The Low Incomes Tax Reform Group (LITRG) has called for changes to avoid people being discouraged from starting self-employment and existing claimants being forced to give up their work.
The changes LITRG is arguing for include:
- allowing self-employed claimants with fluctuating income to average their income over a period of up to a year
- changes to the calculation of the ‘minimum income floor’ and increasing the start-up period during which it does not apply from one to two years
- greater consistency in definitions of self-employment
- more specialist support for self-employed universal credit claimants.
LITRG began to raise concerns about self-employment in universal credit when the universal credit White Paper was first published, and the Welfare Reform Bill began its passage through Parliament in 2011. Although some minor changes to the rules have been made since then, many of the major concerns remain. At present, the system does not work well for self-employed claimants who have fluctuating income and/or expenses, or who have a large, one-off business expense in a particular month, nor does it give people long enough to establish and grow their business.
The report summarises the main shortcomings of the current universal credit system in respect of the self-employed and suggests positive reforms that would encourage entrepreneurial activity and relieve administrative burdens. The LITRG model aims to treat all self-employed people fairly and ensure greater parity with employed people earning similar amounts.
LITRG concerns: lack of parity between the employed and the self-employed
The last ten years have seen a significant rise in the number of people who are self-employed, many of whom are on a low income and therefore unable to afford professional advice. Universal credit is gradually replacing working tax credit as the primary welfare support for low income working-age people.
LITRG has been raising concerns with both Parliament and Government about the proposed treatment of the self-employed under universal credit since 2010. The universal credit assessment period is one month as against one year for tax, definitions of income and profit from self-employment differ for universal credit and tax, and universal credit operates a cash basis which diverges from the cash basis option for tax.
Perhaps the area of most concern of the self-employment regime under universal credit is the minimum income floor which fails to account for fluctuating earnings or one-off large business expenses. This can lead to a situation where a self-employed claimant with fluctuating earnings can receive substantially less universal credit than an employed claimant earning a similar annual income above the level of the current minimum income floor (see page 11 of the report and the example of Fiona and Gregory in Appendix 2, page 31 of the report). LITRG cannot believe that is an intended consequence. From April 2018, the universal credit system will become far more complicated with the introduction of surplus earnings rules for both the self-employed and employed and, in some cases, this will make the disparity worse.
In exploring the implications of the concept of parity between the employed and self-employed under universal credit, this report contributes to the wider debate that is already under way, but needs to be continued in earnest, about the need for greater coherence in policymaking on how the tax and welfare systems should apply to the rewards from work, whether classified as employment or self-employment or any other category of work.
LITRG’s report does not seek to start from the beginning; instead it sets out its own diagnosis of what is wrong with the current system and proposes what it believes to be a workable alternative which can be achieved through changes to the existing system. Its model attempts to preserve the current incentives for entrepreneurial endeavour, brings greater parity between the employed and self-employed and safeguards public finances against abuse.
Without further changes, there is a real risk that those thinking about starting out in self-employment will be dissuaded and those already in self-employment may be forced to give up before they have been given a chance to grow their businesses. LITRG urges the Government to consider its recommendations carefully and make the necessary changes to the existing rules.
The report’s recommendations
- In each Jobcentre office, a small number of staff should undergo specialist self-employment training to become ‘subject experts’ with access to a central expert team who are supported by HMRC.
- Self-employed claimants should see a work coach at least once every 12 months to ensure compliance with the gainful self-employment test. (A claimant is in gainful self-employment if the Secretary of State has determined that they are carrying on their activity as their main employment, that the earnings from it are self-employed earnings and that it is organised, developed, regular and carried on in expectation of profit.) There should be consistency to ensure that claimants who are classed as self-employed by HMRC are also self-employed for universal credit purposes. All claimants passing the test should have the opportunity to access business support from a trained Jobcentre adviser.
- The current one-year start-up period should be extended to two years. (Broadly, the start-up period is the period beginning 12 months from the start of the assessment period in which the claimant is determined to be gainfully self-employed. Claimants can only have one start-up period every five years and any further start-up period must be in relation to a different trade, profession or vocation. During the start-up period, the minimum income floor will not apply.)
- A general anti-abuse provision should ensure people cannot manipulate their income in order to claim universal credit or more universal credit. This would apply to both employed and self-employed claimants and would remove the need for the complex surplus earnings rules that are due to come into force from April 2018.
- Self-employed claimants with fluctuating income or profits should be given an option of averaging their income over a period up to one year.
- All definitions should be fully aligned with the HMRC cash accounting rules and thought should be given to how the system can deal with those who are unable to use the HMRC cash basis for tax purposes.
- In cases where earnings are averaged, LITRG proposes that the system of reporting monthly income and expenses should be changed so that it follows the period for which earnings are averaged.
- The minimum income floor should remain from Year 3 onwards but should be calculated after deduction of pension contributions as well as tax and national insurance. (The minimum income floor (MIF) applies to those who are in the ‘all work’ requirements conditionality group only. Outside of the start-up period, any month in which the self-employed claimant’s profits fall below the MIF, the claimant’s universal credit award is assessed as if they had profits at least equal to the MIF. The level of the MIF is equal to the National Minimum Wage for the claimant’s age group, assuming they work their expected number of hours each week. For most people, the expected number of hours will be 35 hours a week, although it may be less for example if the claimant has caring responsibilities, is responsible for a child under the age of 13, or has a physical or mental impairment. The MIF is calculated after deductions of notional tax and national insurance.) This is to ensure self-employed claimants are treated as favourably as employees who make pension contributions.
- Two exceptions should be made to the minimum income floor. First, a three-month grace period in each 12-month period to allow someone to deal with unexpected events or a one-off large expense without any adverse impact. Secondly, LITRG proposes a discretion for DWP staff to disapply the minimum income floor in certain situations.