Universal credit: Finalising tax credit claims
This page explains how tax credit claims are finalised when a UC claim is made in the same tax year. The process used is different to the normal tax credits finalisation process which is outlined in our tax credits section.
- In-year finalisation – overview
- In-year finalisation – the detail
- Employed income
- Self-employed income
- Household income - general points
In October 2014, HMRC introduced in year finalisation (IYF) of tax credit claims for people moving to UC. This is because HMRC and DWP want claimants to have a ‘clean break’ from tax credits and the normal end of year finalisation would not allow this. It would also mean that DWP would not be able to calculate UC awards accurately for those who are managed migrated (meaning they are moved across by DWP) because the tax credits award would not be finalised until a later time.
To address these issues, legislation was introduced by HMRC/DWP to allow HMRC to in-year finalise tax credits claims in the year of transition to UC. Initially, the legislation was contained in Regulation 17 Universal Credit Transitional Provision Regulations 2013 . However, this was repealed by the Universal Credit (Transitional Provisions) Regulations 2014. Not long after this, SI 1626/2014 introduced Regulation 12A into the 2014 Transitional Provision Regulations, which amends the Tax Credits Act 2002 to allow for in-year finalisation.
This is a huge departure from the standard rules and will create financial winners and losers when compared to the standard end of year finalisation system.
Regulation 12A applies where:
- A claim for UC is made, or is treated as having been made
- The claimant is, or was at any time during the tax year in which the claim is made or treated as made, entitled to a tax credit; and
- The Secretary of State is satisfied that the claimant meets the basic conditions specified in Sections 4(1)(a) to (d) of the Welfare Reform Act 2012 (other than those conditions which the claimant is not required to meet).
In these cases, a modified in-year finalisation process (set out in the Schedule to the Regulations) will operate unless HMRC deem that it is not reasonably practicable to apply the modified legislation. In such cases, normal end of year finalisation will operate.
One point worth highlighting is that the UC claim must be made in the same tax year. In most cases, the UC claim will be made shortly after the tax credit claim ends or it will be made and lead to the termination of the tax credit claim. However it is possible that there will be a long delay – for example a WTC only claimant loses their job and their tax credits stop in September 2022, they live off some small savings for a few months and claim UC in February 2023. HMRC can use the IYF process to finalise the tax credit claim because both claims exist in the same tax year (6 April - 5 April).
However, if a claimant lost their job in January 2022 and claimed UC in May 2023, then it appears that HMRC cannot use the in-year finalisation process.
The current end of year finalisation process operates by comparing income for the ‘current year’ (which is the tax year just ended) with income for the ‘previous year’. So finalisation of 2021/22 tax credits claims involved comparing 2021/22 income with that of 2020/21 and applying any relevant income disregards. This produces a figure referred to as ‘relevant income’. If the claim lasts for a full tax year, then this relevant income figure is used to calculate entitlement. If the claim only lasted for part of a tax year, the relevant income is pro-rated to the period of the claim. The result is that income is spread evenly across a tax year no matter when it is earned.
Under the modified in-year finalisation process, HMRC will use a two-step process. The first step will involve finding the ‘part tax year’ income (as defined in the regulations). For most types of income, this will be the income actually received in the part tax year, but there are special rules for calculating self-employed income. The second step will involve using that part tax year income to calculate a ‘notional current year income.’ This notional current year income will then be compared to previous year income, applying the relevant disregards. This will give the ‘relevant income’ figure to be used in the calculation of tax credits.
‘Notional current year income’ is defined as income for the part tax year to which the claim relates, divided by the number of days in that part tax year, multiplied by the number of days in the tax year in which the part tax year is included and rounded down to next whole number of pence. For couples, it is the joint income that is used.
The easiest way to understand how in-year finalisation will work for those with employment income is using examples.
Example 1 – calculation using in year finalisation rules
Carol is a lone parent. She works 30 hours a week. On 1 December 2022, Carol moves in with David who is already claiming Universal Credit. Carol’s tax credit claim is ended from 30 November 2022. Carol’s income for 2021/22 was £12,000. She expects it to be similar for 2022/23.
As soon as her claim has ended, HMRC will either ask Carol to provide them with her employment income figure from 6 April to 30 November or they will use data obtained from her employer through the RTI (Real Time Information) system as part of an auto-finalise process (whereby Carol only needs to tell them if something is wrong or incomplete). Carol’s income from employment between 6 April and 30 November was £8,000. This will be converted to an annual figure of £12,217.57 (£8,000 divided by 239 days x 365 days ). This £12,217.57 figure will be compared to the £12,000 from previous year and Carol’s claim finalised on £12,000 (because her rise in income was less than the £2,500 disregard).
Example 2 – the financial impact of in year finalisation rules
Suppose Carol (from Example 1) receives a bonus in her employment in August so that her income for the period 6 April 2022 to 30 November 2022 is £12,000 (£8,000 earnings and £4,000 bonus). HMRC will treat her income for the year as £18,326.35 (£12,000 divided by 239 days x 365 days). This will be compared to previous year income of £12,000 and the income disregard of £2,500 applied meaning that HMRC will use income of £15,826.35 when finalising Carol’s claim (although this will be pro-rated down for the number of days in the claim as happens currently in end of year finalisation process).
