CPAG in Scotland Tax Credits Project: Factsheet 7

Tax Credits and Self-Employment

Background
Basic rules
Income and self-employment
Your accounting year-end
From high to low profits, and low to high
Estimating your income
Tax credits and self-employment
Working hours and self-employment
Further information and advice

Background

For some people who are self-employed, income and working hours can be uncertain. Work can be seasonal and include periods on benefits. Sometimes self-employment combines with other types of work such as part-time employment. This leaflet considers how tax credits can help you and looks at issues that particularly affect people who are self-employed.

Basic rules

There are two kinds of tax credits: child tax credit (CTC) and working tax credit (WTC).

To be eligible for CTC, you must meet the following condition.

• You are aged 16 or over and responsible for a child aged under 16, or (with some exceptions) aged 16 – 19 in full-time, non-advanced education or approved training

To be eligible for WTC, you must meet one or more of the following conditions.

• You are aged 16 or over, work at least 16 hours a week and are responsible for a child aged under 16, or (with some exceptions) aged 16–19 in full-time, non-advanced education or approved training
• You are aged 25 or over and work at least 30 hours a week
• You are aged 50 or over, returning to work of at least 16 hours a week after being on certain benefits for at least six months. If you are eligible under this condition, WTC can be paid for 12 months
• You are disabled, aged 16 or over and work at least 16 hours a week

There is also a residence in the UK test and an immigration test for CTC and WTC.

Tax credit awards run from year to year. The award is initially provisional until it is finalised at the end of the year. Every award runs out on 5 April (earlier if you no longer meet the qualifying conditions). When the award runs out, the Revenue (HM Revenue and Customs) sends you an Annual Review form and (usually) an Annual Declaration form to complete. This is to check your income and circumstances for the year and to finalise your award. The Annual Declaration also acts as a renewal claim.

Tax credits are means-tested. The amount you get depends on the level of your income. Couples claim jointly and both incomes are taken into account. The amount you get also depends on your personal circumstances so, for example, you may get more if you or someone in your family has a disability. You may also get help towards approved childcare costs if you qualify for WTC and meet other conditions.

This is a brief outline of the basic rules. See CPAG’s leaflet, Tax Credits – The Basics, for more about how to qualify for tax credits, how to claim and how tax credits are assessed.

Income and self-employment

Key facts about tax credits and income

• The tax credit assessment is based on income in a full year (6 April in one year to 5 April in the next year).
• At the start of your claim, the Revenue asks for income in the previous year and bases your award on that income.
• If your income goes up (compared to the previous year) this usually has no effect on your tax credit award until the following year (beginning 6 April). The exception is where your income has gone up by more than £25,000 compared to the previous year. In this case, your whole award is revised and based instead on your current year’s income less a disregard of £25,000. From the start of the following year, your new award is based on the full amount of income without any disregard.
• If your income goes down compared to the previous year, your whole award is revised based on the lower current year’s income.
• The Revenue checks your income at the Annual Review after the end of the year on 5 April and makes any adjustments. This can result in an overpayment or an underpayment.
• To reduce the risk of being underpaid or overpaid, you can provide an estimate of current year’s income at any time during the award.
• If you start getting income support or income-based jobseeker’s allowance, you are entitled to maximum tax credits while on benefit without an income test, so the amount of your income in the current or previous years does not affect your award.

Your accounting year-end

For tax credits, previous year’s income means taxable profits for the accounting year that ends in the tax year, 6 April to 5 April, before the year of your tax credits award. For current year’s income, you take the accounting year that ends during the year of the tax credits award.

You can make up your accounts to any date. But, if you claim tax credits, a 31 March or 5 April year-end is safest. That way, your tax credit award can respond to changes in your income more quickly. If you make accounts up to a date earlier in the tax year, like 30 April, you could be in difficulties if income starts to fall. You will be faced with high tax bills, low income and low tax credit entitlement – and there may be little you can do to change the position.

If you have an accounting year-end other than 5 April or 31 March, consider changing it. It could take a number of years to do this. You may need help. If you do not have an accountant, you can ask for help at any Tax Office.

A year-end of 30 September can be a good compromise solution. It enables you to work out your income tax liability before payments on account are due, while reducing your risk for tax credit purposes.

