Guidance on the tax relief changes for employer-supported childcare

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HMRC provides initial guidance on the tax relief restrictions for employer-supported childcare and performing the “basic earnings assessment”.

HMRC published a new draft guidance document on 6 April which will be finalised when the Finance Bill gains Royal Assent. However, as the equivalent NICs regulations have already been made by means of the Social Security (Contributions) (Amendment No. 4) Regulations 2011, it is unlikely that there will be any further changes to the tax rules.

In September 2009, the Prime Minister, Gordon Brown, announced that the tax exemption for childcare vouchers would be phased out from 2011. Following widespread dissent, this decision was reversed in December 2009 and, instead, it was announced that, still from April 2011, the tax relief on childcare vouchers would be restricted to the basic rate of tax.

The changes require amendments to both primary and secondary legislation and the changes to the tax legislation are included in the Finance (No. 3) Bill 2011. The equivalent amendments to NICs regulations were made by means of the Social Security (Contributions) (Amendment No. 4) Regulations 2011 and were effective from 6 April 2011.
With regard to the Government’s objective in restricting the available tax relief further, the guidance notes state:

“The purpose of the change is to even out the amount of tax saving available for all employees regardless of the tax rate that the individual pays.”

There are three separate tax and NICs exemptions covering childcare provision in the Income Tax (Earnings and Pensions) Act 2003 and the equivalent social security legislation:

1. Employer-provided childcare, i.e. workplace nurseries, is fully exempt from tax and NICs if the defined conditions are met.
2. The provision of employer-contracted childcare, i.e. where the employer provides access to childcare by contracting with registered childcare providers, is exempt from tax and NICs on the first £55 per week.
3. The provision of childcare vouchers for qualifying childcare is also exempt from tax and NICs on the first £55 per week.

The first of these methods of providing childcare is not affected in any way by the tax restriction. Employers are encouraged to continue to increase the overall availability of childcare by making in-house provision. Only the second and third methods of providing childcare are affected by the restrictions and, together, they are known as “employer-supported childcare” to distinguish them from “employer-provided childcare”. Employees are only entitled to one £55 exemption for “employer-supported childcare” in respect of the same tax week, either employer-contracted childcare or childcare vouchers.

The tax and NICs exemptions are defined in the context of the provision of employer-supported childcare, financed by employers as a fringe benefit for their employees. HMRC calls this way of providing childcare as a “salary plus” arrangement. However, it is more common to find them provided under:

• self-financing “salary sacrifice” schemes, where the employer’s costs are met by voluntary reductions in the salaries of the employees concerned
• flexible benefits schemes, where employees may choose between a range of benefits, including employer-supported childcare, and offset them against each other and, in some cases, against their salary.

For the purposes of the new tax relief restrictions, it does not matter how the employer-supported childcare is provided. If it is provided in such a way that it benefits from the £55 exemption, employers must operate the new restrictions.

Statutory conditions for tax exemption

At this point, it is worth restating the conditions that must be met in order for employees to qualify for the tax exemption, whether under the current rules or under the new rules from April 2011. The new fourth condition, which applies in each case from April 2011, is added for completeness.

The provision of employer-contracted childcare is exempt from tax up to the weekly limit if

1. the child
1. is a child or stepchild of the employee and is maintained (wholly or partly) at the employee’s expense, or
2. is resident with the employee and is a person in respect of whom the employee has parental responsibility,
2. the care is qualifying child care, and
3. the care is provided under a scheme that is open
1. to the employer’s employees generally, or
2. generally to those at a particular location
4. the employer has, at the required time, estimated the employee’s relevant earnings amount for the tax year in which the care is provided.

The provision of childcare vouchers is exempt from tax up to the weekly limit if:

1. the voucher is provided to enable an employee to obtain care for a child who
   1. is a child or stepchild of the employee and is maintained (wholly or partly) at the employee’s expense, or
   2. is resident with the employee and is a person in respect of whom the employee has parental responsibility,
2. the voucher can only be used to obtain qualifying child care, and
3. the vouchers are provided under a scheme that is open—
1. to the employer’s employees generally, or
2. generally to those at a particular location
4. the employer has, at the required time, estimated the employee’s relevant earnings amount for the tax year in respect of which the voucher is provided.

