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's Budget speech, Chancellor Gordon Brown announced the
Government would introduce a new children's 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's allowance for those aged under
This is an interesting use of the word “replace” as the married couple's
allowance disappeared this month – a year before the arrival of the new tax
How will children's 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's 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's 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's 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
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's 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
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
As you can see, the introduction of children's 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.