent it differs from what you may have put on your tax return.
  
  
  
  • Notional income is a difficult concept which is described in more detail below.
  
  
  
  • Miscellaneous income is broadly what used to be called Sch D Case VI income in tax - a sweeping up category which catches any taxable income not specifically covered elsewhere.




• Relief for trading losses

  While the computation of trading profits and losses are the same for income tax and tax credits, there are the following important differences in the way the relief is calculated for tax and tax credits.

  • Where the trader is part of a couple and a joint claim is in force, a trading loss in a year must be set off, for tax credits, not only against the trader's current year income but against the joint income of the trader and his or her partner.
  • There is no carry-back of losses for tax credits.
  • Any surplus may be set off against profits of the same trade in future years for tax credits (ie the same as ICTA 1988, s 385 for income tax losses).
  
  
  

  Unrelieved losses of 2001-02 can be carried forward to 2003-04 and beyond for tax credits; but losses incurred in years prior to 2001-02, or in 2002-03, cannot. These are effectively 'non-years' for tax credits, because the income of those years are not used for any tax credit purpose.

Notional income

Like other categories of tax credit income, notional income is defined by regulations rather than by act of Parliament. Regulations are made by civil servants under a power granted by Parliament (an enabling power).

The enabling power which gives authority for the regulations dealing with notional income is in the Tax Credits Act 2002, section 7(9). It states that for tax credits purposes a person may be treated:

• as having income which he does not in fact have; or
• as not having income which he does in fact have.

The object is clearly to prevent people from manipulating their income to claim more tax credit than they would otherwise be entitled to.

There are four categories of notional income, as follows.

1. Certain sums deemed to be income for purposes of income tax. In the tax system, there are so-called anti-avoidance rules which aim to prevent people manipulating their income in order to pay less tax.



2. Income of which claimants have deprived themselves in order to secure entitlement to tax credits, or to a higher credit (known in social security shorthand as income deprivation).



3. Income which would become available to claimants if they applied for it.



4. A reasonable rate of pay where work is done at less than the going rate, and the recipient of the service can afford to pay it. This does not apply where a volunteer works free of charge for a charitable or voluntary organisation.

• Sums deemed to be income for income tax

  An example of 1 above is income from trusts or other arrangements where the person who set up the arrangement can still, in certain circumstances, derive some benefit from it.

  Other examples are loans released to a participator in a close company; lease premiums treated as rent; scrip dividends (i.e. new shares given in lieu of cash); and so forth.

  See the TC600 guidance notes at page 25ff.

• Income deprivation

  An important point to note about category 2 above (income deprivation) is that there is a motive test: the restriction only applies to you if you deprive yourself of income for the purpose of securing entitlement to, or increasing the amount of, a tax credit.

  So, if you are a company director and you waive a dividend in order to retain the profits within the company so as to aid future growth, you ought not to be caught by the provision; if on the other hand you waived the dividend in order to increase your credit entitlement, you might be caught.

  About the importance of the tax credit motive relative to others, the Tax Credits Technical Manual at TCTM 04903 has this to say:

  the claimant may have more than one reason for disposing of income, only one of which is to obtain tax credit or more tax credit. Securing or increasing entitlement to tax credit may not be a claimant's main motive, but it must be a significant one.

Income available on making of a claim

Exceptions from category 3 above include:

• income from a personal injury trust;
• interest on personal injury damages;
• periodical payments under a structured settlement; and
• income under a personal pension (including stakeholder) scheme, a retirement annuity contract, or a state retirement pension.




It follows that such pensions can be deferred without the deferred element being counted as tax credits income under these provisions.

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