From high to low profits, and low to high

The income of some self-employed people varies a great deal from year to year – and even within a year. Taxable income may be high one year and very low the next or the other way around. This can happen for example, because:

• That is the nature of your business (such as farming or writing)
• You have purchased expensive equipment for the business in one year only
• Your business has run into difficulties

For income tax purposes you may be allowed to average these years. You cannot do this for tax credit purposes. However, if your business has made a loss, your self-employed income is nil for that year for tax credit purposes. If you or your partner have other taxable income (eg, earnings from employment), you should deduct the loss from that income. Any amount left over should be deducted from profits of the business in the following year(s).

If your business goes from high to low profits, there are special tax credit issues. Because tax credit awards are initially made on the basis of the previous year’s income, if previous year’s income was high, your initial award may be very low or even nil. You may not even consider applying for tax credits. When you start a new business your profits may go from low to high.

• If you applied for tax credits, received a nil or low award and profits fall. You should phone the Tax Credit Helpline and give an estimate of your current year’s income. Your award can then be increased to reflect the fall in income (but see ‘Your accounting year-end’ above). Take care when giving an estimate. If your estimate turns out to be too low, you will be overpaid tax credits. If your award is based on an estimate for the current year and you later give a higher estimate, the award will be revised based on the higher estimate (the £25,000 disregard only applies where current year’s income is higher than previous year’s income, not to increases in estimated income during the current year).
  
  
• If you have not applied for tax credits. You can consider making a tax credit claim to protect any potential entitlement you might have. The reason for making such a claim is that you can only backdate claims for three months, so if you do not claim within the first three months of the tax year you might lose some of your entitlement. This type of claim is sometimes called a protective claim. You make it to protect any entitlement you may have when there is uncertainty about your level of income.
  
  
• Remember to budget. With the £25,000 disregard, your profits can rise substantially without affecting your current year tax credit award. But next year’s tax credit award will be affected and could fall. Your tax bill may rise dramatically.

Estimating your income

To avoid overpayments and underpayments of tax credits during the year, you may need to give the Revenue a good estimate of your income for the current year of your claim. If your estimate is too high, then you will be underpaid tax credits. If it is too low you risk being overpaid. In view of the difficulties some people have repaying overpayments, it is probably better to estimate slightly on the high side for your income figure. The Revenue checks during the Annual Review at the end of the tax year whether your estimate was correct or not and revises your award accordingly.

When you are self-employed, it can be very hard to know what your income is during the year. If you have a regular pattern of paying your bills and collecting money due to you – and if you take a regular amount from the business for yourself, this should help you estimate your income.

As a self-employed person, your income for tax credits purposes is your taxable profit. This may be very different from the amount of money you take out of the business for private purposes. It is also different from your accounts profit. To make an accurate estimate of your self-employed income it is necessary to take the following things into account:

• Your accounting year. Taxable profits are based on your accounting year. Often your accounting year-end will be 5 April. If it isn’t, remember to choose the right 12-month period when you estimate your income.

• Profits not cash. Your tax credit income is the profit earned, rather than the cash the business makes or the amount of money you take for yourself. Watch out for changes in the bank balance, changes in what you owed or are owed, purchases of vehicles or equipment and changes in stock.
• Taxable profits, not accounting profits. Your accounting profit is unlikely to be the same as your taxable profit. Check the notes that come with the self-employment pages of your tax return for details here.

Tax credits and self-employment

Telling the Revenue about changes in your income
You need to keep the Revenue up to date with changes in your income and circumstances. You can do this by phoning the Tax Credit Helpline (0845 300 3900, text phone 0800 300 3909). Keep a note of the date and time of your call and what was said.

Income you can be treated as having – even when you don’t
Under tax credit rules, some things can be treated as your income, even though you wouldn’t think they are. This is called ‘notional income’ and includes

• Sums which tax law treats as income (eg if you repeatedly build your own home and sell it at a profit)
• Income you have deprived yourself of, in order to get more tax credits (perhaps by shifting income from one tax year to another)
• Income you would be entitled to if you claimed it (but you are not expected to claim a personal pension if you do not want to)
• Earnings waived or reduced, when the person receiving them can afford to pay the full rate (eg barter or working at a lower rate for a friend; charities are exempt from this requirement)

Working hours and self-employment

To claim WTC you need to work 16 or 30 hours a week depending on your circumstances. Hours only count towards working hours if you expect to be paid for them. For an employee, the connection between hours worked and payment received may be straightforward. This is not so for the self-employed. Some activities may be necessary, but they are only indirectly connected with payment. The Revenue says that you can include not only the hours costed to the customer but also time spent in necessary associated tasks, such as

• Trips to wholesalers
• Visiting potential customers
• Book-keeping
• Some sorts of research work where it is necessary for your work
• Cleaning business premises or a vehicle used in the business (like a taxi or a driving school car)
• Time spent in advertising

In particular, when you are between contracts, you may need to work out how much time you spend on associated tasks to see if you continue to meet the 16 or 30-hour threshold.

