Unexpected Bonus - ELIZABETH LATHWOOD BA, ATII looks at ways of improving cash flow for self-employed child carers

The effect of the rather disproportionate increase in the Class 4 National Insurance charge this year, with its consequent impact on payments on account under self assessment was highlighted by John Newth in his article 'Another Stealth Tax' in Taxation, 31 May 2001.

At the end of his article, John referred to reducing the payments on account by using the entitlement to working families' tax credit, an issue which I thought it would be useful to consider further. Some readers may still think that an individual earning £15,000 a year would not be entitled to any additional help from the state but, as John rightly points and the calculation below shows, Bruce's income would be boosted by £14.20 a week, or £738 a year, if he had a child aged under 16 resident with him and he had the knowledge and inclination to make a claim.

I have been waiting to see what references to this rebadged welfare payment would appear in the 2000-01 tax return. Should people paying taxes under self assessment be advised more directly, via their tax returns, as to the availability of this benefit? The answer is apparently not. There is no mention of it in the tax return – not even to make it clear that it is non-taxable. It is mentioned in the Tax Return Guide in the notes on employment at EN2, but I cannot find any similar point of clarification for the self employed.

Another source of confusion is that some commentators refer to working families' tax credit as a 'refundable' credit in that, even if it is in excess of the tax liability, it is paid to the individual often through the pay-as-you-earn system. This distinguishes it from a 'non-refundable (or wastable)' credit where the set-off is limited to the amount of tax, as in the case of the new children's tax credit. But to call working families tax credit 'refundable' is something of a misnomer, as it does not refund anything. It is purely a social security payment paid, in the case of employment, as an addition to net pay. It is shown separately on the payslip and on the form P60, and does not feature in any part of the self-assessment return. Its set-off against pay-as-you-earn tax, by the employer, is merely an administrative convenience with the employer effectively acting as a benefits bank or agency for the Government.

So where does this leave a taxpayer such as Bruce in John's article who faces large payments on account for 2001-02? If he does have a child resident with him, the best claim to reduce his payments on account is to point out to the tax office the availability of the children's tax credit. Following the Finance Act 2001, his tax bill for 2001-02 will reduce by £520. He might be expecting his bill to reduce by £1,040 if his partner is expecting a baby in the tax year, but this additional relief (the so-called 'baby rate') does not come in until 6 April 2002. If he is aware of the correct reliefs and knowledgeable enough to recalculate his liability including it, using 2001-02 rates and an accurate estimate of his profits for the year, he could ease his cash flow considerably. Should all practitioners therefore be considering this for their self-employed, child-caring clients?

The following calculation of Bruce's entitlement to working families' tax credit uses the June 2001 rates, and assumes the rate of profit remains the same (working families' tax credit claims for the self employed are generally based on previous six-months figures). It also assumes that there is no material difference in taxable profits and profits for working families' tax credit.

Regulation 23 of the Family Credit (General) Regulations SI 1987 No 1973 bases the tax and National Insurance deductions on the law applicable in the year of claim (see also paragraphs 38101, 38204 and 38208 of the Decision Maker's Guide, the 647-page Inland Revenue 'manual' on working families' tax credit). Statutorily the calculations are based on the length of the assessment period, but for the familiarity of the reader all sums are shown as annual amounts and a division by 52 applied at the end:

Working families' tax credit is based on post tax and National Insurance income:

Working families' tax credit credits:

Elizabeth Lathwood is technical officer – personal and capital taxes, at The Chartered Institute of Taxation.

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