Monday, 4 January 2016

A question about tax credits

I recently received this query about tax credits and self-employment. With the person's agreement I have answered his questions as this public post. Both the person's name and some non-relevant information have been changed.

'I was receiving Self Employed Working Tax Credits for 3 years after claiming Jobseeker's allowance before that. I was earning an insufficient amount to make my situation sustainable so I moved onto Universal Credit in June.  In December I received a letter from HMRC re my tax credits award for the tax year 2014-15 with a 30 part questionnaire. I am nervous about how exactly I should answer some of these questions. If unhappy with my level of activity are HMRC likely to claim all my Tax Credits back? Are HMRC likely to charge me an additional penalty if they consider my activity does not constitute 30 hrs of work and I had not informed them? I know that HMRC changed their approach to Self Employed Tax Credits in April, but I thought this was for new and current claims

"Bill W"'

There's quite a few issues hidden inside this query: I'm going to tease these out and deal with them individually.

  1. How does self-employment fit into the tax credit rules (and how did this change in April 2015)?
  2. What powers does Her Majesty's Revenue and Customs ('HMRC') have regarding tax credits paid for previous years?
  3. What should I do if I get a letter from HMRC's compliance team?
  4. What rights do you have if they ask you to pay money back from previous years? 

1. How does self-employment fit into the tax credit rules (and how did this change in April 2015)?


To be entitled to Working Tax Credit you need to be in 'qualifying remunerative work'[1]. The work can be as an employee or as self-employed, but must be done 'for payment or in expectation of payment', and you must normally work at least 30 hours per week, or, for some people, 16 hours per week (for more details about this see www.benefitsowl.info/tax credits.html).

For employed earners showing this is easy enough: clearly for self-employed people it's a bit trickier: it may be hard to show that you're doing work for payment or in expectation of payment if you've only just started. It can also be hard to show how many hours you work.

All the above requirements have been in place since tax credits were invented.

Now let's look at what changed in April 2015.

The main change[2] was to add some wording to Regulation 2 of the Working Tax Credit (Entitlement and Maximum Rate) Regulations 2002. Regulation 2 is a long list of definitions used in the rest of the regulations. The change was to add some words to the definition of 'self-employed'.
  • Before April 2015 it said '"self-employed" means engaged in carrying on a trade, profession or vocation;'
  • Now it says: '"self-employed" means engaged in carrying on a trade, profession or vocation on a commercial basis and with a view to the realisation of profits, either on one’s own account or as a member of a business partnership and the trade, profession or vocation is organised and regular;'
Who would fit the rules before April 2015 but not afterwards? This would need to be someone who was carrying out a trade, profession, or vocation, and receiving or expecting payment, but wasn't aiming to ever make a profit. For example, someone who was employed for 29 hours per week and then spent an hour each week making and selling jam as a hobby probably wouldn't be able to use the jam-making to bring the hours up to 30.

I suppose the use of the words 'commercial basis' is to rule out cases where there was a profit, but it was   never expected to be more than a trivial amount.

Note that you don't have to be making a profit to fit these rules: you just need to satisfy the authorities that you are aiming to make a profit eventually. 

As far as I can work out the change cannot be applied retrospectively (in other words, your activity shouldn't have to satisfy these rules before the rule change came in), although if someone was on Working Tax Credit before April 2015 they would have to meet the extra requirements from April 2015 onwards. If HMRC does try to apply the change retrospectively that decision should certainly be challenged (see below).

If you want to know more about the change, you might want to look at what the tax credit decision makers' manual has to say about it: http://www.hmrc.gov.uk/manuals/tctmanual/tctm02415.htm. (Note that when it says 'you' it means the decision maker, not you!). You could also look at the following page on the gov.uk website: www.gov.uk/government/publications/revenue-and-customs-brief-7-2015-new-rules-for-the-self-employed-claiming-working-tax-credit


2. What powers does HMRC have regarding tax credits paid for previous years?


As you probably know, tax credits are assessed on an annual basis. After the end of the tax year in early April, HMRC ask you for finalised information about your income for that year: they then issue a final decision: this is technically called a Section 18 decision[3]. As a result of this decision you may find that you have been overpaid, or underpaid, or paid just the right amount, for that - completed - tax year. Normally a Section 18 decision is the end of the matter.

However there are two scenarios in which HMRC can re-assess finalised decisions:

  • It has the power to open an enquiry and revise a final decision up to one year after the deadline for the annual review, if it thinks it is necessary[4];  
  • It can revise a final decision up to five years from the end of the tax year in question, if the decision was wrong due to fraud or neglect on the part of the claimant, or if a person's income liability was revised[5].

(The deadline for the annual review depends on a range of factors, but cannot normally be later than the first 31st January after the tax year in question ended.)

Unless they suspect fraud or neglect they can only look at the most recent year. If, of course, the investigations into that year suggest that there has been fraud or neglect they can then extend the investigation backwards.

The words 'fraud' and 'neglect' mean aren't defined in the rules: however the former is going to cover deliberate lies and omissions, and the latter is likely to come into play when a claimant simply can't be bothered to inform HMRC of changes, for example.

In practice, these exercises are normally carried out by the infamous compliance department. It's worth bearing in mind that just because an enquiry is started it does not mean that the compliance team are necessarily expecting to find something wrong.

So, if they compliance team ask you for information about the previous tax year, and you provide it (or their deadline to you expires) they could decide that everything checks out OK, in which case that's the end of the story.

