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HMRC internal manual

Tax Credits Manual

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HM Revenue & Customs
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Eligibility - income (employed and self-employed): Self-employed income (Info)

You should accept a person’s statement of self-employment unless there is reason to doubt it. The rules set out below apply equally to customers who carry on business solely on their own account as well as those who carry on business in partnership.

What is trading from self-employment?

Self-employment means the carrying on of a trade, profession or vocation which is commercial with a view to the realisation of profits. A self-employed person is responsible for the paying the tax due under Income Tax (Trading and Other Income) 2005 (ITTOIA 2005) and for meeting their own National Insurance contributions.

Calculating business profits

Trading income for tax credit purposes is the taxable profit made by the customer from their trade, professions or vocation without adjustment for averaging claims.

The profits of the business for the tax year are the taxable profits of the business for the basis period for that year.

The starting point for taxable profit is the profit shown in accounts drawn up in accordance with UK Generally Accepted Accounting practice. That figure may then need to be adjusted to take into account specific tax reliefs and adjustments provided for by statute and case law.

Accounts should be drawn up on an accrual basis not on a cash basis. It isn’t simply a matter of cash received less cash spent.

Generally, the profit is the amount of money earned minus allowable expenses. Allowable expenses are those incurred wholly and exclusively for the purposes of the trade and not disallowed by statute or case law. Examples of allowable expenses may include (but are not restricted to)

  • costs of sales or buying goods to sell
  • sub-contractor costs
  • employee costs (wages, NI contributions)
  • premises costs - for example, heat, light, rates, insurance, security to the extent they relate to the business
  • repairs
  • general administration
  • business motoring costs
  • travel and subsistence
  • advertising, promotion
  • legal and professional costs, for example, accountancy
  • bad debts
  • interest on bank and other loans
  • costs of business phone calls.

The cost of capital items, for example cars or computers are not included in the profit and loss account. However, Capital Allowances may be claimed on these items and deducted from the net profit shown in the profit and loss account to arrive at the net business profit for tax purposes.

Conditions of entitlement

The customer must meet the conditions of entitlement to Working Tax Credit as set out in Regulation 4 of the Working Tax Credit (Entitlement and Maximum Rate) Regulations 2002.

Directors

Directors are office holders, usually engaged under a director’s service contract. Occasionally they are also an employee of the same company.

As an office holder the pay directors receive may be less than the national minimum wage (NMW). If the director is also employed by the company then they must receive at least the NMW for the hours worked as an employee. In either case, remuneration is taxed under the Income Tax (Earnings and Pensions) Act 2002.

For more information on dealing with income from this source, follow the guidance in TCM0118080.

Earnings

The customer must provide details of their income from self-employment by reference to

  • the appropriate entry in their Self Assessment tax return for the previous tax year

or

  • a computation showing the amount of their taxable profit for the previous tax year.

Note: Any self-employed income from overseas must be included for tax credit purposes in the same way as self-employed income received in the UK.

New Deal

Participants in the self-employed route of New Deal receive a ‘training allowance’ in place of Jobseeker’s Allowance. This allowance is taxable as part of the profits of the trade and, for tax credits purposes, should be treated as trading income. This includes payments made to the customer who is undertaking a ‘test trading’ period.

Particular types of self-employment

Tax credits regulations do not provide for any departure from the method of calculating taxable profit for tax purposes for any particular self-employment.

Details of trading income from self-employed earners should be provided by the customer in line with the usual Self Assessment guidelines.

Foster carers

With effect from the tax year 2003-04, Chapter 2 of Part 7 of ITTOIA provides for new income tax relief for foster carers.

Profits from foster care will be exempt from income tax in a year of assessment, if the total receipts from foster care do not exceed an individual amount based on two elements

  • a fixed amount of £10,000 annually for each residence

and

  • a weekly amount for each foster child (£200 for a child aged under 11, £250 for a child aged 11 or above).

If a person’s total receipts from foster care exceed their individual amount, they can elect to have their taxable profits calculated under

  • the normal ITTOIA 2005 rules

or

  • a simplified method under which only the excess receipts over the individual amount are taxable but without relief for expenses or capital allowances.

