Working for Families tax credits

Sections MD 13 and MF 7 of the Income Tax Act 2007

The Taxation (Annual Rates and Budget Measures) Act 2011 introduced a number of amendments that affect the calculation of Working for Families (WFF) tax credits.

There are three parts to the amendments to the WFF tax credits:

• The rate at which WFF tax credits are abated will increase by 1.25 percentage points every time the Family Tax Credit (FTC) amounts are increased for inflation, until the abatement rate reaches 25%. The first abatement rate increase will occur on 1 April 2012 when the first inflation increase under section MF 7(2) of the Income Tax Act 2007 applies.
• The threshold at which WFF tax credits begin to abate will decrease from $36,827 to $36,350 on 1 April 2012. The threshold will continue to decrease by $450 each subsequent time the FTC amounts are increased for inflation, until the threshold reaches $35,000.
• The FTC amounts for children aged 16 and over will no longer be increased for inflation until the FTC amounts for the eldest child under 16 or for subsequent children aged 13 to 15 equals the respective 16 and over amounts. At this point subsequent increases for inflation will apply.

Background

Under the previous rules, WFF tax credits (excluding the Minimum Family Tax Credit) abated at the rate of 20 cents in the dollar from an abatement threshold of $36,827. When a person's annual income exceeds this threshold, the WFF tax credits are abated - FTC is abated first, followed by the In-Work Tax Credit and then the Parental Tax Credit.

The amounts of FTC prescribed in section MD 3(4) of the Income Tax Act 2007 are adjusted for inflation. The inflation adjustment ensures that the real value of assistance is maintained over time. The adjustment occurs once the cumulative increase in the Consumers Price Index (CPI) reaches 5% from the last adjustment. The last adjustment was on 1 October 2008.

The next inflation adjustment will occur on 1 April 2012 because 5% cumulative inflation was breached in December 2010. The size of the adjustment will not be known until the September 2011 CPI is published, which is used for calculating the amount by which the FTC is indexed. The amount will be the cumulative CPI from September 2008 to September 2011, and will exclude the 2.02% increase in FTC on 1 October 2010, which is consistent with sections MF 7(1), (2) and (2B) of the Income Tax Act 2007.

Key features

The policy objective of the WFF amendments is to reduce the fiscal costs of the scheme while protecting amounts of tax credits for lower income earners, and minimising the effects on work incentives.

The end result is for WFF tax credits to abate at a rate of 25% from a threshold of $35,000, with one amount of FTC for the eldest child and two amounts of FTC for subsequent children, for 0-12 years and 13 and over.

This result is achieved by staggering the increase in the abatement rate, the decrease in the abatement threshold and the alignment of amounts of FTC over time so the impact on families is gradual, while still generating fiscal savings.

Section MD 13(3)(a) has been amended so that:

• in the first inflation adjustment round on 1 April 2012, the abatement rate increases from 20% to 21.25% and the abatement threshold decreases from $36,827 to $36,350;
• in the second inflation adjustment round, the abatement rate increases from 21.25% to 22.5% and the abatement threshold decreases from $36,350 to $35,900;
• in the third inflation adjustment round, the abatement rate increases from 22.5% to 23.75% and the abatement threshold decreases from $35,900 to $35,450; and
• in the fourth inflation adjustment round, the abatement rate increases from 23.75% to 25% and the abatement threshold decreases from $35,450 to $35,000.

These changes to the abatement rate and threshold mean that entitlements to WFF tax credits reduce faster and sooner as income increases. These changes will come into force when inflation adjustment rounds are required by section MF 7(2) of the Income Tax Act 2007.

Section MF 7(1)(a) has been amended so that the prescribed FTC amounts for children 16 years and over in sections MD 3(4)(a)(ii) and (b)(iii) are no longer adjusted for inflation until FTC amounts for the eldest child under 16 or for subsequent children aged 13 to 15, equals the respective 16-year and over amount. At this point the older and younger child amounts are aligned by Order in Council and subsequent increases for inflation apply. This change simplifies the FTC, leaving one rate (rather than two) for a first child and two rates (rather than three) for subsequent children.

Application dates

The amendments come into force at the same time as the inflation adjustment rounds required by section MF 7(2) of the Income Tax Act 2007. The first inflation adjustment round will take effect on 1 April 2012.