Universal credits

Since April 2014, it has no longer been possible to make new claims for tax credits, but the bulk of tax credit or benefit claimants will not be in the new system until 2015/16.

When working tax credit and child tax credit were introduced, many tax practitioners chose not to advise on these benefits. This is unlikely to be an option when universal credit comes into force.

HMRC’s welfare responsibilities are to be moved back to the Department for Work and Pensions (DWP), but the welfare implications of tax advice will become more important for tax advisers.

One reason for this is real time information (RTI), where employers are required to report their employees’ pay, tax and national insurance deductions to HMRC online, on or before payment, and HMRC makes the data available to the DWP to calculate the employee’s entitlement to universal credit. 

There will be no penalties for the first year of operation of RTI, but when the majority of persons become entitled to universal credit, this may no longer be the case.

Tax credits - working tax credit in particular - support many business owners when starting out or experiencing difficult times. Disabled people in particular have been helped from welfare into work by these credits, which are aligned with the tax system. Many may have never needed to complete a tax return; this is about to change.

However, whereas there are problems with employees, not least in relation to the higher income child benefit charge, it is the self-employed who will need most assistance and these are the client base of many practitioners.

‘Gainful self-employment’ means that the claimant is carrying on a business that is ‘organised, developed, regular and carried out in expectation of profit’ and the claimant is taking active steps to increase their earnings. This would usually be expected to reach the equivalent of 35 hours at the minimum wage per week. In this case, the claimant’s earnings from self-employment are subject to the minimum income floor (a minimum level of profit per month).

Where they do not meet this requirement and the claimant continues in self-employment, they will be subject to conditionality requirements; they must attend interview courses and take steps to increase their earnings.

It is the calculation of self-employed earnings that will place the greatest burden on small businesses. Self-employed earnings are based on the ‘gross profit’ of a monthly assessment period.

Unlike the normal accounting definition of ‘gross profit’, the figure will be based on the actual receipts of the month, including tax, VAT or NICS repayments from which are deducted tax, Class 2 and 4 NIC, and ‘permitted expenses’ wholly and exclusively incurred for the purpose of the business, except any that were ‘incurred unreasonably’ (not defined)!

No deductions can be made for payments of capital or interest on a loan.

Unlike normal accounts, there is no provision for accruals or carry forward of a deficit from one month to another. Thus an annual expense (insurance is a prime example) incurred for a year in advance can only be deducted in the month in which it is paid, even though it relates to a whole year.

Universal credit is based on an assessment period of one month. The requirement to account monthly on a different basis from HMRC and within seven days from the end of the month will create an enormous burden on small businesses and they are the most vulnerable. The basis of reporting will also create distortions and the accountant who can explain the differences will be needed more than ever.

Under these provisions a self-employed person can be doing the same tasks as an employed person and working the same hours for the same money and be deemed to be earning more.

The good news is that the legislation has yet to be debated and pass into law. We can only hope for some changes, but be prepared: the start is not far away.

Members are well advised to ensure that their engagement letters can cope with this addition to their services; in the case of tax credits, the composite letter may well be the recommended choice.

ACCA’s Technical factsheet 173: Engagement letters for tax practitioners - available in the 'Related documents' section on this page - may help.