Tax Credits: Income from self-employment (or trading income)
Trading income for tax credits is the claimant’s taxable profits as defined in Part 2 of ITTOIA 2005. This is broadly the same as the business profits appearing in the claimant’s self-assessment return. HMRC publish some information on the GOV.UK website and further information is available on page 15 of TC600 guidance notes (please note, whilst they can still be useful, HMRC have discontinued publication of the TC600 guidance notes and they have not be updated since April 2019).
However, the income tax rules on the averaging of trading profits which apply to farmers and creative artists do not apply to tax credits.
HMRC are introducing some changes to accounting rules for basis periods. From the 2024/25 tax year, taxable business profits will be assessed on the profits that arise in the tax year rather than on the profits in an accounting period ending in a tax year. To introduce the change, 2023/24 was a transitional year moving from the old to the new basis. For tax credit purposes, any amounts of transition profits for the tax year 2023/24 that are calculated as ‘transition profits’ under the abolition of basis period rules (ie under step 5 of paragraph 70(2) and paragraph 72 and 73 of Schedule 1 to the Finance Act 2022) are disregarded.
Note also that relief for trading losses is computed differently from tax - see below.
If the claimant is a partner in a trading partnership their trading income for tax credits is the taxable profit arising from their share of the partnership’s trading or professional income.
Relief for trading losses
While the calculation of trading profits and losses is the same for income tax and tax credits, there are important differences in the way the relief is calculated for tax and tax credits.
Where the trader is making a joint claim with their partner, a trading loss must be offset, for tax credits, not just against the trader's current year income but against the joint current year income of the trader and their partner.
There is no ‘carry-back’ of losses for tax credits – see example below.
Any surplus may be offset against profits of the same trade in future years for tax credits.
Trading losses cannot be carried forward for tax credits unless the trade in which they were incurred is being undertaken on a commercial basis and with a view to realising profits.
HMRC have produced worksheet TC825 which gives guidance on certain deductions and trading losses.
Example
Bill has the following trading results from 2019/20 to 2023/24. His wife Emily has employment income of £10,000 for each of those years.
|
Tax year |
Profit/(loss) £ |
Bill – taxable £ |
Emily salary £ |
Bill/Emily tax credits income £ |
|
2023/24 |
5,000 |
NIL |
10,000 |
10,000 |
|
2022/23 |
(15,000) |
NIL |
10,000 |
NIL |
|
2021/22 |
3,000 |
NIL |
10,000 |
13,000 |
|
2020/21 |
2,000 |
NIL |
10,000 |
12,000 |
|
2019/20 |
5,000 |
NIL |
10,000 |
15,000 |
As can be seen, Bill makes modest trading profits in 2019/20, 2020/21 and 2021/22. He then sustains a serious loss in 2023/24.
The £15,000 loss is offset against the couple’s current year income for 2022/23 i.e. Emily’s earnings, leaving £5,000 to be carried forward and set against Bill’s £5,000 profits of the following year. Their income for tax credits for 2023/24 is just Emily’s salary of £10,000.
Legislation: Income Regulations (SI 2002/2006), reg 3(1), Step 4.
£1,000 Trading Allowance
From 6 April 2017, the Government introduced a £1,000 trading and miscellaneous income allowance alongside a similar allowance for property income. The rules are quite complicated but broadly it means those who qualify and choose to take advantage of this tax allowance (rather than deduct actual expenses), won't pay tax on the first £1,000 of their taxable income from self-employment or miscellaneous or casual income. For tax credit purposes, anyone claiming this allowance should declare in their tax credit claim, the amount of their income from self-employment after the £1,000 tax allowance is deducted – as this will already be taken into account for tax purposes on the self-assessment tax return, tax credit claimants should continue to use their taxable profit/loss figure from the relevant box on their tax return for tax credit purposes. You can read more about how the £1,000 trading and property allowances work on the GOV.UK website and on the LITRG website.
Last reviewed/updated 13 June 2024