If your work is part time you may need to be careful that what you are doing is not classed as a hobby and not counted for WTC. On the other hand, you may regard what you do as a hobby while the Revenue treats it as paid work. The key test is whether you are paid or have a real chance of being paid, rather than just hoping to make money.

If you disagree with the Revenue’s decision on whether your work counts for tax credit purposes, you can appeal within 30 days of the decision on the award, or up to a year later in special circumstances.

Working irregular hours
Being self-employed, you may work irregular hours. This can make it difficult to know if you have reached the 16 and 30-hour thresholds for WTC. If your hours are different each week, but form a regular pattern, you should be able to average your hours over a couple of weeks to get a figure for your normal hours.

If your hours do not form a regular pattern, it is a good idea to keep a record of all the hours you work – so that you can prove the position if needed.

Where your working hours cross the 16 or 30-hour threshold (either going over or under the threshold), tell the Revenue. Call the Tax Credit Helpline. Keep a note of the date and time of your call and what was said.

Recording your partner’s hours
Couples claim tax credits jointly. Recording your partner’s hours, if they help you in the business and are paid for doing so, is important. Your combined hours may exceed 30 hours and enable you to claim the 30-hour element if you have a child (see below).

If you already work 16 hours or more a week, recording your partner’s hours may enable you to access help with childcare costs. Recording your partner’s hours, you may find that he or she reaches the 16 hours necessary for a couple with children to access help with childcare costs.

Coping with multiple jobs
Some people who are self employed also work as employees. You may have a number of part-time jobs as an employee together with self-employed work. For tax credit purposes, you add together all the income from your different jobs. If your total income falls, you can tell the Revenue via their Tax Credit Helpline and your award can be increased. You should also tell them if your current year’s income increases compared to the previous year. Tell them straightaway if the increase is more than £25,000 because your award may need to go down. Give them an estimate of current year’s income before 5 April if the increase is less than this so the Revenue can pay you the right amount on next year’s award from the start.

As a single claimant with a number of jobs, you can add together the hours you work in each to make up the 16-hour and 30-hour thresholds to qualify for WTC. For couples, each individual must add together his or her own hours from different jobs, ie, you cannot combine your hours with your partner’s to qualify for WTC (see below for combining hours for the 30-hour element).

Extra help if you work longer hours
If your hours increase so that you are now working 30 hours or more, then you are entitled to more tax credit – you get a 30-hour element included in your award. You should phone the Tax Credit Helpline to let them know. You need to do this within 3 months of the change to make the most of your claim.

If you are making a joint claim and have children, you can get the 30-hour element if you and your partner together work 30 hours or more ie, you can combine your hours. If you do not have children, you cannot combine your hours to reach the 30-hour threshold.

Time that counts as working hours
Normal holidays are ignored for calculating hours worked. Time off for meals, refreshments and hospital visits only count if you expect to be paid for them.

Time you are off work ill is usually treated as working hours for the first 28 weeks, so long as an employee in the same circumstances would be entitled to a benefit such as statutory sick pay or to National Insurance credits.

Further information and advice

CPAG in Scotland Tax Credits Project summary webpages

Child Poverty Action Group in Scotland
0141 552 0552 advice line for advisers on benefits and tax credits,
Monday, Tuesday, Wednesday and Thursday 10am to 12pm

Email: advice@cpagscotland.org.uk
email advice for advisers on benefits and tax credits

Website: www.cpag.org.uk
for more tax credit leaflets from CPAG in Scotland

CPAG publishes the Welfare Benefits and Tax Credits Handbook, a comprehensive guide to benefits and tax credits for claimants and advisers.

CPAG in Scotland’s advice line is only for advisers. If you are having problems with your own tax credit or benefit claim and are in need of advice you should contact your citizens advice bureau or other local welfare rights service.

HM Revenue and Customs
Tax Credit Helpline 0845 300 3900
(textphone 0845 300 3909)
Website: www.hmrc.gov.uk

© Child Poverty Action Group, August 2006
This leaflet is funded by HM Revenue and Customs.
CPAG in Scotland’s Tax Credit Project is funded by the Scottish Executive.

This fact sheet was last updated March 2008