We take a look this month at the heavily criticised initial guidance published recently by HMRC on restricting tax relief on 'Employer Supported Childcare'.

What's Happening?

Until recently, employees receiving childcare vouchers (or other direct childcare support) from their employer, typically via salary sacrifice arrangements, would qualify for tax relief up to the maximum of £55 per week at their marginal tax rate. In other words, those employees paying 40% or 50% tax would save the most money, in terms of tax saved, under such arrangements which goes against the Government's original intentions in helping lower paid parents back into work.

However, from 6 April 2011, the tax rules have been changed so that all employees entering into 'Employer Supported Childcare' arrangements on, or after, this date will only receive tax relief at the basic rate of tax (currently 20%) regardless of earnings and the rate of tax normally paid. This will be done by restricting the value of vouchers or childcare that qualifies for tax relief based on the employee's tax band which involves the employer doing a 'Basic Earnings Assessment' each tax year to identify which tax group each employee falls into.

How Do The New Tax Rules on Childcare Work? (the "easy to understand" bits !)

1. Situations where employees still qualify for full tax relief (i.e. the previous rules)

The fundamental point for the more beneficial old rules to apply is that the employee was already in the employer's childcare (voucher) scheme before 5 April 2011, or had an application accepted before then to join (and was eligible to do so, e.g. by having started work for the employer and had a "qualifying child" at that point in time).

However, HMRC has confirmed that the previous tax rules will still apply where the following changes take place affecting existing scheme members:

  • Annual renewal of agreement with employer
  • Change in voucher value (either decrease or increase, any increase being subject to the usual £55 limit)
  • Change of voucher provider by employer
  • Temporary cessation of childcare vouchers/employer support (e..g whilst on a career break, sick leave, etc) provided this is not stopped for longer than 12 months
  • Change of employer due to a merger or reorganisation, including any transfer of employment rights under TUPE regulations  

2. When the new rules DO apply

  • When an employee signs up for a scheme on, or after, 6 April 2011
  • When an employee first becomes eligible for tax relief on, or after, 6 April 2011 even if the agreement was signed before the deadline e.g. because the "qualifying child" was not born at the time the paperwork was signed
  • The employee changes job and enters into a scheme with their new employer on, or after, 6 April 2011

3. General principles of the Basic Earnings Assessment

a) The employer assesses the level of earnings for the employee for the tax year - based on that employment alone - taking into account the following elements:

    • Contractual pay
    • Guaranteed bonuses
    • Commission
    • Regional allowances
    • Guaranteed overtime
    • Shift allowances
    • Taxable Benefits In Kind
    • Special payments (the example given by HMRC is in relation to First Aiders)

b) The employer records the calculation and keeps this on file with other payroll related records

c) The employer then applies the relevant tax limits to the childcare being provided to that employee based on the level of 'relevant earnings' as follows:



Earnings at Basic Rate Tax

Earnings at Higher Rate Tax

Earnings at Additional Rate Tax (50%)

Weekly tax-free limit




Monthly tax-free limit




Annual tax-free limit





d) The employer declares any excess paid over the tax-free limits on form P11D at the end of the tax year for tax purposes and through payroll for National Insurance (this will be a Class 1 NI liability, i.e. employer and employee, not the usual Class 1A due on most other benefits)

e) The employer does another Basic Earnings Assessment for the employee at the start of the next tax year

Basic Earnings Assessment Problem Areas

The biggest gripe at the moment is that HMRC's initial guidance is rather vague on certain points around the Basic Earnings Assessment calculation which is causing a lot of confusion amongst those tasked with doing the Assessments.

It is also fair to say that many of the well-known childcare voucher providers have been slow off the mark in supporting their clients with these changes and as a result we have spoken to a number of employers with voucher schemes over the last few weeks who had received nothing at all from their provider around this and some didn't even know the tax rules had changed ! Clearly this is far from ideal and is just asking for trouble in terms of the employer's tax compliance responsibilities.

The main problem areas we see with the guidance as it stands at the moment include the following:

  1. As we would expect of any payroll related information, there is a requirement for a proper record to be kept by the employer of the Basic Earnings Assessment so that this can be reviewed by HMRC during any compliance checks. However, HMRC openly state that they "do not stipulate the format of these records" which, in our opinion, is an open invitation for employers to get it wrong by not recording sufficient information as "evidence" of the data and rationale used for their calculation. These things always work out better for all concerned if there are clear rules as to what is acceptable/required.
  2. HMRC states that a Basic Earnings Assessment is valid for the full tax year when done, even if circumstances, e.g. earnings, change during that year. On the one hand we can understand why HMRC has taken this approach as it is to everyone's advantage to keep things as simple and as admin free as possible which wouldn't be the case if multiple Assessments were required each year. However, there is a distinct lack of clarity around how far in advance an employer is required to look to in estimating the employee's earnings for the year which could be complicated in relation to future payrises as many employers know many months in advance what payrises will be given to their staff. We just can see a lot of arguments arising between HMRC and employers on the validity of the Assessment due to the current vagueness of HMRC's guidance, particularly around payrises.
  3. There will be situations where an employee's external income, e.g. through investments or pensions, will mean that the employee pays tax at 40% or 50% on a large part of his income. However, the rules as they stand only require an employer to look at earnings from that employment in isolation and to "allow most employees the basic standard personal allowance" in doing the earnings calculation. This could mean that some employees clearly in the higher tax brackets could still receive more tax relief on childcare costs than they should be entitled to and we believe that more clarity around the interaction with PAYE tax codes is needed here to clarify things for employers to minimise the risk of HMRC penalising the employer where clear errors have been made due to  external information such as coding notices.
  4. It will be difficult for many employers to accurately guess the level of some contractual payments, e.g. shift allowances, bonus payments etc at the start of the year and we are concerned that the validity of an Assessment could come down to the opinion of an individual HMRC Inspector who may disagree with the data used by the employer originally. Legislation and guidance needs to be as clear as possible in such matters, not only to protect the Exchequer but also to avoid unnecessary and time consuming disputes with HMRC.



The logic behind the change to tax relief on Employer Supported Childcare is both sensible and transparent and it is something that employers wishing to continue with childcare voucher and other childcare schemes are going to have to deal with.

However, the current guidance issued by HMRC is surely a backward step in trying to make our tax system simpler and fairer. We believe that further, much clearer, guidance is needed by HMRC around some of the above points otherwise both employers and HMRC will be caught up in a ridiculous cycle of claim and counter claim with a never ending trail of paperwork and negotiations to deal with on what could be relatively small amounts of tax at the end of the day.

We are hoping that things will become clearer around this once the 2011 Finance Bill has been given Royal Assent over the next month or so.

In the meantime, please do contact us for assistance or advice if you have any difficulties with either the Basic Earnings Assessment or deciding which employees are in or out of the new rules.

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