Child benefit and tax – uncomfortable bedfellows?

Published on 18 January 2012

Even if the Government solve the potential unfairness of withdrawing child benefit from a claimant immediately he, she or his or her partner or spouse becomes a higher rate taxpayer, that will still leave a host of administrative problems to resolve. At worst the new policy could spell the end of independent taxation, or become effectively a new tax on marriage.

The Prime Minister and the Chancellor have now announced that the Coalition Government policy of withdrawing child benefit from households in which there is a higher rate taxpayer will go ahead, but be made fairer. They were referring, of course, to the cliff edge whereby a household with one earner on (say) £44,000 a year, just above the higher rate threshold for tax, would lose their child benefit, while a household with two earners, each on (say) £42,000 a year, just below the threshold, would keep theirs.

The policy sounded simple enough when first announced at the Conservative Party Conference in 2010. But the implementation will open up all sorts of complexities. There are two main problems apart from the cliff edge: the absence of any definition of ‘household’ in tax law; and the fact that it is impossible to tell who is a higher-rate taxpayer until their income for the whole tax year is known. Underpinning them are the dissimilarities between tax and benefits which have always made the two systems uncomfortable bedfellows.

The cliff edge – and some history

The Prime Minister said that they are looking at ‘the steepness of the curve’ and how it is implemented. Tapered withdrawal is nothing new in the tax system. The age-related personal allowance is tapered away by £1 in every £2 when income reaches a certain level (£24,000 in 2011/12). The basic personal allowance goes through a similar process once a taxpayer’s income reaches £100,000.

Tapering was also used during 2001/02 and 2002/03 when children’s tax credit took over from the additional personal allowance (a tax reduction for people with children) and the married couple’s allowance, both of which were abolished for the under-65s from 2000/01. In 2003/04 children’s tax credit itself was abolished and replaced with child tax credit.

While it lasted, children’s tax credit was very much an integral part of the tax system. It was given as an income tax reduction and was paid through the PAYE code, or via self assessment. Where one partner in a married or unmarried couple had income chargeable at the higher rate of tax, the credit was progressively withdrawn by £2 for every £3 of income in the higher rate band.

It may be that the Government is thinking along similar lines for child benefit. But what may have worked for children’s tax credit will not necessarily work for child benefit. Children’s tax credit was part of the tax system; child benefit is not. Children’s tax credit as an income tax reduction was worth nothing to people who paid no tax; child benefit is paid at the same rate to everyone. Child benefit has never been means-tested, has never been part of the tax system and is assessable weekly not – like tax – annually.

So if the Government are thinking of a tapered withdrawal of child benefit once household income reaches the higher rate band, they will have to contend with huge administrative complexity because of these fundamental differences in structure and design.

What is a ‘household’?

Child benefit is payable to a person for any week in which he or she is responsible for one or more children or young persons. Responsibility for a child entails two things: that the person has the child living with them, and is contributing to the cost of providing for the child, in that week.

Thus child benefit was always intended to go to an individual who cared for a child, irrespective of what their spouse or partner earned. The rationale for this, no doubt, was the fact that a person who lives in the same household as a high earner does not necessarily have knowledge of, or access to, their partner’s earnings. Child benefit is one of the simplest instruments in the social security system, and it is because it is so straightforward that its take up is consistently around the 98% mark.

Independent taxation has been a feature of the tax system for the last quarter of a century – husbands and wives have each been responsible for their own tax as individuals. But if the proposed withdrawal of child benefit goes ahead, because the computer systems operating child benefit are incompatible with other systems in HMRC, taxpayers and benefit recipients will themselves have to supply income data to HMRC.

This means that couples will have to be open with one another about their financial affairs, or perhaps face penalties and other sanctions from HMRC. Independent taxation will become a thing of the past, at least for child benefit recipients.

What if a couple split up during a tax year? If they are married or civil partners, the tax system will treat them as continuing to live together unless and until they are separated under a court order, or in such circumstances that the separation is likely to be permanent. One only has to look at the number of cases in which HMRC have tried to argue that separated couples remain inextricably bound to one another for the purpose of claiming child tax credit, but later on have had to relent or have been overruled by the tribunal, to understand that the question is by no means clear cut.

In tax credits, HMRC naturally tend to favour joint claims and therefore incline towards finding a continuing relationship even where the parties do not regard themselves as being together. The same is likely to happen if the choice is between paying child benefit or not – HMRC may be more inclined to recognise the continuance of a household if it enables them to deprive one member of it of their child benefit.

A single mother may think twice about starting a relationship with a higher-rate taxpayer if it means she will lose her child benefit – will this be a new ‘tax on marriage’?

What if a couple take a long time to separate – how will one determine the point at which the household has ceased to exist? And how will trial separations be treated? If such difficulties of statutory interpretation are already arising in relation to couples who are married or civil partners, how will these questions be decided in relation to unmarried couples who are as yet unrecognised by the tax system?

Another difficulty we have seen with tax credits is that claimants do not always keep HMRC informed of their single/couple status, even if their changed circumstances would entitle them to more tax credit, not less. They simply have other things on their minds at such times. The efficient working of a system that pegs child benefit entitlement to household income will depend upon both partners keeping HMRC promptly and fully informed of any changes in their circumstances. Any delay of more than one week is likely to cause an overpayment of child benefit to arise – and everyone knows what a huge problem overpayments of tax credits have proved to be.

Inevitably, also, there will be an increase in intrusive HMRC enquiries and investigations into the status of CB recipients and their households – something which only tax credit claimants have hitherto experienced.

Who is a higher-rate taxpayer?

The other big question is how one determines whether a person is a higher-rate taxpayer. Year by year the higher rate threshold is creeping downwards in real terms in order to pay for above-inflation increases in the personal tax allowance, so each year more people are becoming higher rate taxpayers who were previously only basic rate taxpayers.

For many, an adjustment to their PAYE coding will alert them to the fact that they are now higher rate taxpayers. But others may not realise their new tax situation until they prepare their tax return a year and ten months later. That will be 95 weeks during which they or their partner may have been receiving child benefit, blissfully ignorant that they should not have been. How will the overpayment be clawed back?

Besides, nobody knows what their income will be for a year until that year is over. The new system will have to cope with the £40,000 earner who gets a £5,000 bonus, the £50,000 earner who loses their job or gets a nil bonus, or the basic rate taxpayer who is made redundant but the redundancy payment takes him into the higher rate band. One could think of many more examples of the same thing.

Finally, national insurance credits towards a state pension are available to those who care full-time for children through their child benefit. If they no longer receive child benefit, the Government will have to find some other way of ensuring they continue to be credited with national insurance contributions.

Big questions

These, then, are some of the big questions which Treasury officials will be wrestling with in the next 12 months, before this change takes effect. How to manage the cliff edge between the two-earner household on the right side of the higher-rate threshold, and the one-earner household on the wrong side of it, may yet turn out to be the least problematic.

(18-01-2012)

Contact: Robin Williamson (please use form at http://www.litrg.org.uk/ContactUs)