To the extent that they qualify for relief from income tax under these arrangements, foster care receipts of the tax year 2003-04 and subsequent years should be disregarded for tax credit purposes. Regulation 11(2) of the Tax Credits (Miscellaneous Amendments No 2) Regulations 2003 refers.

Self Assessment tax return

In their tax credits claim, where the customer

  • is a sole trader and providing information from the self-employment pages (SA103S) or (SA103F) of their Self Assessment tax return, they should include the figure they have entered in Box 27 (SA103S) or Box 72 (SA103F) unless they are farmers or creators of literary works and have made an averaging claim.

Note: Where an averaging claim has been made, the figure to be returned is the figure shown in Box 72 plus or minus the amount shown in Box 71 (for Tax Credits we deal with averaging adjustment the opposite way to Taxes).

  • carries on business in a partnership and providing information from the partnership pages (SA104 or SA104F) of their Self Assessment tax return, they should include the figure they have entered in Box 14 unless the partnership carries on business as farmers or creators of literary works and they have made an averaging claim.

Note: Where an averaging claim has been made, the figure to be returned is the figure shown in Box 14 plus or minus the amount shown in Box 10.

Self-employed and also employed

A person may work as a self-employed earner and also as an employed earner. Where a person is a self-employed earner and an employed earner, the number of hours worked in both employments should be added together for the purpose of deciding whether the person works for 16 hours or more weekly or more than 30 hours weekly.

Where a person has income from self-employment and income from employed earnings, these will be added together by the tax credits computer when calculating entitlement to Working Tax Credit.

Sickness

If, at the date of claim, the customer can not work because of sickness and they are in receipt of

  • Statutory Sick Pay, or they would have qualified but for self-employment
  • short-term Incapacity Benefit at the lower rate
  • Income Support (IS) on the grounds of incapacity for work
  • Employment and Support Allowance (ESA) on the grounds of limited capability for work

or

  • National Insurance credits on the grounds of either incapacity or limited capability for work

then

they are to be treated as being engaged in remunerative work provided that they normally worked at least 16 hours or 30 hours weekly, whichever applied immediately before beginning to receive any one of these benefits.

Note: A person who receives IS, ESA or National Insurance credits as specified above is treated as being in qualifying remunerative work for a period of 28 weeks only.

Note: If the customer was receiving Statutory Maternity Pay (SMP) immediately prior to getting Statutory Sick Pay (Short Term Lower Rate), they would also satisfy the remunerative work condition if they had been working 16 hours weekly or more immediately before getting SMP.

Thirty hour element

The conditions for the thirty hour element apply to self-employed earners in the same way as they apply to employed earners.

Trading income - adjustments

When calculating income for Self Assessment purposes, the following are able to make an adjustment to the taxable profit in the later of two years, such that the taxable profits is the average of the taxable profits of that year and the previous year

  • farmers
  • market gardeners
  • creative artists.

Regulations direct that this averaging is not taken into account in calculating the trading income of the customer for tax credits purposes.

Trading income - calculation

Self-employed income for the purpose of calculating entitlement to tax credits will be the taxable profit for the year from

  • the person’s work in their trade, profession, or vocation which is commercial with a view to the realisation of profits

or

  • their partnership share of net profit if the person is a partner in a trade, profession or vocation.

For tax credit purposes, ‘taxable profit’ has the same meaning as it has in ITTIOA 2005 - that is, the amount after the deduction of business expenses.

Contributions or premiums paid by the self-employed earner toward the purchase of a retirement annuity or personal pension are deducted from the taxable profit when calculating entitlement to Working Tax Credit.

Any self-employed income from overseas must be included for tax credit purposes in the same way as self-employed income received in the UK.

Trading loss

The amount of any loss from trades carried on, on a commercial basis made in the year of assessment should be offset against any other income of the family for that year. For more information, follow the guidance in TCM0116020.

Where the amount of loss is not fully offset against any other income in that year, the unused part of the loss may be carried forward and set off against trading income from the same trade, profession or vocation in subsequent years until the amount of the loss is extinguished.