The Wrong Type Of Tax

Self-employed taxpayers with low profits may not be able to take full advantage of the children's tax credit, explains JAMES BROOM ATII.

VARIOUS TAX RELIEFS have been eroded over the years, as shown by David Reilly in his article 'The Goose Starts to Hiss' in Taxation, 31 January 2002 at pages 399 to 400. The one that always raises a wry smile is the fact that an employee earning more than £8,500 is considered to be a 'higher paid employee', although the term is not used in the legislation anymore.

David Reilly's article brought to mind the low earning self-employed worker. An unfortunate anomaly will affect self-employed earners whose profits are less than £7,925 in 2001-02, and who are eligible to claim the full amount of children's tax credit.

An example could be a self-employed individual who has a net profit in 2001-02 of £7,200. Section 257AA(1), Taxes Act 1988 states in connection with children's tax credit that, provided the conditions are met, 'the claimant shall be entitled to an income tax deduction, to be known as a children's tax credit'. It is important to note that the credit is allowed only against income tax. The problem is that since 2000-01, the lower limit for Class 4 National Insurance has been reduced to the level of the personal allowance. Therefore a self-employed taxpayer with a profit of £7,200 will be liable to Class 4 National Insurance of £186.55. However, as shown in the Example, there is unused children's tax credit of £159.30, which cannot be used to reduce this liability.

Example

Class 4 National Insurance is as much a tax as income tax itself, as it gives absolutely no social security benefit rights. The liability is calculated by reference to Schedule D profits and is generally collected through the self assessment system of tax payments by the Revenue. In years prior to 2000-01, the lower limit was set at such a level that it was unlikely that a Class 4 National Insurance liability would arise without a corresponding tax liability. However, the level of the lower limit now gives rise to an effective waste of children's tax credit. As children's tax credit was due for the first time in 2001-02, it was only when tax returns were prepared after April that the problem came to light.

Taxpayers on this level of income are likely to be claiming other state benefits and it seems absurd to expect them to have to repay almost £200, in this example, by way of Class 4 National Insurance. Tax advisers will have to try to explain to clients that, although Class 4 National Insurance is very much like a tax, almost identical in fact, it is the wrong type of tax and therefore they still need to pay it.

Solution

What is the solution, that is assuming that the Government, and the Inland Revenue as its agent, consider that one is required? There have always been instances of allowances being wasted but, in this instance, a little more thought in the rule-drafting process would have resulted in the lower earners not being penalised. What is needed is a provision which acts in a similar way to section 559(5), Taxes Act 1988 which allows tax deductions under the construction industry scheme to be allowed as deductions against the Class 4 National Insurance liability up to the full liability to tax and Class 4 National Insurance (the subtle difference is that construction industry scheme deductions are actually tax credits, whereas children's tax credit is an allowance called a credit). Such a change would only benefit the lowest earners, as most taxpayers earning more than £8,000 will be able to use fully their children's tax credit against the income tax liability.

This may seem like a minor point for most readers, but £200 is a lot for low earners to find when it is unexpected. Does the Revenue have a suggestion box?

James Broom ATII may be contacted on tel: 01305 830001, and by e-mail: jtbroom@hotmail.com.

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