Employees affected by the new restrictions

The new restrictions apply only to employees who join the childcare or voucher scheme on or after 6 April 2011. These include:

• employees who join the scheme for the first time
• employees who apply to join the scheme before 6 April 2011 but who do not meet the qualifying conditions until 6 April 2011 or later
• employees who have left the scheme in the past and who rejoin
• employees who cease to meet the qualifying conditions but who rejoin when they qualify again
• new employees joining the scheme, even if they have participated in a scheme with their previous employer with the same scheme provider.

Employees who stop receiving childcare or vouchers temporarily are not treated as leaving the scheme, as long as the break is for no longer than twelve months. Examples of such temporary periods are:

• parents working during term-time who care for their children personally during school holidays
• employees taking maternity, adoption or additional paternity leave
• employees on long-term sick leave
• employees taking a career break.

Conversely, employees who are not affected by the new restrictions are those who:

• joined the scheme before 6 April 2011,
• are continuously employed by the employer during the period from 6 April 2011 to the current tax week, and
• during that period, there has not been a 52-week continuous period throughout which vouchers and/or childcare were not being provided for the employee under the scheme.

For as long as employees remain scheme members and meet the qualifying conditions, the new restrictions do not apply to them. Therefore, entitlement to the full £55 tax exemption is not affected because

• vouchers are first provided on or after 6 April 2011
• there is a requirement for employees to renew their scheme agreement each year
• the value of the childcare or vouchers they receive changes
• there is a change in employer due to a business merger, reorganisation, TUPE transfer, or public sector transfers under the Cabinet Office Statement of Practice (COSOP) on Staff Transfers, or
• the third-party voucher scheme provider changes.

Tax restrictions for existing scheme members

Employees who are not affected by the new restrictions continue to benefit from the £55 weekly exempt amount. This is equivalent to £243 per month. (There are 53 weeks in a tax year for the purposes of employer-supported childcare.)

If the value of the employer-contracted childcare provided exceeds the weekly or monthly exempt amount, the excess must be reported on the employee’s P11D at the year end and the employer must pay the relevant amount of Class 1A NICs.

If the value of childcare vouchers provided exceeds the weekly or monthly exempt amount, the excess must be:

• added to the employee’s gross pay in that particular week or month for NICs purposes, and
• reported on the employee’s P11D/P9D Return at the year end.

Tax and NICs liabilities, if any, are determined in each pay/earnings period. If a liability occurs in one pay period it cannot be offset against periods where no liability arises. These are the existing procedures and they are not changing at all for existing scheme members.

Where employees receive variable values of childcare vouchers in each pay period and some of them exceed the weekly or monthly limit, special rules apply for calculating the amount that must be reported for NICs purposes.

Basic earnings assessment for new scheme members from April 2011

Instead of the single £55 exempt amount that applies for existing scheme members, new scheme member from 6 April 2011 will have an exempt amount that relates to their marginal rate of tax. The restrictions are aimed at employees who pay tax at the higher 40% rate or the additional 50% rate. The effect of the restrictions is to ensure that such higher-paid employees do not receive more from the tax exemption in actual monetary terms than employees who pay tax only at the basic 20% rate.

To achieve this, the exempt amount is:

• £28 per week, £124 per month, £1484 per annum, for employees with an “relevant earnings amount” that is estimated to exceed the higher rate threshold but not the additional rate threshold for the tax year,
• £22 per week, £97 per month, £1166 per annum, for employees with an “relevant earnings amount” that is estimated to exceed the additional rate threshold for the tax year,
• £55 per week, £243 per month, £2915 per annum, otherwise.

The monthly and annual figures are based on the 53-week year used for these benefits. HMRC’s guidance does not say how to calculate equivalent fortnightly and four-weekly values and we have asked HMRC for guidance on this.

