When you fill in your tax credits claim form or your annual declaration, you need to state what your income was for the last tax year. For example if you fill in a claim form during the 2013/14 tax year it will ask for your income for the 2012/13 tax year. In both cases the notes accompanying the form give 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.
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.
- pension income
- investment income
- property income
- foreign income
- 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.
- employment income
- social security income
- student income
- miscellaneous income
- Add together the amounts in Step 1 and Step 2
Add trading income to - or if there is a loss subtract trading loss from - the total in Step 3
- bank conversion charges or commission
- gross gift aid, payroll giving or give as you earn donations made in current year
- gross pension contributions
Unlike most social security benefits, for tax credits the gross income is used - that is income before tax and national insurance contributions are taken off. 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
The guidance notes follow the claim form and show you the information you need to include; this commentary covers some of the points you should note when completing the form.
Social security income
This category includes, broadly, taxable state benefits and excludes the non-taxable benefits. The notes to TC600 (see page 11) show which benefits to include and which to leave out. Income-based jobseeker’s allowance, although taxable, is not income for tax credit purposes.
Note that state pensions are included not here but under 'other income' in box 5.6 of the form (see below) - the significance is that the other income category is broadly the Step One equivalent and therefore eligible for the £300 deduction.
See pages 12-14 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.
'Deemed payments' under the IR35 rules for income tax are not included in employment income. The IR35 rules come into play if you are an employee of your own company, and you have to pay tax not only on the dividends and salary you receive from the company, but also on the payments your clients make to your company.
From 06 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.
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.
Taxable benefits that are not counted for tax credits are living accommodation, vans, beneficial loans, taxable sick pay, and scholarships.
Other payments and benefits that are disregarded for calculating income tax on income from employment (for example, the provision of one mobile phone for an employee, or of computer equipment, etc) are generally disregarded in assessing employment income for tax credits.
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. Payment of the Continuity of Education Allowance to members of the armed forces during their employment or after their death is also disregarded.
Gross contributions to an occupational pension scheme are deducted here, along with any give-as-you earn contributions made through the payroll. HMRC have produced worksheet TC825 to help with these deductions.
£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 15.
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) are classified on form TC600 as Other income. Follow the guidance on page 16.
- 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.
Trading losses cannot be carried forward for tax credits unless the trade in which they were incurred is being carried on upon a commercial basis and with a view to realising profits.
HMRC have produced worksheet TC825 which gives guidance on certain deductions and trading losses.
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.
- 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.
- 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).
- Income which would become available to claimants if they applied for it.
- 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 16.
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 04803 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.
Back to the top