TCTM04004 - Income: Trading (self-employed) income

The Tax Credits (Definition and Calculation of Income) Regulations 2002, Reg. 6

Self-employed income for the purpose of calculating entitlement to tax credits will generally be the taxable profit for the tax year from the person’s work in their trade, profession or vocation, carried on in the United Kingdom or elsewhere or their share in a partnership’s 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 Part 2 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA). That is the amount after deduction of allowable business expenses.

Averaging profits for farmers, market gardeners and creative artists

For the purposes of determining income tax liability, farmers and market gardeners who have significantly fluctuating trading profits may, subject to certain conditions, ask HMRC to average their profits over a period of either 2 years or 5 years. The average is then taxed at the end of the final year. Creative artists can only average over 2 years.

The “averaging” of profits of farmers, market gardeners and creative artists by virtue of Chapter 16 of Part 2 of ITTOIA is not allowed for the purposes of calculating trading profits for tax credits. This means that only the actual trading profit or loss for the year should be included. However, where a farmer has received or will receive compensation for the compulsory slaughter of animals by virtue of Chapter 16ZA Part 2 of ITTOIA, the averaging of profits is allowed for tax credits

Disguised remuneration tax avoidance scheme

Disguised remuneration tax avoidance schemes claim to avoid the need to pay income tax and national insurance contributions. These schemes normally involve a loan or other payment from a third-party which is unlikely to ever be repaid.

If a self-employed person is in a disguised remuneration scheme, and does not settle their tax affairs by 5 April 2019, the new charge brought in by the Finance Act (No 2) Act 2017, will apply to all such outstanding loans.

However, by virtue of The Tax Credits, Child Benefit and Childcare Payments (Miscellaneous Amendments) Regulations 2019, for the purposes of tax credits the relevant notional income is disregarded.

Where there is no taxable profit but a trading loss, any portion of that loss which remains unrelieved after the sideways set-off described in Step 4 in the calculation of income (see TCTM04002) can be set-off against future income of the same trade, profession or vocation. This mirrors the carry forward of a trading loss allowed in income tax rules. There are slight differences in the rules relating to trading losses for tax credits purposes and income tax. However, relief can only be claimed once for each pound of loss.

For example, there is a trading loss of £5000 in the accounting period ending 2004-5. For tax and tax credit purposes this is treated as a loss for the tax year 2004-5. The claimant’s only other income that year is gross building society interest of £800, only £500 of which is included in the tax credit claim (allowing for £300 de minimis limit). If he were then to make a trading profit of £10,000 in the following accounting period ending 2005-6, for tax credit purposes he could then set the £4500 balance of his 2004-5 loss against this later profit to give a reduced profit of £5500 in his 2005-6 tax credit claim.

A trading loss is not available for tax credits purposes unless the trade is carried out on a commercial basis and with a view to the realisation of a profit.

Coronavirus Support Scheme

For Tax Credits, taxable payments made under the coronavirus self-employed income support scheme are included in the calculation of ‘taxable profit’ as the payments are included in Part 2 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA).