Migration to ESA

ESA 16

Written evidence submitted by the Low Incomes Tax Reform Group

1. Executive Summary

1.1. We welcome this inquiry into the migration from incapacity benefit (IB) to employment and support allowance (ESA) as it allows us to reiterate concerns about how the migration process impacts on the tax liabilities, tax credit entitlement and passported benefits position of a migrated claimant. We are particularly concerned with those former invalidity benefit (IVB) claimants who, on migration to CBESA, will lose their transitional tax protection.

1.2. So far, despite our repeated requests, neither DWP nor HMRC has given adequate guidance to those in the migration process, despite the potentially serious consequences on their household income.

1.3. We therefore urge the Committee to press DWP and HMRC for commitments to:

· Work together to provide adequate guidance to individuals caught up in the migration process, particularly those former invalidity benefit (IVB) claimants for whom tax and tax credits matters need to be carefully considered. This is because the transfer from their formerly non-taxable IB to taxable contributory ESA could have serious financial impacts on their household income;

· Ensure that processes are in place to issue correct PAYE codes to all individuals moving from a hitherto non-taxable benefit to one which is taxable;

· Work together to identify those former IVB claimants who are also claiming tax credits and write off any tax credits overpayments which have arisen as a result of the departments’ contributory error, ie their failure to provide adequate guidance as to the potential tax credits consequences of the migration;

· Ensure that the impact on passported benefits is also adequately explained;

· Consult with the Committee and stakeholders on their staff guidance, in particular ensuring that HMRC staff deal sympathetically and speedily with claimants who may come within the tax net for the first time in many years.

2. Introduction

2.1. About us

2.1.1. The Low Incomes Tax Reform Group (LITRG) is an initiative of the Chartered Institute of Taxation (CIOT) to give a voice to the unrepresented. Since 1998 LITRG has been working to improve the policy and processes of the tax, tax credits and associated welfare systems for the benefit of those on low incomes.

2.1.2. The CIOT is a charity and the leading professional body in the United Kingdom concerned solely with taxation. The CIOT’s primary purpose is to promote education and study of the administration and practice of taxation. One of the key aims is to achieve a better, more efficient, tax system for all affected by it – taxpayers, advisers and the authorities.

2.2. Our response

2.2.1. We welcome this opportunity to comment on the inquiry into migration of incapacity benefit (IB) claimants to employment and support allowance (ESA). There are many organisations which are better placed than us to comment on the work capability assessment, decision-making and appeals processes and overall outcomes for claimants. Our response will therefore focus on how the migration process interacts with the tax and tax credits systems.

3. Background

3.1. Transitional protection for invalidity benefit claimants

3.1.1. Incapacity benefit was introduced in April 1995 as a replacement for invalidity benefit (IVB). One of the crucial differences between IVB and IB is that the former was non-taxable, whilst the latter is primarily taxable.

3.1.2. IB has 3 rates:

· Short term-lower rate which was non-taxable (paid for the first 28 weeks of a new claim – not available since the introduction of ESA in October 2008)

· Short term-higher rate which is taxable

· Long term rate which is taxable

3.1.3. In order to give protection to those moving from non-taxable IVB to taxable IB in 1995, transitional tax protection was given meaning that their IB, although long term, is non-taxable. This protection is given under Section 663 Income Tax (Earnings and Pensions Act) 2003.

3.2. Interaction with tax credits

3.2.1. The tax credits system generally follows the tax system when determining what counts as income for tax credits purposes. If income is taxable it will normally be income for tax credits purposes (although there are some exceptions) and if non-taxable it will not be included as income.

3.2.2. For IB, tax credits follow the tax treatment and therefore both the short term-lower rate and long term IB for those previously in receipt of IVB are not taken into account as income.

4. The impact of migration to ESA on tax and tax credits

4.1. The tax position

4.1.1. Those IB claimants who successfully meet the requirements will be migrated to contribution-based ESA (CBESA) which is a taxable benefit.

4.1.2. It has been confirmed that there will be no transitional protection for those currently in receipt of non-taxable IB (old IVB claimants) and therefore they will move from a non-taxable to taxable benefit.

4.2. The impact on claimants

4.2.1. The explanatory memorandum to the ESA transitional regulations [1] states that ‘the Government will ensure that no customers whose benefit rates are higher than the ESA rate will experience a cash reduction in their benefit on migration to ESA, by transitionally protecting their existing level of benefit’. In addition, in went on to say that ‘Anyone receiving Housing Benefit and Council Tax Benefit at the point of migration will not see a reduction in overall benefit income as a result of migration due to transitional protection in Housing Benefit and Council Tax Benefit’.

