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Children&#39s tax credit where it&#39s due

For those of you who regularly advise couples living together and

financially supporting children, life will get increasingly awkward from

April 3, 2001. You will need to start preparing for it now, if you have not

already done so.

In last year&#39s Budget speech, Chancellor Gordon Brown announced the

Government would introduce a new children&#39s tax credit from April 2001.

In a significant shift in Government policy away from fiscal support for

marriage to fiscal support for children, he announced that the new tax

credit would replace the married couple&#39s allowance for those aged under


This is an interesting use of the word “replace” as the married couple&#39s

allowance disappeared this month – a year before the arrival of the new tax


How will children&#39s tax credit work? It will take the form of an allowance

which attracts income tax relief at a flat rate of 10 per cent. The

allowance for the first tax year will be £4,160. However, where the person

claiming the allowance is subject to higher-rate tax, the allowance reduces

by £2 for every £3 of income above the point at which he or she starts to

pay higher-rate tax.

This will remind you of the limits on age-related personal allowances.

Indeed, the tax traps we are all too familiar with on age allowance will

also arise here. However, the familiar solutions are also available.

Unlike income-producing investments, life policies do not produce amounts

included in income where withdrawals do not exceed the 5 per cent annual


However, in calculating the children&#39s tax credit available, income does

include chargeable gains on life policies such as where withdrawals exceed

the 5 per cent allowance. Thus, basic-rate taxpayers may find the full

amount of the gain, without the benefit of top-slicing, will serve to

reduce or erase their right to children&#39s tax credit, resulting in a

greater income tax liability. This occurs even though they may escape a

higher-rate liability on a chargeable gain by claiming top-slicing relief.

Similarly, higher-rate taxpayers could suffer a “double whammy” by having

to pay higher-rate tax on the gain as well as suffering a cut in their

right to children&#39s tax credit.

Who will get the tax credit? The following applies where a couple who are

married or living together have at least one qualifying child under age 16

living with them.

Where neither is a higher-rate taxpayer, the higher earner will get the

tax credit. However, the lower earner can elect to share the credit equally

between them or the couple can elect for the lower earner to receive all

the credit.

Where one is a higher-rate taxpayer or they are both higher-rate

taxpayers, the higher earner will receive all the tax credit. The allowance

will then reduce by £2 for every £3 of income above the point at which they

start to pay higher-rate tax. The couple do not have the opportunity to

make elections to share or give away the tax credit.

Where a partner&#39s right to the allowance exceeds his or her taxable

income, he or she can elect to transfer the unused portion to the other


An absurdity occurs where each of the couple has identical total income

for the tax year. This could easily occur – consider a couple who are in

business together as equal partners. Another example might be where neither

of the couple receives earned inc ome and their savings are all held in

joint names.

In both these circumstances, neither of them will have a right to the tax

credit unless they make an election that one of them be treated as the

lower earner.

As you can see, the introduction of children&#39s tax credit is yet another

example of how important it is to ensure that the most suitable person

holds particular investments.

Where you are advising couples with children, life insurance bonds will

assume an even greater importance in tax planning than is already the case.


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