A basic rate employee receiving vouchers worth £55 has tax relief of £11. The lower weekly limits for taxpayers with marginal tax rates of 40% and 50% ensure that they also have tax relief of approximately £11 (40% of £28 = £11.20, 50% of £22 = £11).

The decision as to which weekly exempt amount applies to each new scheme member is made by the employer. This is the principal administrative problem with the new tax restrictions. The explanatory notes that accompanied the initial draft legislation stated:

“This measure creates an administrative burden for businesses by asking them to undertake a basic earnings assessment for employees each year. Most childcare vouchers are delivered by way of flexible benefit schemes or salary sacrifice schemes which means that for any employee who is has voucher eligibility restricted or increased the employer may need to contact the employee to agree amendment of the employment contract, revise the agreed pay for the employees pay up or down, contact the voucher provider with new details, and explain the outcomes to the employee.”

In many cases, an employee’s marginal rate of tax can only be correctly determined after the end of a tax year, when the employee’s total earnings for the year are known. However, which of the three exempt amounts apply to any employee has to be decided in advance. To do this, employers must carry out an entirely artificial calculation, called a “basic earnings assessment”, to estimate the employee’s “relevant earnings amount”. The only positive aspect of the assessment procedure described below is that the employer’s estimate will usually be less than the employee’s final total earnings for the year and, as a result, the estimate will be in the employee’s favour.

There are no exceptions to this requirement to perform a basic earnings assessment when an employee joins an employer-supported childcare scheme, even in businesses and business sectors with a high turnover.

Neither may the procedure be ignored and replaced by declaring the benefit on form P11D. The arrangement is intended to provide an approximate level of exemption at the time the benefit is provided rather than deferring it for up to two years.

Estimating the “relevant earnings amount”

The “basic earnings assessment” is not based on payments that have been made in the past, either in the present employment (e.g. on the previous year’s P60) or with a previous employer (as quoted on a P45). Rather, it looks ahead to the whole of, or the remaining part of, the tax year in questin and is made on the basis that the employee’s current contractual circumstances will continue unchanged for the rest of the tax year. Therefore, for example, if it is already known that the employee is leaving or will be redundant, that does not make any difference to the assessment.

It would be appropriate, however, for an employer to listen to any views an employee has about the assessment in case there are other contractual factors that the employer should take into consideration or ignore.

An employee’s “relevant earnings amount” for a tax year is defined as:

1. all payments due under the employee’s contract of employment, but not any discretionary payments. For example:
1. basic pay or salary
2. guaranteed overtime that is paid whether or not it is worked, but not overtime that is only paid if it is worked
3. shift allowances
4. guaranteed bonuses, but not performance-related or discretionary bonuses
5. contractual commissions
6. London weighting or other regional allowances
7. qualification payments, e.g. first-aid allowance
2. plus the amounts (using P11D reporting values) of any taxable contractual benefits-in-kind (including the value of the employer-contracted childcare or childcare vouchers to be provided)
3. less the total of any “excluded amounts”, namely
1. pension contributions and payroll giving donations deducted from gross pay under the net pay arrangement
2. any expenses payments that are included in the payments above but that may be paid without deduction of tax
3. any relocation-related removal expenses that are taxable earnings from the employment
4. “the amount of any allowance under Part 3 of [the Income Tax Act 2007] to which the employee is shown to be entitled in the code determined in accordance with PAYE regulations for use by the employer in respect of the employee for the tax year”.

With reference to:

