Tax Credits: Understanding self-employment
This section covers some aspects of the tax credits system that are of particular importance for the self-employed.
- Self-employment and tax credits
- Calculating working hours
- Self-employment and income
- Renewals and the self-employed
To be entitled to tax credits you must be in ‘qualifying remunerative work’. For claims prior to April 2015, there was no restriction on claiming WTC for people who were self-employed, providing the work was done for payment, or in expectation of payment, and they met the remunerative work conditions. You can find out more about the qualifying remunerative work requirement in our entitlement section.
For claims from 6 April 2015 onwards, claimants must be either employed or self-employed. For tax credit purposes, HMRC define self-employed as meaning the self-employed activity is done on a commercial basis with a view to realising a profit and it must be organised and regular.
HMRC have applied this test to new claims from 6 April 2015 and they also check existing claims to see if those claimants also meet the new test. HMRC wrote out to existing claimants about the new test from July/August 2015 before they started to apply these rules to existing claims.
As a general rule, HMRC accept that a self-employed activity meets the test where income from that activity is at least the equivalent of the national minimum wage. HMRC have clarified that claims are checked against the test if the claimant's previous year income from self-employment is less than the number of working hours declared by the claimant x standard rate of national minimum wage.
Notably, this means for example that where a claimant says they normally work say 25 hours a week even if they are only required to work 16 hours a week to qualify for working tax credits, they may be selected for a check if their earnings fall below the threshold based on the hours they declare. (You can find the national minimum wage rates in our national minimum wage section). If they are not earning that amount, then HMRC may ask the claimant to provide evidence that they meet the requirements of the new test. The evidence asked for may include things such as business plans and other business records, including any relevant insurance documents (see HMRC’s Helpcard – note that this helpcard has not been updated in recent years to take account of the revised test but it can still prove a helpful guide.) It is expected that not everyone whose earnings fall below the threshold will necessarily be asked to prove their self-employment is commercial with a view to realising a profit and is organised and regular.
It has not yet become clear how this test is applied in joint claims, where there is a joint hours requirement nor whether there are tax implications where HMRC determine that the self-employment is not commercial for tax credit purposes.
HMRC issued a briefing in March 2015 about how they apply these rules.
HMRC’s Tax Credits Technical Manual contains some information about the test (what is meant by ‘a commercial basis’ and ‘view to the realisation of profits’ for tax credit purposes. It should be noted that even where HMRC determine that a self-employed activity is not undertaken on a commercial basis with a view to realising a profit and is organised and regular, any taxable income from that activity will still be taken into account when assessing the tax credit award amount. This may be relevant where CTC is awarded but WTC refused or claims where the basic remunerative work conditions are met other than by the self-employment activity in question.
HMRC say that the requirement to be either employed or self-employed will not be applied so as to remove entitlement from those whose status is unclear, such as some company directors and some agency workers.
'Company directors who are not otherwise employees are covered as regulation 2(4) extends references to being 'employed' to include being the holder of an office and thus covers company directors as mentioned in your e-mail.
We can also confirm that agency workers are covered in the amended regulations. Although the definition of ‘employed’ in regulation 2 refers to being employed under a contract of service or apprenticeship, the policy intention is that the definition should be read as including agency workers engaged under a contract for services whose earnings are chargeable to income tax as employment income under Chapter 7 of Part 2 Income Tax (Earnings and Pensions) Act 2003 (ITEPA.) This reading of the ‘employed’ definition is supported by the qualification in relation to engagements falling within Chapter 8 of Part 2 (arrangements made by Personal Service Companies) where similarly individuals may not necessarily be engaged under a contract of service. Agency workers, as described in your e-mail, will therefore be considered to meet the entitlement conditions as an employed person for the qualifying remunerative work test for working tax credit.
HMRC will look to clarify this position and if necessary, put it beyond doubt in regulations at the earliest opportunity.'
The position for foster carers remains less certain. HMRC state that where a foster carer makes a loss, their activities may not meet the conditions which apply to the self-employment test in which case they will not necessarily be regarded being in qualifying remunerative work for tax credit purposes. Although the fact they have made a loss does not necessarily mean their self-employed activity fails the test, it may be difficult for a foster carer to provide evidence that their foster caring work is commercial and undertaken with a view to realising a profit due to the very nature of the work. Similar questions arise for shared-lives carers as the tax credit treatment for both foster carers and shared-lives carers has historically been very similar. We will provide more information if it becomes available - see our section on special circumstances.
Note : Where claimants hours of work were temporarily reduced as a result of the impacts of the Coronavirus outbreak but they had not ceased trading, HMRC treated them as continuing to the work their normal hours,(ie prior to the temporary reduction) and this was not be regarded as a change in circumstances. This applied until 30 September 2021. Various run-ons were introduced from 1 October 2021 for people previously covered by these temporary rules. See our tax credits and coronavirus page for more information about these temporary rules.
Under the Working Tax Credit (Entitlement and Maximum Rates) Regulations 2002, the number of hours which a self-employed person is in qualifying remunerative work is defined as ‘the number of hours he normally performs for payment or in expectation of payment’.
