Child Benefit Clawback

Last month I looked at the relief capping proposal and tried to encourage you all to take part in the consultation process- that still hasn’t commenced and on the treasury website that tracks all consultations it is merely scheduled for the summer.  Keep watching this space or… listening to these podcasts…

This month I’m going to consider another part of the budget proposals intended to claw back part or all of the Child Benefit from certain taxpayers – but before I do I think we need to consider some taxation history.

Until 1973 when a couple married the wife lost her independent status as a human being – I know that sounds awfully dramatic but if a wife wrote to the revenue pointing out that she had paid too much tax on her earnings under the PAYE system the reply was addressed to her husband and the cheque making the repayment was made out to him and not her! 

This was not misogyny on the part of the tax officials, because the revenue could not legally write to a wife at that time. From 1973 onwards they were permitted to write to a wife directly but our taxation system was still based on the family unit and the husband had the legal obligation to return his wife’s income and the overall liability was still his and his alone.

This caused enormous practical problems for a minority of taxpayers – I remember a young man who’d received a letter from the revenue pointing out that he had not returned bank interest – except… he didn’t have any.  Eventually he was pointed in the right direction and asked his wife to provide him with the details that needed to be returned to the revenue – she refused and he was visited by his father-in-law threatening violence if he continued to ask his wife these inconvenient questions!

It was possible for taxpayers to elect to submit separate tax returns and pay their own share of liability but the assessments that were issued were still based on total family income with personal allowances and reliefs being apportioned.  I can remember the practical difficulties of acting for a wife who submitted her own return but her husband used a different firm of accountants and was considerably in arrears in submitting his actual figures.  To make matters worse both firms of accountants were under strict instructions not to correspond with each other and so we had no way of checking the revenue’s calculations!  The only solution was to surreptitiously take the file down to the pub on a Friday night , unofficially meet an opposite number from the other firm and check the figures unofficially!

These practical difficulties came to an end in 1990 with the advent of independent taxation – at last spouses submitted their own returns, were responsible for their own taxation liabilities, and these idiocies of the old system disappeared – that is until the idea of clawing back child benefit was floated.

Child benefit is one of the fundamental building blocks of the benefit system and has been paid, as of right, to individuals resident in the UK for more than six months with responsibility for children – in a couple usually the wife will receive it – it was at one time paid on a weekly basis through vouchers that were cashed in at post offices but is now normally paid 4 weekly into the claimant’s bank account.

It used to be paid only for second and subsequent children but when the special tax allowance for children was abolished many years ago the value of that relief was incorporated into this benefit.  It has never before been subject to taxation.

That it is unfair that a higher rate taxpayer gets the same benefit as a basic rate or even a non-taxpayer seems to have been a suggestion made at a Conservative Party conference which has been subsequently taken up as coalition government policy – and it clearly creates an enormous headache for the revenue who have to implement this idea.

Given the constraints of independent taxation it was decided that the clawback would take place in the hands of the spouse with the highest income where this exceeded the initial threshold, as set in the budget, of £50,000.  1% of the benefit would be clawed back from this person whether they were the actual recipient of the benefit or not for every £100 of their income in excess of £50,000.

Therefore if a taxpayer had income for this purpose of, say, £53,500 then they would suffer a clawback of 35% of the child benefit received.  If the income exceeded £60,000 the whole of the benefit will be clawed back.  Instead of restricting the benefit actually payable it was decided that the clawback would take place through the tax system.

With one child the benefit currently payable is £20.30 per week, for each subsequent child the amount payable is £13.40 per week. The clawback starts, strangely, from 7 January 2013, some people have suggested that this is a needless complexity but for most claimants the amount payable will be known.  If you have three children you will be paid a total of £47.10 per week or £188.40 each 4 weeks.  7th January is simply the first Monday of 2013 and the benefit paid 4 weekly during the remainder of the that tax year would be £565.20, exactly the same for every taxpayer with three children.  The clawback would then be 35% of this figure – £197.82.

For the following year assuming total income was now, say, £56,500 the clawback would be 65% of the benefit.  The benefit has been frozen until 2014 so we know that the amount payable for the year would be £2,449.20 and the clawback £1,591.98.