• points 1 and 2, if an employee starts in the employment during a tax year, the “relevant earnings amount” relates only to the remaining part of the tax year. For example, an annual salary should not be used; it should be apportioned for the remaining part of the tax year. The resulting “relevant earnings amount” is then “grossed up” for a full year by dividing it by the number of days in the rest of the tax year and multiplying by 365.
• point 1(a), if the employee is party to a salary sacrifice, the post-sacrifice wage or salary is used.
• point 1(e), the value of commissions due in the tax year in question may be determined using the lower of the previous year’s commission total or an average of the totals for the previous two years.
• point 2, the legislation also refers to payments that must be treated as earnings from the employment, namely sickness payments, notional payments, payment of a director’s tax and payments for restrictive undertakings. However, it may be assumed that such payments should only be included if it is known at the time the assessment is carried out that they will be made during the tax year. (The legislation is not clear on this point and these payments are not referred to in HMRC’s guidance. We have asked HMRC for clarification.)
• point 3(a),the amount to exclude is the total amount of any pension, AVC and charity contributions by which the gross salary will be reduced during the tax year (or remaining part of the tax year) before the calculation of tax.  If the pension contribution is made by the employer under the provisions of a salary sacrifice scheme, the post-sacrifice salary is used at point 1(a) – although the effect is the same.
• point 3(a), HMRC guidance also refers to share scheme payments in this context, which sounds correct, but no mention of them is made in the legislation.
• point 3(d), the statutory wording is quoted in full to highlight the significant compromise that is made by HMRC when taking each employee’s tax code into consideration. See the next paragraph.

The use of the employee’s tax code in reducing the total “relevant earnings amount” is clearly indicated in the legislation, both for tax and NICs purposes. Part 3 of the Income Tax Act 2007 makes reference to the following tax allowances that can be applied by means of the tax code, i.e.

• the personal allowance (under age 65)
• the personal allowance (age 65 to 74) (reduced as appropriate where earnings exceed the income limit)
• the personal allowance (age 75 and over) (reduced as appropriate where earnings exceed the income limit)
• the blind person’s allowance (adjusted as appropriate by the transfer provisions)
• the allowance for married couples and civil partners (reduced as appropriate where earnings exceed the income limit, and adjusted as appropriate by the transfer provisions).

It would clearly be impossible for an employer to take into consideration any of such allowances to which an employee might be entitled. They cannot be determined from the employee’s tax code and the employer is not entitled to know what allowances and liabilities have been used in calculating the tax code. As a result, HMRC’s guidance makes a significant concession in the way in which the reduction to the relevant earnings amount is made.

Instead of using the tax code, it is assumed that all employees, other than those earning above £150,000, are entitled to the full person allowance (under age 65). The effect is that point 3(d) is ignored completely in calculating the “relevant earnings amount”. In almost all cases, the concession operates in the employee’s favour.

When to estimate the “relevant earnings amount”

The new fourth condition for tax exemption requires the employer to estimate the employee’s “relevant earnings amount” for the tax year “at the required time”. This is:

• the start of each tax year, if the employee is already a scheme member, or
• the date from which the employee “joins the scheme” during a particular tax year.

An employee “joins the scheme” when the employee agrees to provide vouchers or childcare, as appropriate to the scheme, and there is a child in relation to the employee as required by the qualifying conditions for tax exemption. An employee would also be treated as “joining the scheme” on returning from a temporary break and was not receiving normal contractual pay at the start of the tax year.

The resulting total from the basic earnings assessment applies for the whole of the tax year. It is based on the employee’s circumstances at the time it is calculated and may not be changed during that tax year to reflect any changes in the employee’s earnings. A new assessment is carried out at the start of the next tax year, based on the employee’s circumstances at the start of that tax year.

Consequently, it would not be inconsistent or incorrect for an employee to be entitled to an exempt amount of £55 per week for the whole tax year based on an assessment of earnings at the start of the tax year but, later in the year, to start paying tax at 40% due to a promotion.

The way in which each employee’s basic earnings assessment was determined becomes a part of the employer’s payroll records and they must be retained and produced in the event of a compliance check. There is no defined format for the records – they must contain enough information to show how each assessment was calculated.

Using the “relevant earnings amount” to determine the exempt amount

Having determined each employee’s “relevant earnings amount”, the next step is to compare it with the higher rate tax threshold and the additional rate tax threshold. This allows the full personal tax allowance (under age 65) to be taken into consideration other than in the case of employee’s earning over £150,000. The use of the higher rate threshold in this way takes the place of the statutory requirement to deduct the allowances included in each employee’s tax code to arrive at the “relevant earnings amount”.