4.2.2. Whilst this commitment was welcome, we pointed out in our evidence to the Social Security Advisory Committee’s review of these regulations, that it is still possible for some claimants to be worse off as a result of migration by virtue of a hitherto non-taxable benefit becoming taxable. As well as decreasing net income due to an increase in tax payable, in turn it could lead to a substantial reduction in tax credits and the loss of passported benefits.

4.2.3. In a discussion about the Employment and Support Allowance Regulations 2008 in the House of Lords it was said [2] that most claimants who receive only CBESA will not be liable to tax because their income is likely to be under the personal allowance. However, the documents provided by DWP to SSAC [3] show that DWP estimate 50,000 claimants will be affected by the loss of transitional protection with an average income tax liability of £1,000 a year. The rationale given for this is that ‘these will be customers with the highest incomes, the vast majority of whom are already liable for tax’.

4.2.4. Given that the personal allowance for 2011-2012 is set at £7,475, many claimants who have income over this amount, for example because they have a small occupational pension or because they do ‘permitted work’, may well already pay tax but to say they are on the ‘highest incomes’ is not accurate given that we are talking about people in relative poverty. The impact of the increased tax bill, which could be around £19 per week for someone with a small private pension and CBESA, should not be underestimated.

4.3. The tax credits position

4.3.1. Tax credits play a crucial part in reducing child poverty, supporting families with children and helping low-income workers move into and remain in work.

4.3.2. At present, tax credits rules broadly follow the tax system. Therefore, if income is taxable it is generally counted as income for tax credits and if it is non-taxable it is generally not counted as income for tax credits. Under the current tax credits rules, those who receive non-taxable LTIB (former invalidity benefit claimants) do not have this counted as income for the purposes of their tax credits claim.

4.3.3. However, if these claimants are moved to taxable CBESA it follows that their CBESA would become income for tax credits. For most claimants on low incomes, this would eventually mean a loss of tax credits of 41p for every £1 of CBESA income.

4.3.4. In 2007, we wrote to Lord Kirkwood outlining our concerns about the transfer of claimants to ESA and particularly about the implications for tax credits. As a result of that letter, DWP replied stating that ‘the likelihood of people on low incomes facing loss of tax credits as a result of receipt of contributory ESA is limited when you consider that, as with the current system, people will not receive both Employment and Support Allowance and Working Tax Credit at the same time as the qualifying conditions are mutually exclusive’. It went on to conclude that ‘this means that the people facing receipt of ESA and withdrawal of tax credits at the same time would be those with children’.

4.3.5. As stated to SSAC in our response to their consultation on the ESA regulations, we believe that presumption is incorrect because it is indeed possible in some circumstances to receive both ESA and Working Tax Credit (WTC). Although admittedly this is generally not possible in the case of those on LTIB moving to ESA, it is possible that claimants of LTIB (non-taxable) will be part of a couple claiming WTC jointly. It follows therefore that in such cases there will be an increase in the joint household income when there is a change from non-taxable to taxable benefit.

4.3.6. For example, let us consider a couple with no children where one partner works 32 hours per week in a low-paid job, and the other is on LTIB (non-taxable). Their WTC award will presently be based only on the employment income of the working partner. If no transitional protection is given, when LTIB is converted to CBESA under the current rules it will be classed as income for tax credits purposes, thus eventually resulting in a significant reduction in the tax credits award. Based on 2011-2012 rates of ESA, if CBESA is paid at £94.25 per week, loss of tax credits could be as much as £2,010 per year or about £39 per week. Whilst there may be no loss from ESA, there is a substantial loss of WTC as a result of the transfer from IB to CBESA.

4.3.7. We acknowledge the role of the disregard in tax credits, so that the impact of the change from non-taxable LTIB to CBESA may not be seen immediately where claimants’ awards are based on previous year income. However, in the second and subsequent years (applying the current rules) the income from CBESA will have to be taken into account. For tax credits claimants who are already paid their tax credits on an estimated current year basis, any change in income would impact on their award immediately and may create an overpayment.

4.4.8. Similarly, low-income families with children may also see a fall in tax credits where a parent moves from non-taxable IB to taxable CBESA. This will run counter to the Government’s broader child poverty agenda.