If we look at this same scenario under the standard end of year finalisation rules, Carol would declare to HMRC her 2022/23 income as £16,000 (£12,000 earnings plus a £4,000 bonus). This would be compared to her previous year income of £12,000 and the £2,500 disregard applied, Carol’s claim would be finalised using an income of £13,500 (again this would be pro-rated down for the number of days in the claim).
You can see that in this example, Carol will be worse off under in-year finalisation because of the timing of the bonus which artificially inflates her earnings across the whole year.
In Example 1, there is no real difference between end of year and in year finalisation. This is because Carol earns her income equally across the year with the same amount each week. But in a situation like Example 2 where there is an increase in income in the early part of the year, in-year finalisation will mean the person receives less tax credits for the period than they would have done under end of year finalisation. The opposite is also true, so that someone who has lower income in the first part of the year, for example because they are on maternity leave, will get more tax credits that they would under the end of year finalisation process.
The legislation states that the claimant’s trading income is the amount of the ‘actual or estimated taxable profits attributable to that part tax year’.
Actual or estimated taxable profits attributable to that part tax year are called the ‘relevant trading income’ and are to be calculated by reference to the basis period (determined by reference to the rules in Chapter 15 of Part 2 of ITTOIA) ending during the tax year in which the claimant made, or was treated as making, a claim for UC.
The relevant trading income is to be calculated by:
- Taking the figure for the actual or estimated taxable income earned in the basis period
- Dividing that figure by the number of days in the basis period to give the daily figure; and
- Multiplying the daily figure by the number of days in the part tax year on which the trade, profession or vocation was carried on.
David has a basis period covering 1 May 2021 to 30 April 2022. He moves to UC on 1 November 2022. His profit for that basis period was £10,000.
David’s relevant trading income (his part tax year income from self-employment) will be £10,000/365 x 209 = £5,726.02.
Sanjay has a basis period covering 1 February 2022 to 31 January 2023. He moves to UC on 1 November 2022.
David is likely to know his actual figure if his accounts have been prepared but Sanjay will not know his income for the basis period ending in the tax year in which he moves to UC. He will therefore need to estimate his income for that period. If accounts haven’t been prepared because the period has not yet ended or if it has ended but the accounts are not ready then an estimate will need to be used.
The legislation does not explain how claimants are to estimate their taxable trading profits, nor does it explain what happens if the estimate is wrong. Given the point of in-year finalisation is to have a ‘clean break’ from tax credits, it is not clear how HMRC will deal with people who give estimates that turn out to be significantly different to the actual figures declared for tax purposes at a later date.
The guidance notes (page 11) state that a ‘realistic and reasonable’ estimate should be provided. This can be based on accounts for the year so far and previous years, a business plan and season variations or future work expected. The guidance notes suggest claimants keep a note to show how this estimate was made.
The guidance sets out the steps needed to carry out the calculation. Note however that the guidance incorrectly uses the term ‘accounting period’ but the legislation refers to ‘basis period’. In most cases, the two will be the same but it is possible for some people to have a longer accounting period in some cases in which case they need to use the figures for the basis period ending in the tax year they move to UC.
Where claimants use an estimated figure to calculate their relevant trading income, there is no opportunity in the legislation to subsequently use an actual figure, unlike the standard finalisation rules where the second specified date (2SD) is a deadline to provide actual figures to HMRC for them to make a further final entitlement decision. In practice, this means HMRC will input the figure provided at in-year finalisation as an ‘actual’ figure to the tax credit system, rather than as an estimate, but this is an internal procedural matter and should not be taken as a refusal to accept the IYF estimate provided by the claimant.
Carried-forward losses - losses carried forward from previous years (that can be offset from profits from the same trade should be deducted from the profit figure calculated for the part-year period.
Theo is working out his income figure for in-year finalisation for a 150 day part award period. His carried forward loss from the previous year is £5,000. His estimated taxable profit for the basis period ending in the tax year he claimed UC is £15,000 and for the 150 day award period is £6164. He should deduct the £5000 from £6,164, leaving £1,164 to declare for his trading profit for the part-year period.
For the following types of income, claimants should declare the actual amount they have received in the part year, that is, from the start of the award to the date that the award ends due to in-year finalisation:
- Social Security income
- Student Income
- Pension income (note pension income for in-year finalisation is the amount ‘received in’ or ‘relating to’ the part-year)
- Investment Income
- Property income
- Foreign income
- Notional income
- Miscellaneous income
The £300 disregard for ‘Other income’ is not pro-rated and the figure is applied in full. In other words, when working out the amount of other income (pension; investment; property; foreign; notional), the total ‘other income’ for the part-year is added together and the full £300 disregard applied.
The normal tax credit rules allow the gross amount of contributions to approved pension schemes and of authorised gift aid payments to be deducted from the gross income figure. Whilst there is nothing specific in the amended legislation for in-year finalisation on this point, HMRC have confirmed to us that they expect only the actual pension contributions/gift aid payments that have been paid in the part-year award period to be deducted from the part-year gross income figure for in-year finalisation. This includes for self-employed claimants.
Last reviewed/updated 23 May 2022