Now this is income which has already been taxed at 40% and if earned income is also subject to NIC of a further 2%.  The more children a taxpayer has the greater the benefit they will have received and so the larger the clawback they will be subject to. With three children the effective total tax rate at this level is 66.5%, with eight children the effective tax rate is 101.34%!

If the income is derived from a company which the taxpayer controls the effective liability is even greater when employers’ NIC get added into the equation.

Income is measured in the same way that it is measured for the clawback of personal allowances that takes place at £100,000 worth of income.  This means that the gross equivalent of pension contributions, personal pensions, stakeholder pensions etc and the gross equivalent of gift aid donations, reliefs usually given by extending the taxpayer’s basic rate band will actually be deducted from income for the purpose.  Incidentally if the effective tax rate is more than 100%, as it can be for very large families, then the effective tax relief available for these payments is in excess of 100% as well!  It is possible, by careful planning, to keep income just below the clawback figure and so avoid the liability.

It is unfair that where one taxpayer earns substantially more than the other the one with the higher income is subject to the clawback.  Where a couple each have income of £49,999 their joint income will be £99,998 and yet as neither has income in excess of £50,000 no clawback will occur, whereas a taxpayer with income of £50,500 will suffer a 5% clawback.

Taxpayers with their own companies or partnerships may be able to divide income between themselves to avoid or at least minimise the clawback that may occur.  They could also transfer income producing assets to the other partner to avoid the clawback.  Of course this is only possible if you know what your income is going to be in the tax year.  Pension contributions cannot be carried back to the year before but interestingly gift aid donations can be.

Lets look at some of the other practicalities involved…

The clawback will be recovered through the self-assessment system which may mean that having attempted, successfully, to reduce the number of taxpayers subject to self assessment there will now be a dramatic increase in the number of taxpayers subject to self assessment.  The clawback could also take place through the PAYE system for certain taxpayers but this would often involve delay in determination and collection of the liabilities involved.

It will be applied to single parents of course but couples will have to decide who is the one with highest earnings – fine if they are prepared to sit down and discuss their financial affairs with each other but if they don’t, or won’t… This brings back the spectre of couples deliberately not revealing their income to each other or even simply getting it wrong.

Suppose Alan earns £57,000 per annum and his wife, Zena, earns £54,000 – it seems clear that Alan is subject to the clawback.  Suppose he was encouraged by a financial adviser to pay £2,880 into a stakeholder pension some years ago and this is paid through a direct debit.  When they are talking about this Alan forgets this and so he becomes subject to clawback until he puts the premium paid on his return, this is grossed up to £3,600 and Alan’s income is now £53,400 and so it is Zena who should have been subject to clawback. She can be penalised for failing to make this adjustment to her liability.

To make matters worse still the legislation says that it applies to couples who are married to each other and also to civil partners.  But it will also apply to people who live together as though they were married and also to couples who live together as though they were civil partners.  This is a potential minefield.

Let’s suppose that Beatrice is a single mother earning £20,000 as a teaching assistant, her best friend Charlotte is also single and earns £65,000 and has her own house.  Knowing how tough life is for Beatrice Charlotte asks her to come and live with her and Beatrice gladly accepts.  Are they living together as though they were civil partners?

This is not as straightforward as it may seem.  The law permits any two persons of the same sex as each other to register a civil partnership provided that they are not already married to someone else, or in a civil partnership with someone else, and are not within the prohibited degrees of relationship – close relations like brothers and sisters.  Civil partnership resembles civil marriage in all respects bar one.

And this is why people have advocated so-called “gay marriage” even though a civil partnership is treated as though it were marriage for all practical legal purposes.  You do not need to be homosexual or to have a homosexual relationship to enter into a civil partnership so – are Beatrice and Charlotte living together as though they are civil partners?  I am not sure that anyone would like to have to answer this question or even ask it, but this legislation may make this unavoidable.

To satisfy an off-the-cuff political statement the revenue have been forced to create a considerable trap for the unwary, a deeply unfair and potentially divisive system – this is what happens when we let politicians dabble in our taxation system.  It may see the return of the crazier aspects of taxation that applied before independent taxation was created. Oh dear!