4.5 Passported Benefits

4.5.1. Tax credits often act as a gateway for entitlement to certain passported benefits. For example, exemption from NHS health costs can be given if you receive:

· Child Tax Credit (CTC) and your gross annual income used to calculate your tax credits award does not exceed £15,276; or

· CTC and WTC and your gross annual income used to calculate your tax credits award does not exceed £15,276; or

· WTC including a disability or severe disability element and your gross annual income used to calculate your tax credits award does not exceed £15,276 per annum.

4.5.2. As well as receipt of WTC or CTC (or both) there is often an income criteria attached to passported benefits. Claimants moving from non-taxable LTIB to taxable CBESA will see a rise in household income that may cause them to lose valuable passported benefits because they no longer meet the criteria.

4.5.3. Although other benefits can also act as a gateway to certain passported benefits, CBESA is not a benefit which normally gives rise to such entitlements. For example, receipt of CBESA would not give automatic exemption from NHS health costs. A family which loses passported benefits as a result of their tax credits income rising after transition would not be able to use CBESA to keep their passported benefits.

4.5.4. As we have shown, the transition from a non-taxable to taxable benefit can have serious financial consequences both in relation to a fall in tax credits but also the potential loss of related passported benefits.

5. Administrative concerns

5.1. Importance of good administration

5.1.1. In light of the potentially severe impact on a claimant’s tax and tax credits position, it is absolutely crucial that accurate information is given to claimants so they understand how the migration will impact upon them.

5.1.2. We stressed this in our submission to SSAC in 2010, and urged DWP and HMRC to address the administrative issues linked to tax and tax credits and to ensure that claimants have adequate information about the impact of the migration on their tax and tax credits position.

5.1.3. Unfortunately, as the pilot exercise has ended and migration has rolled out nationally, neither DWP nor HMRC seems to have adequately addressed these concerns.

5.2 Administration and tax

5.2.1 Although the letters we have seen indicate that HMRC will be in touch with claimants, such contact is said to be in the context of income tax. But we have seen no evidence that there is a co-ordinated programme to ensure that HMRC will provide individuals with an accurate PAYE code at the point of migration. A failure to do this may add a tax underpayment to an already confused and unsatisfactory position. We would ask the Committee to obtain the appropriate training materials provided to HMRC staff to ensure that they are equipped to understand the nature of the migration issues and to deal sympathetically and speedily with former IB claimants who may come within the tax net for the first time in many years after losing transitional tax protection.

5.3 Administration and tax credits

5.3.1. There appears to be little, if any, joint working between DWP and HMRC despite the clear necessity for it. As far as we are aware, the letters that are being sent to claimants by DWP in relation to migration do not contain any reference to tax credits. This needs to be corrected immediately.

5.3.2. At the time of writing this evidence, we have had no information from HMRC as to how they are dealing with those migrating from non-taxable IB to taxable ESA despite several requests.

5.3.3. The HMRC website contains no specific information about the change, neither can we find any reference in HMRC’s series of tax credits leaflets. Those that are migrated mid-year are unlikely to appreciate the need to inform HMRC for tax credits purposes, due to the lack of information give to them by either government department, therefore it is possible that an overpayment could be building up. We urge HMRC to give a commitment that they will write off any overpayments that occur in these circumstances and that they undertake an exercise, with DWP, to identify those affected and write off the overpayments without the need for the claimant to dispute.

5.3.4. For those who are not impacted immediately, due to the £10,000 income disregard in tax credits, HMRC need to have processes in place to ensure that claimants who have been migrated from non-taxable to taxable income are identified so that their tax credits for 2012-2013 are based on correct income. As well as updating their materials immediately, they need to be pro-active in contacting claimants. It is not acceptable to rely on the claimant to understand the relevance of the change from IB to ESA for tax credits when neither DWP nor HMRC has given them any information.

5.3.5. DWP also need to ensure that their letters are amended to include information about a potential loss of passported benefits.


April 2011


[1] Employment and Support Allowance (Transitional Provisions, Housing Benefit and Council Tax Benefit) (Existing Awards) Regulations 2010 (SI 2010/875) .

[2] http://www.parliament.t h e-stationery- o ffice.co.uk/p a /ld200708/ldhansrd/text/80522-0015.htm (22 May 2008, col 1649)

[3] http://ssac.independent.gov.uk/pdf/employment_and_support_allowance_regs.pdf