Child benefit clawback: how to avoid it

 

The high-income child benefit clawback has been making the news recently – for all the wrong reasons. 

 

It seems that several mainstream newspapers have recently picked up on the child benefit clawback and that it has started to catch people out again – probably because HMRC has done very little to publicise the issue since its introduction several years ago. 

 

This article looks at what triggers the clawback, and what may be done to avoid or to mitigate the charge.

 

The high income child benefit charge (HICBC) was introduced in January 2013 to help offset the national cost of child benefit. It operates as a clawback of the child benefit paid in a tax year, which is triggered when ‘adjusted net income’ (ANI) exceeds £50,000 in the tax year in question, at a rate of 1% per £100 in excess of £50,000. As such, it is fully clawed back when ANI reaches £60,000. 

 

The clawback is supposed to be self-assessed through one’s tax return. In other words, the taxpayer is supposed to realise that the clawback applies and to calculate the amount of the child benefit to be clawed back in the tax return he or she prepares for the tax year in question. 

 

Martha has three children for whom she claims child benefit, and she receives £2,500 child benefit in 2019/20. Martha’s salary is £55,000 (she has no other income or deductions). 

 

She must repay 50% of the child benefit she has received through her 2019/20 self-assessment tax return, i.e. £1,250. 

 

Martha therefore has a marginal income tax rate of 65% (more, if National Insurance contributions are also considered). 

 

There are a few traps that frequently catch people out:

• It is not necessarily clawed back from the claimant/recipient of the child benefit. If the claimant is part of a couple, the higher earner is assessed to the clawback, regardless of whether or not the higher earner is a parent of the relevant child or has received any child benefit income. 
• That couple does not have to be married or in a civil partnership; simply living together as if married or in a civil partnership is enough to fall within the scope of the HICBC. It is conceivable that the taxpayer who is ‘caught’ may have no idea that his or her spouse or cohabitee is in receipt of child benefit. 
• Many taxpayers whose annual incomes have gradually risen above £50,000 will have forgotten about the HICBC by the time it matters, even if they may have been peripherally aware of it when their children were first born. 

The clawback might be seen to be quite unfair. And it is easy to get caught out. Aside from publicising the clawback in 2013 when it was first introduced, HMRC has done little to warn people that they may be caught – although it does seem to be reasonably proficient at telling people afterwards that the HICBC applied and charging interest and penalties accordingly! 

 

Adjusted net income (ANI) is essentially income from all sources – profits, salary, interest, dividends, etc. – but net of allowable deductions, the most important of which are:

• losses allowable against income;
• pension contributions; and
• gift aid payments.

Landlords should also be aware that, for these purposes, ANI reflects any disallowance of dwelling-related loans (mortgages, etc.) on residential property income. A landlord can, therefore, suffer a clawback of child benefit he or she has not personally received, based on income he or she has never seen.

 

How to avoid the clawback

There are several measures one might take to avoid or reduce the charge:

 

1. Reduce income by sacrificing salary or a potentially problematic bonus in exchange for an employer pension contribution instead. Provided the taxpayer is already a member of an employer-supported childcare scheme, it may alternatively be possible to exchange salary for more childcare vouchers. The new so-called ‘tax-free childcare’ scheme does not affect ANI, but the ‘old’ employer-supported childcare scheme closed to new entrants from October 2018. 

 

Note that, aside from childcare vouchers and pension contributions, there are now very few ‘salary sacrifice’ arrangements that will actually reduce deemed taxable income; broadly, from April 2017 most salary sacrifice arrangements have been deemed ineffective for tax purposes, leaving HMRC able to tax the employee on the higher of the salary given up or the deemed value of the benefit received in exchange. 

 

2. Make a private pension contribution, which is deemed to reduce ANI. The effective reduction is 125% of the amount actually paid into the pension scheme.

 

Paulo is a partner in a firm of architects. The partnership accounting year end is 30 April, so his 2019/20 income is based on his share of the partnership profits to 30 April 2019 – leaving plenty of time before 5 April 2020 to make a pension contribution. 

 

Paulo’s share of taxable profits to 30 April 2019 is £55,000. Between Paulo and his wife, he is the higher earner (strictly, he has the higher ANI) so Paulo is exposed to the HICBC even if he has not personally claimed the child benefit. 

 

Having sought appropriate financial advice, Paulo makes a pension contribution of £4,000 before 5 April 2020 – the end of the 2019/20 tax year. This is ‘grossed up’ by the basic rate of income tax – every £80 of pension payment is deemed to be £100 after 20% tax has been deducted. Paulo’s £4,000 pension contribution is therefore deemed to reduce his ANI by £5,000 down to just £50,000, avoiding the HICBC. 

 

3. Gift aid works in a similar way, although it is perhaps less ‘efficient’ because it is a third party that receives the money, rather than the taxpayer’s own pension fund. However, gift aid does have one advantage, which is that it can be paid after the end of the tax year and ‘carried back’ by election to the previous tax year. 

 

So, in the above example, Paulo could make a gift aid contribution after 5 April 2020 and carry it back to 2019/20 (but note that there are strict rules about such gift aid contributions, notably that the election to carry back the donation must be made in the original tax return for the later tax year). 

 

Where there is a couple involved (i.e. not just a single parent/guardian household), it is essential to consider the incomes of both parents (or guardians, etc.). Where both partners in a couple earn similar amounts, planning for one is insufficient. 

 

By way of illustration, for several years I advised a husband and wife professional partnership, where the wife was in receipt of child benefit. Partnership profits were split equally. But the wife always suffered the HICBC because she had slightly more bank interest each year (and overall income) than her husband. For several years, she queried why her tax bill was so much higher than her husband’s, despite their incomes being almost the same. And for several years, I explained the HICBC mechanism and suggested that the easiest solution, for her, was to spend or transfer some of her savings to her husband, so that her total income fell to just slightly less than that of her husband, so that he would in future become the higher earner and suffer the HICBC…

 

Of course, this does not really benefit the couple overall, as it merely moves the HICBC to the other partner. In such cases, where the ANIs of both spouses fall between £50,000 and £60,000, one might attempt to equalise incomes (net of pensions, etc.) so far as possible, to maximise household income for the given HICBC.

 

The HICBC is easily overlooked and is particularly problematic for tax advisers who may not know about young children or the circumstances of both parents, etc., in a couple. While it is possible to elect not to receive child benefit, one should always register eligibility for child benefit at birth because it can secure entitlement to state pension even when not working, when caring for young children.