The HMRC compliance manual states that any hours which will be costed to the client/customer as spent in producing/providing the individual order or service count when working out hours for self-employment. In addition, the following activities also count:
- trips to wholesalers and retailers
- visits to potential clients for giving quotes etc
- time spent on advertising or canvassing business
- cleaning the business premises or space used specifically for business purposes
- cleaning a vehicle used as part of the business, for example a taxi
- travelling for the purposes of the business, but not from home to their business premises
- book keeping
- research work, for example where the claimant is an established author. Research carried out be persons who are not established authors, but are working in the hope of one day becoming established will not count.
It goes on to say that:
'The amount of time being spent on these activities may also depend upon how established the business is. If a business is in its early days, it is more likely that the claimant will have to invest large amounts of time and effort in building up business contacts for little or no outcome. However, over time the amount of unproductive time spent in this way reduce considerably. If it does not, it may be an indication that the work is not genuinely remunerative.'
The compliance manual also acknowledges that particular trades may present claimants with more difficulty in calculating their working hours and guidance is given for bed and breakfast owners, artists, writers, property renovators and door to door sales people.
Tax credits generally follow the tax system when it comes to calculating income from self-employment.
HMRC have produced some online guidance which explains how to calculate income from self-employment. This basically involves taking the claimant’s taxable profit and deducting various allowed items such as gift aid and pension contributions. The remaining figure is to be entered into the self-employment income box on the form. If the figure is a loss, 0 should be entered on the form.
Working sheet TC825, provided by HMRC, can be used to calculate income where trading losses, gift aid and pension contributions are involved.
While the computation of trading profits and losses are the same for income tax and tax credits, there are the following important differences in the way the relief is calculated as between tax and tax credits.
A trading loss in a year must be set off against the claimant’s other income for that year. Where the trader is part of a couple and a joint claim is in force, a trading loss in a year must be set off, for tax credits, not only against the trader's current year income but against the joint income of the trader and his or her partner.
Any surplus may be set off against profits of the same trade in future years for tax credits (ie the same as ICTA 1988, s 385 for income tax losses).
There is no carry-back of losses for tax credits.
Unrelieved losses of 2001-02 could be carried forward to 2003-04 and beyond for tax credits; but losses incurred in years prior to 2001-02, or in 2002-03, could not. These were effectively 'non-years' for tax credits, because the income of those years was not used for any tax credit purpose.
Trading losses cannot be carried forward for tax credits unless the trade in which they were incurred is being carried on upon a commercial basis and with a view to realising profits.
Walid’s trading results and Leila’s employment income for the years 2018/19 to 2021/22 are shown below, alongside their income for tax credits after taking account of Walid’s loss relief.
Tax credits claims last for a maximum of one year. After the end of each tax year, HMRC send renewal packs to claimants. The purpose of these packs is two-fold. They finalise the claim for the year just ended and act as a claim for the new tax year.
In order to finalise the claim for the year just ended and ensure any new claim is as accurate as possible, HMRC ask claimants to provide their actual income for the year just ended.
These packs are generally sent out in the summertime. Many self-employed claimants will not have completed their tax returns nor had their final figures from their accountants. For this reason, HMRC allow claimants to complete their declaration forms using an estimated income.
It is important that claimants give an estimated income to HMRC by the deadline (in most cases 31 July) even if they cannot provide an actual income. If they don’t, their payments may stop. The self-employed should give an estimate even if they receive an auto-renewal and their estimated income is within the limits quoted on the renewal form. This will ensure the system knows they have used an estimated income. See the information on missing the deadline in our renewals section.
The claimant then has until the following 31 January to report their actual income. That is also the filing date for income tax self-assessment purposes.
Thus, in order to renew a claim for 2023/24, a self-employed claimant should provide income figures for 2022/23 by 31 July 2023, but that may be an estimate. If so, the claimant must report their actual 2022/23 figures by 31 January 2024.
It is important that they give HMRC their actual (final) income otherwise HMRC will finalise the claim for the previous tax year using the estimated figure which may not be correct. This could potentially lead to penalties and overpayments.
In January 2021, HMRC confirmed a temporary concession due to the impacts of the coronavirus pandemic. Recognising that in some exceptional circumstances people may not be able to give their actual income figure by the 31 January 2021 deadline, they adopted an additional process to accept late declarations of actual income for tax credits in certain situations.
Claimants (or their agents) who missed the 31 January 2021 deadline to provide their 2019-2020 actual income (after giving an estimate by 31 July 2020) for tax credits were told to ring HMRC’s tax credits helpline and explain why they missed the deadline. HMRC said that if the reason was COVID related, they would use their tax credit enquiry powers to accept the actual income figure and issue an updated final award. You can read more about this in our blog.
HMRC repeated the same concession for 2022. It means that claimants who provided an estimate of their 2020/21 income figure by 31 July 2021 but could not provide their actual income figure to HMRC by the deadline of 31 January 2022 were to contact HMRC as soon as possible with their actual income figure after the 31 January deadline. Where the lateness is due to the coronavirus pandemic, HMRC say they will accept the late reported actual income figure and issue and updated final award decision (again, using their powers under s19 of the Tax Credits Act).
We understand HMRC are willing to apply this same relaxation for the 31 January 2023 deadline.
Where a claimant makes a claim for universal credit (UC) in the same tax year that they have claimed tax credits, their tax credit claim will be terminated at the point of their UC claim. The tax credit award may be subject to ‘in-year’ finalisation and there are different rules for how to calculate income from self-employment for in-year finalisation.
Last reviewed/updated 4 May 2023