Memo to tax credit claimants: it's safe to return to the system

Reforms will improve a flawed scheme that left thousands of families in poverty, reports David Prosser

housands of families who have given up on the crisis-hit tax credits system should be able to start claiming much-needed money following this week's Pre-Budget Report. Charities and accountants say that the reforms announced by the Chancellor Gordon Brown will eventually restore faith in the scheme.

The most significant reform is that from April 2006, the "income disregard" will rise from £2,500 to £25,000. Currently, families claim tax credits on the basis of their income in the previous financial year. However, if it subsequently emerges that your household income in the current year is more than £2,500 higher than in the previous year, HM Revenue & Customs is entitled to reclaim the overpayments it has made.

So, for example, a family with an income of £15,000 in the 2003-04 tax year would have been paid tax credits on that basis during 2004-05. If their income in 2004-05 rose to above £17,500, the Revenue would have ruled they had been overpaid credits and begun clawing back the extra money.

The system has caused many families extreme hardship, particularly in cases where the Revenue has been very aggressive in clawing back. The National Audit Office said in October that the Revenue had overpaid £2.2bn of tax credits in 2003-04, even though many families had tried to report increases in income during the tax year.

Once the income disregard rises in April, the Revenue will ignore income rises of up to £25,000. It estimates that 95 per cent of increases will fall within the new allowance - even where people move from part-time to full-time work, a major reason for overpayments.

Accountants say the move should reassure people. "This is a very welcome change. It means most recipients of the credit will not have to repay it even if their income increases," says Colin Ben Nathan, a tax partner at KPMG. The change reflects "recent serious difficulty in administering the tax credit system," he says

However, overpayments will not disappear altogether. According to Revenue figures, only half the overpayments made in the past have resulted from income increases. Many have been caused by changes in circumstances: claimants stopped working the minimum hours required for the work element of Working Tax Credit, for example, or childcare costs changed.

Katie Lane, a tax credits expert at Citizens Advice, says this is why the charity is particularly pleased that there will be limits on the amount of money that can be clawed back when overpayments are identified.

Currently, a bizarre dual system operates. If the Revenue discovers it has been overpaying tax credits in the current financial year, there are no limits on how much it can claw back. As a result, some families have been overpaid during the first half of the year and then had their credits stopped altogether during the second half.

However, if the Revenue identifies overpayments made in a previous financial year, it is not allowed to claim any more than 10 per cent of the credits you are currently receiving. So if you get £100 a week, the maximum you can lose is £10.

Following the Pre-Budget Report, from November next year, this latter rule will apply on current-year overpayments too. "That will ensure that where overpayments do still occur, people are not left without money to live on," Lane says.

Citizens Advice says it will continue to campaign for better communication from the Revenue on how credits are calculated. However, the charity is keen to reassure families who have been so scarred by their experiences that they are no longer making claims. "People should be encouraged by these measures," Lane says.

Who can claim tax credits?

* Families may be eligible for two types of tax credit - the Child Tax Credit and the Working Tax Credit.

* The first is available to families with children, whether the parents work or not. Families with household incomes of up to £58,000 can claim, though the size of the credit reduces the closer you are to this limit.

* This year, families earning up to £50,000 get the family element of Child Tax Credit, worth at least £545 a year. Families with incomes below £13,910 can claim a further element worth £1,690 a year per child, falling for higher incomes.

* The Working Tax Credit is aimed at people who work - whether or not they have children - and is paid through your employer. The basic element is worth up to £1,620 a year. Families can claim further help of up to 70 per cent of childcare costs if both parents work at least 16 hours a week.

* Tax Credit Helpline (0845 300 3900); the Revenue website (www.hmrc.gov.uk).

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