Tax Credits and ‘Notional Entitlement’ – Fairness for Claimants who Report Changes Late

Robin Williamson welcomes HMRC’s revised policy allowing a notional offset of the amount of tax credits that would have been due against overpaid credits on a change in household. 

Previous Practice and the Case for Change

Sometimes, tax credit claimants who form a couple or who become single, either because they separate or because one partner dies, are slow in reporting the change to HMRC. Yet in many cases, if they had acted promptly they would have continued to be entitled to tax credits, albeit in a different capacity. Hitherto, HMRC’s policy has been to recover any overpayment arising on the old claim because of the delay in reporting the change, but not to give any credit for what the claimant would have received had they made a new claim at the right time. This practice has given rise to considerable hardship where the claimant’s only fault is tardiness in dealing with paperwork.

Pre-Budget Announcement

In the December 2009 Pre-Budget Report it was announced that from January 2010, the vast majority of claimants who are  late in reporting a change of household would have their overpayment reduced by the amount to which they would have been entitled, had they made a new claim promptly (‘notional entitlement’). The change in policy was instigated by a letter from John Andrews, chairman of the Low Incomes Tax Reform Group, on behalf of a number of tax bodies and welfare rights organisations, to Jane Kennedy MP, the then Financial Secretary to the Treasury, in October 2007. That gave rise to a long series of discussions between the signatory bodies, ministers and officials, culminating in the PBR announcement.

The Legislation

Under the tax credits legislation, entitlement to a tax credit depends upon making a claim for it; and if a single claimant can no longer make a claim as such (i.e., becomes part of a couple), or if joint claimants are no longer able to make a joint claim (i.e., they split up, or one of them dies or goes abroad for an extended period), their entitlement automatically ends.

As with any other change of circumstances, prompt reporting is essential to prevent an overpayment building up, and claimants are in any case legally obliged to notify HMRC within one month of the change, or from when they are first aware of it. When there is a change in the adults who make up a household, the claimant must report it so that HMRC can end their previous award and set up a separate claim for them in their new capacity. If there is a delay in doing that, an overpayment accrues from the date of the change, but the new claim can be backdated by only three months. Applying ‘notional entitlement’ will mean that most claimants will have any overpayment wholly eliminated, as they will be entitled either to more tax credits in their new capacity than previously, or to the same amount. A minority will still have a net overpayment to repay even after the notional entitlement calculation because their new tax credits award is less than their previous award.

The Mechanics of Paying ‘Notional Entitlement’ Claims

Claimants are entitled to three months' backdating when making a new claim for tax credits. The tax credits IT system will automatically pay this three months' backdating. HMRC will not calculate a notional entitlement for the three-month backdating period because it would create a double provision. So where a claimant delays advising HMRC of such a change, they will always be required to pay back any overpayment created under the old claim in this three-month window. It is therefore important that everybody in this situation ensures they get their new claim backdated by three months, and, if HMRC’s systems do not automatically award such backdating, they must call the helpline and ask for it.

Example

Karen and her young son Kenny moved in with Derek on 1 May 2010, but did not notify HMRC until a year later, at which point she and Derek made a joint claim.

While single Karen was earning £20,000 a year and claiming tax credits. As a result of the delay in reporting the change of circumstances to HMRC, an overpayment of approximately £2,148 was generated, which HMRC propose to recover directly from Karen.

Now Karen and Derek are jointly earning £22,000 a year and their tax credits award is calculated at about £1,368 a year.  On claiming, they were awarded three months’ backdating. Karen can therefore claim notional entitlement for the remaining nine months since she moved in with Derek - £1,368 x 9/12 = £1,026. The net overpayment she will have to repay is therefore £2,148 - £1,026 = £1,122.

Commencement

Notional entitlement is applied to new cases on and after 18 January, and to cases ongoing at that date to the extent of any outstanding overpayment (i.e., any overpayment that has already been paid to HMRC will not be repaid).

Example

Samson (single, no children, working full-time and earning approximately £9,500 a year) married Delilah (previously single, no children, working part-time and earning some £8,000 a year) on 1 May 2009. He did not notify HMRC of this change in his circumstances until 30 November 2009, at which point he and Delilah made a new joint claim. They were awarded £208 per annum, plus 3 months' backdating amounting to £52.

Samson incurred an overpayment on his former, single claim amounting to £852, which Samson must repay by 12 monthly instalments. The sum of £320 has already been repaid. Notional entitlement for the 4 months between his marrying Delilah and the start of 3 months' backdated award for the new claim amounts to £208 x 4/12 = £70, which will be deducted from later instalments, leaving £462 to be paid (£852 less £320 already paid less £70 notional entitlement). 

Some claimants will automatically be identified as notional entitlement cases; but in the main, the system will be operated manually, so will be largely dependent on claimants or their advisers coming forward to ask for notional entitlement to be applied. Code of Practice 26 which sets out HMRC’s policy on recovery of overpayments will be updated to reflect the new practice, and a short insert placed into hard copies sent out in the meantime. HMRC are also looking at all their relevant customer communications, such as caller scripts, to make appropriate amendments where necessary to reflect the change. 

Penalties

The law allows HMRC to charge a £300 penalty for failure to report a change of circumstances within the statutory time limit of one month, and in addition a maximum penalty of £3,000 where such failure is due to fraud or neglect. In practice, HMRC do not intend to charge any penalty at all if there is no neglect and the claimant has simply made a mistake or has misunderstood.  In other cases, the amount of the penalty will depend on the behaviour that led to the failure: 15% of the net over-claim where the claimant has shown ‘failure to take reasonable care’, and 25% of the net over-claim in the case of ‘serious’ or ‘deliberate error’. Systematic fraud will attract a 50% penalty. Claimants who accrue an overpayment even after notional entitlement is applied, but who are not judged worthy of a penalty, might receive a letter explaining their reporting obligations, and warning that a repeat offence might attract a penalty.

Useful links

Tax Credits guidance on the LITRG website
Tax Credits Overpayments Guide

Article Added Wednesday, 27 January 2010

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