The two thresholds for 2011/12 are:

• the £42,475 higher rate threshold (i.e. the £35,000 basic rate limit + the £7,475 personal allowance), and
• the £150,000 additional rate threshold (no personal allowance as it is phased out when earnings reach £100,000).
• In 2011/12, therefore, an employee would have an “exempt amount” of
• £55 pw/£243 pm if the “relevant earnings amount” is less than £42,475,
• £28 pw/£124 pm if the “relevant earnings amount” is between £42,475 and £150,000, and
• £22 pw/£97 pm if the “relevant earnings amount” exceeds £150,000.

Having established the “exempt amount” for each employee, it is then used for whole of the tax year to check whether a liability for tax and/or NICs arises.

• If the value of the employer-contracted childcare provided exceeds the employee’s exempt amount, the excess must be reported on the employee’s P11D at the year end and the employer must pay the relevant amount of Class 1A NICs.
• If the value of childcare vouchers provided exceeds the employee’s exempt amount, the excess must be:
• added to the employee’s gross pay in that particular week or month for Class 1 NICs purposes, and
• reported on the employee’s P11D/P9D Return at the year end.

Errors in calculating the basic earnings assessment

Even though it does not reflect an employee’s actual earnings in a tax year, an assessment that was based on the best information available at the time will be treated by HMRC as correct for P11D reporting purposes.

If the assessment is wrong for tax purposes because of a failure to use the relevant contractual information available at the time, it will also be wrong for NICs purposes. If the assessment is too low and the employee receives too much tax relief, HMRC’s guidance is that the additional benefit should be reported on form P11D. No corresponding guidance is given for NICs however. The reverse situation is also not considered for either tax or NICs, where the assessment is too high and too little tax relief is given. We have asked HMRC for further guidance.

Transitional provisions

Curiously there aren’t any transitional arrangements. Generally when a tax advantage is removed, tax avoidance measures follow closely. Is it possible for employees paying higher rates of tax to avoid the restrictions? Yes – by joining an employer-supported childcare scheme before 6 April 2011. There is a catch of course – the first of the three conditions for both employer-contracted childcare and childcare vouchers require them to have a child who can benefit from the childcare.

HMRC’s guidance is very clear on this. Can an employee join the employer’s scheme before her, or his, baby is born?

“No – you must be a parent or have parental responsibility for a child at the time you join your employer’s scheme.”

The statutory definition in the case of employer-contracted childcare is also clear – and obvious. The tax liability on the benefit arises at the time the childcare is provided, so there must be a child to enjoy the childcare. But, childcare vouchers do not have to be used immediately. In response to a question we asked, HMRC stated:

“Parents can receive childcare vouchers before they incur childcare costs which can then be redeemed at a later date. If the employer permits this within the scheme which is offered to all its employees, it does not contravene any HMRC requirements.”

However, do childcare vouchers qualify for the tax exemption if they are obtained even before the child who will benefit from them is born? In the case of childcare vouchers, the wording of the first condition is not explicit. It says that the voucher “is provided to enable an employee to obtain care for a child who (a) is a child…, or (b) is resident with the employee…” Does this mean that there must be a child at the time the voucher is provided or at the time the voucher is used? Although the wording is unclear, it must logically mean that there must be a child when the voucher is provided as it is at that point that the tax liability arises. In answer to our question on this subject, HMRC replied:

“Entitlement to the exemptions for childcare vouchers does require an employee to be a parent or have parental responsibility for a child at the time the voucher is issued. The vouchers themselves may however be used at a later date.”

There is, therefore, nothing to prevent higher-paid employees entering into a childcare voucher scheme before 6 April 2011 to ensure they benefit from the £55 exempt amount – but only if they are already a parent or have parental responsibility.

Further information:

Employer Supported Childcare – Guidance and FAQs for Employers

Tags: employer supported childcare, Guidance on tax relief, Recent Payroll News

This entry was posted on Monday, April 11th, 2011 at 10:56 and is filed under Tax Calculations. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.