Tax Credits
There are two tax credits of interest here - child tax credit (CTC) and working tax credit (WTC). You can claim for both if you are 25 or over and work 30 hours a week. (There are different rules for under 25s).The system works by adding together those elements for which you qualify, then looking at your income, and reducing the amount of credit (the "abatement") accordingly. If your income is too high, the credits reduce to nil. The maximum income for CTC is c£58k (£66k if there is a child under 1).
The initial claim is based on the previous year's income and revised when the income for the actual year is known.
There are major tax planning opportunities in certain circumstances, because it may be possible to reduce your income by making pension contributions, or by investing in your business and claiming capital allowances, and thereby increase the tax credit.
In addition, an increase in income from one year to another of up to £25,000 is disregarded - ie you are considered to have the same income in year 2 as in year 1 - which means that the tax credit benefit of such an income reduction in one year can apply also to the following year.
Example
Rates of tax, NI and tax credit in this article are those applying in 2007-8
David and Victoria are married with 2 children. They both work, and pay childcare of £250 per week. Their total income is £30,000.
They qualify for the following elements
| WTC | |
| Basic | 1920 |
| Couple | 1890 |
| 30 hours | 790 |
| Childcare (£250x52x80%) | 10400 |
| CTC | |
| Family | 545 |
| Child x2 | 4600 |
| Total | 20145 |
| Abatement | |
| Income | 30000 |
| Less threshold | (6420) |
| 23580 | |
| x39% | (9196) |
| T C payable (20145-9196) | 10949 |
David decides to buy a new energy efficient car for his business, qualifying for 100% FYA, and costing £10,000. There will be 20% private use, which is disallowed for tax, so his taxable income is reduced by £8,000. He therefore saves tax of 20%, and class 4 NI of 8%, a total of £2,240 (£8,000 x 28%). It also reduces the family income to £22,000, and reduces the tax credit abatement, (increasing the tax credit payable) by £3,120.
In the following year, actual income is again £30,000. However, because of the income disregard, the amount of £22,000 is again used for tax credits. So the car counts twice!
Hence:
| Cost of car | 10000 |
| Tax & NI saved | 2240 |
| Tax credit increase (3120 x 2) | 6240 |
| (8480) | |
| Cost of car after tax | 1520 |
Tax Planning Point
Capital expenditure can be used to reduce income and increase tax credit claims. A similar effect can be achieved using pension contributions.
Capital expenditure can be used to reduce income and increase tax credit claims. A similar effect can be achieved using pension contributions.
A critical point about tax credits is that they can only be backdated for 3 months before the date of the application. This means that if there is a nasty surprise on the income front more than 3 months into the tax year, the claim will be less than it might have been if a "protective" claim had been made.
Example
Bob the Builder, a single parent with 4 children, usually earns £75,000 per year, so he doesn't make any claim for tax credits. In September one of his clients goes bust, owing him £10,000. Then on January 1st he realises that the effect of the recession is much worse than anticipated, and makes his tax credit claim, which is backdated to October 1st. His final income for the year is only £50,000, less his bad debt of £10,000.
| WTC | |
| Basic | 1920 |
| Lone parent | 1890 |
| 30 hours | 790 |
| Childcare (£300x52x80%) | 12480 |
| CTC | |
| Family | 545 |
| Child x 4 | 9200 |
| Total | 26825 |
| Abatement | |
| Income | 40000 |
| Less threshold | (6420) |
| 33580 | |
| x39% | (13096) |
| Tax Credit full year | 13729 |
| Days claimed: 182/ 365 | |
| Tax credit payable | 6846 |
| Tax credit unclaimed | 6883 |
Bob would have received the amount of £13,394 if he had claimed from the beginning of the year on a precautionary basis. At first he would not receive anything. However, when he advises his change of circumstances and income, his claim is changed for the whole year.
Tax Planning Point
A claim for tax credits should be made as early as possible. Even if it appears that no credit will be due, circumstances may change.
A claim for tax credits should be made as early as possible. Even if it appears that no credit will be due, circumstances may change.
Regarding childcare, there is a weekly tax free allowance of £55 for employees. If this is accepted from the employer (for example by salary sacrifice) it may reduce the amount of tax credits payable. It may therefore be better to accept normal salary, or an alternative benefit.
Finally on tax credits, it is imperative to keep renewals up to date. A renewal pack is sent out in April and must be returned by July 31st to keep the claim live. There are also certain changes in circumstances that must be reported promptly to avoid penalty.