Tax Credits: Overpayments and underpayments
Overpayments and underpayments are a normal part of the tax credits system. This is because when a tax credits award is made it is not final until a final entitlement decision is made which is usually after the end of the tax year for which it has been given or shortly after a claim is ended during a tax year (where a person claims Universal Credit in the same tax year).
This section of the website gives a brief view of overpayments and underpayments.
- The annual nature of the system
- What are overpayments?
- Causes of overpayments
- Challenging overpayments
- Dealing with overpayments
The tax year runs from 6 April in one year until 5 April in the next year. To start with the award is based on existing circumstances in the current year (for example, working hours or the number of children a claimant has responsibility for) but using income from the previous tax year.
It is possible in certain circumstances to have the award changed and based on a current year estimate if the claimant anticipates their income will be less than the previous year. However, it is possible for an overpayment to occur if the estimate turns out to be too low. See our section understanding the disregard for an explanation of how this occurs.
After the current tax year has ended, when income and circumstances and any changes during the year are known in full, HMRC then consider any adjustments. This adjustment process can, but does not always, throw up underpayments or overpayments. This annual design means that overpayments can, and do, occur without fault by HMRC or the claimant.
It is also difficult to ascertain from an award notice whether or not there is an overpayment. Generally it is shown in Part 3 of the award notice as shown in the example below -
Overpayments occur when, as the law says:
'... the amount of tax credit paid for a tax year to a person or persons exceeds the amount of the tax credit to which he is entitled, or they are jointly entitled, for the tax year. (Section 28 Tax Credit Act 2002)
The law goes on to say that HMRC may decide that the amount of the excess, or any part of it, is to be repaid to them. It also allows HMRC to adjust the award during the year in order to reduce or eliminate the likely overpayment.
Similarly, HMRC may decide to treat any tax credit already paid as an overpayment, if they decide that the claimant is not entitled to it.
So you can see that the law gives HMRC complete discretion over whether to collect any overpayment, and how much of it to collect, or whether and by how much to adjust an award during a year in order to prevent an overpayment arising.
Tax credits are designed to follow changes in income (to an extent) and personal circumstances. There are a number of reasons why an overpayment might arise following such a change:
- A large increase in income from one year to the next. (This was less likely to occur when the income disregard for rises in income was £25,000 but has been much more likely since April 2013 when it reduced to £5,000 and then further reduced to £2,500 from April 2016)
- The claimant is late reporting a change in circumstances that causes their entitlement to fall – perhaps a drop in working hours, a change of household or a child leaves full-time education, etc.
- The claimant reports an estimated current year income which turns out to be too low
- HMRC delays processing a reported change.
- The claimant makes a mistake in their own favour on the claim form or renewal form.
- HMRC makes a mistake, whether human or computer error, or gives the claimant erroneous advice which they act upon to their detriment. • An award is adjusted downwards following an investigation by HMRC.
- The payments that are received in the first few months of a new tax year (from April), before the renewal forms have been processed, are too high.
- The claimant fails to complete their renewal forms on time (and does not have the claim reinstated by contacting HMRC within the designated time limit).
- Where a tax credit claimant makes a claim for Universal Credit, their tax credit award ends. The 'stopping tax credits process' can create a tax credit overpayment due to the way income is calculated for in-year finalisations. See our Universal Credit - finalising tax credits section.
Underpayments occur when an award for a tax year is finalised and it is found that HMRC has paid the claimant less that their finalised entitlement. Section 30 Tax Credit 2002 covers underpayments and states that they must be paid to the claimant. Generally these payments are made automatically following the renewals process.
Most advisers are likely to see tax credits claimants who want help to understand an overpayment and challenge it. You can find detailed information about how to do this in our challenging overpayments section.
You can find information on how to deal with overpayments, repayment, in our how to deal with overpayment debt section.
Last reviewed/updated 26 April 2022