Tax Credits can be important to contractors and limited company directors for two reasons: firstly, and of significant importance, is the ability to make a ‘protective claim’ whereby you can safeguard yourself against unexpected drop in income, providing it’s low enough to warrant income support.
As part of a 2003 Labour initiative on welfare, Gordon Brown introduced the system to integrate benefits into the tax system, as opposed to granting straightforward cash handouts.
It was intended as an incentive for people to remain in low-waged employment instead of seeking similar benefits in unemployment. The money acts as a buffer to low-income workers and people with children that need financial support.
So, if you make a claim, you might not receive any additional income, but in the event that your income falls, you could be entitled to significant monetary cover.
The second benefit is that you may also be eligible for a number of cash benefits, depending on your income and whether you have children or not.
Who can claim?
Tax Credit claims are based on your individual circumstances and can be made by freelancers, contractors and directors of limited companies – though not all will be eligible to receive payments immediately. Particularly in the case of a limited company director, applying for Tax Credits is more of a fail-safe in the event your income dips.
What about Universal Credit?
It’s important to note that if you’re currently claiming a tax credit, you’ll probably find yourself transferred onto universal credit sometime between 2019 and 2022. Universal credit will combine a number of existing benefits, such as jobseekers allowance and housing benefit, to simplify the system and pay claimants in a single lump sum.
How are these Tax Credits calculated?
HMRC have created a notoriously difficult process to calculating Tax Credit, so we’d suggest using their automated calculator and leaving it to the ‘experts’ to see how much you may be entitled to.
It’s a good idea to use the calculator even if you have a joint income, as the number of additional elements can push the qualifying bracket into the high earners.
We would encourage contractors and limited company directors to make what’s known as a protective claim with HMRC. You might not actually receive any benefits at first – you only qualify for support if your income drops below £6,420 a year. But that’s exactly why it’s worth your time filling in the paperwork each year; if your income should ever drop below that threshold, your information will already be in HMRC’s system, which will allow you to make a claim immediately. Being self-employed can be unpredictable – keeping yourself covered with a protective claim could be a life-saver.
Working Tax Credit
This is one of the two types of credit you can claim.
If you’re working a minimum amount of hours a week on low income, you’ll likely to qualify for a Working Tax Credit. The sum you receive is determined by your income, which includes dividends.
You must have a contract drawn up with your limited company to qualify for Working Tax Credit.
The amount you can claim for is related to your rate of pay. A lower income will receive a higher tax credit. This is on the provision that you’re working the necessary number of hours on National Minimum Wage.
There are several additional elements which can affect the Working Credit available to you.
Firstly, your living status needs to be considered. If you’re living as a couple, you’ll need to make a joint claim based on your household income. If you’re confused as to what defines a couple, HMRC aren’t asking about how you see your relationship; if you’re married or simply just living with a partner, you’ll need to make a joint claim.
Disability, age, hours worked and children are all additional elements which set the qualifying bracket for a claim and how much you can be awarded.
However, be careful of the contract of employment that may need to be created to entitle you to credits. You’ll then fall within the National Minimum Wage legislation and need to be careful about the salary level you take. Remember that the low salary, higher dividend policy to extract funds from your limited company tax efficiently can be affected by this.
Child Tax Credit
Child Tax Credits are payable to individuals and couples with children, such as parents and guardians. The credit is usually payable to couples with a joint income of under £40,000, although this cap can increase and vary significantly depending on additional elements. Households with higher incomes can also qualify if they have more than one child, a child with a disability and/or childcare costs.
The money is allocated to the individual with the main responsibility. If you’re separated and can’t decide who has priority care, HMRC will decide for you.
If you’re responsible for at least one child (under 16) or young person (under 20 and in education or training), you may qualify for a Child Tax Credit. This Tax Credit is also accumulative, so someone with two children will qualify for more cover than someone with one. This is limited to four children.
These credits aren’t taxable and can be awarded in addition to each other. They also supplement existing benefits you may already have, such as child benefit.
Important information when applying
If your circumstances change, it’s crucial that you notify HMRC or you may be overpaid. This might sound appealing, but when you end up having to repay the sum you’ve already spent, you could potentially struggle. This is especially prudent advice for Crunch clients as the nature of your income may be less consistent and therefore need reporting as and when it changes.
If you’re receiving Tax Credits, every April or May you’ll receive a Tax Credit renewal pack, which as the name suggests renews your Tax Credit claim. You can submit any relevant changes here, but you must return the form by the 31st July or risk having your benefits withdrawn.
Limited companies and contractors that receive a low income may attribute this to being between contracts with clients, this might make you think you won’t qualify due to the minimum 16 hours a week, but don’t panic. You’re employed by your company, so all the hours spent searching for clients, filing accounts and conducting admin are all classed as working hours.
Credits are determined by a range of factors, so the least complicated option, as mentioned above, is to use HMRC’s questionnaire to see if you qualify.
Bear in mind that the income threshold increases with additional elements, such as multiple children, child care or a disability. It’s definitely in your best interest to check!
A word of caution
As a limited company, you may be tempted to adjust your income so that you reap the highest Tax Credit and keep your own profits sitting in your company for a later date. This is, however, against the law. HMRC are fully aware of this potential abuse of the system, so make sure you’re accurate and honest with your responses.