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
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 However, this was repealed by the Universal Credit (Transitional Provisions) Regulations 2014.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 2021, they live off some small savings for a few months and claim UC in February 2022. 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 2021 and claimed UC in May 2021, 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 20202021 tax credits claims involved comparing 2020/2021 income with that of 2019/2020 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). 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 2021, Carol moves in with David who is already claiming Universal Credit. Carol’s tax credit claim is ended from 30 November 2021. Carol’s income for 2019/20 was £12,000. She expects it to be similar for 2021/2022.
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 2021 to 30 November 2021 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 2021/2022 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 2020 to 30 April 2021. He moves to UC on 1 November 2021. 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 2021 to 31 January 2022. He moves to UC on 1 November 2021.
Unlike David, 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.
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 legislation appears to allow an estimate to be used with no facility to go back and change it to an actual figure.
Last reviewed/updated 9 August 2021