Alternatively, they could decide that the Section 18 decision was wrong, and issue a new decision replacing it. This new decision could reduce your award for that year, remove it completely, or increase it (unlikely!). They also have the following options:

  • If they reduce or remove your award, this will have the effect of creating an overpayment which they will ask you to pay back;
  • If they think you have acted fraudulently or negligently, they can also: 
    • impose a penalty of up to £3,000[6];
    • open up the enquiry to cover previous years, up to the five year maximum.
They may decide that you were not actually in 'qualifying remunerative work', but also that you've not done anything wrong enough to count as fraud or neglect. If this is what they decide they cannot issue a penalty or investigate previous years. 


3. What should I do if I get a letter from HMRC's compliance team?


The obvious answer to this question is just to say that you need to respond to it, giving them any information they ask for. But there are some other things worth saying.

If you don't respond to the request for the information, or miss their deadline, you will still have opportunities to pass on information in the future. They will make a decision based on what they do know, but you will then have the write to ask them to look into the matter again (see below) and if that doesn't work you will have the right to take the case to an independent tribunal (ditto).

So if you're really struggling to give some information, or are reluctant to do so, that's OK. On the other hand, if there is information or documentation that supports your position, send it.

Here's some more guidelines:

  • You'll probably notice that some of the things they are for in the letter are not relevant to you (it might ask for P45s, which will be irrelevant if you've not worked as an employee): this  is not surprising as the letter you're sent is likely to be a generic one. Remember that, for all they know, you were, say, an employee for part of the time, but didn't tell them.
  • If there is information you think might be helpful but they haven't asked for, by all means include this. For example, you could talk about difficulties you faced in your self-employment, and explain how you came to your decision to move from tax credits to Universal Credit.
  • Whatever you do don't guess, or even worse, invent, information, just to get your reply complete.

Once you send your reply in, they may send you further requests for information before they make their final decision. If you're worried this is going to drag on and you have nothing else to say, reply to them saying this, and asking them to make a decision. If they fail to do this, complain.


4. What rights do you have if they ask you to pay money back from previous years? 


  • If HMRC makes a decision that you were previously awarded the wrong amount, you have the right to challenge that decision. 
  • If HMRC decided to impose a penalty, you have the right to challenge that decision (against both the existence and the size of the penalty).
  • You don't have the right to challenge the overpayment itself, but this doesn't matter because the overpayment is dependent on the decision changing the amount of the award, and this can be challenged.

If you want to challenge either a new entitlement decision or a penalty decision, or both, there is a two stage process:

  1. You must first ask HMRC to look again at their decision: this is called 'asking for a mandatory reconsideration'.
  2. If this does not resolve the matter, you have the right to appeal to an independent tribunal.
For more details about how to do these, check out http://www.benefitsowl.info/TCopay4.html.


At both stages, it's important to be clear about what you are disagreeing with, being careful to match this with the decision you are seeking to challenge:

  • If HMRC hasn't accused you of fraud or neglect but is simply saying that what you were doing doesn't count as qualifying remunerative work, don't waste time saying you haven't been fraudulent or neglectful, instead say why what you were doing should count;
  • If they are accusing you of fraud or neglect, look exactly at their reasons for saying this (if they give clear enough reasons), and respond to these point by point;
  • If they are imposing a penalty, make sure you make clear that you are challenging this as well.
I said earlier in this post that I didn't see how they could apply the April 2015 change to previous years. If they do try this, make sure you make it clear at both stages that you believe that this is unlawful. (If they are trying to do this, this should be clear because the words from the change should appear somewhere (i.e. 'on a commercial basis and with a view to the realisation of profits, either on one’s own account or as a member of a business partnership and the trade, profession or vocation is organised and regular').)


HMRC may propose to you that you agree some settlement with you: I have previously seen letters which seemed to be urging claimants against taking their cases to tribunals. Be very careful about accepting such proposals. You ultimately have the right to have your case heard by an independent body if that is what you want. If you have difficulty getting them to issue a formal response to your request for a mandatory reconsideration you should complain.

Ultimately, cases like this are decided 'on the balance of probability'. It may not be possible for you to prove you were in qualifying remunerative work: but it may also not be possible for HMRC to prove that you weren't. A tribunal will need to consider and weigh all the evidence, including your testimony and how you come across at tribunal.


Summary


To be entitled to working tax credit you need to be in 'qualifying remunerative work': this normally means working enough hours, and as well as this, for self-employed people, you need to be means engaged in carrying on a trade, profession or vocation.

Since April 2015 self-employed claimants will need also need to show that the work is on a commercial basis and with a view to the realisation of profits.

It is hard to see how the April 2015 change can be applied to tax credits paid before April 2015.

HMRC have the right to re-open tax credits award up to one year after the deadline for the final review.

HMRC have the right to change decisions going back up to five years in cases of fraud or neglect.

If their compliance team writes to you, you should respond, but be aware that you will have the opportunity to supply further information if you need to challenge their decision.

You have the right to challenge an HMRC decision to reduce an award, or to impose a penalty. You need to ask HMRC to look at their decision themselves first (mandatory reconsideration) but if that does not succeed you have the right to take your case to an independent tribunal (appeal).

If HMRC does not progress your case properly you have the right to complain.

Ultimately your case must be decided on the balance or probability. Just because you cannot provide conclusive proof of something it doesn't mean that you are not telling the truth, and HMRC and the tribunal need to take this into account when they consider your case.


Information sources


[1] Regulation 4 of the The Working Tax Credit (Entitlement and Maximum Rate) Regulations 2002: http://www.legislation.gov.uk/uksi/2002/2005/regulation/4/made
[2] The Working Tax Credit (Entitlement and Maximum Rate) (Amendment) Regulations 2015
[3] Tax Credit Act Section 18: http://www.legislation.gov.uk/ukpga/2002/21/section/18
[4] Tax Credit Act Section 19: http://www.legislation.gov.uk/ukpga/2002/21/section/19

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