Background
The workplace nurseries exemption was introduced many years ago. This exempts from tax and NIC the provision to an employee of a place in a nursery at the workplace or in a facility wholly or partly financed and managed by the employer.

Whilst these sorts of arrangements are not that common, the later introduction of a limited tax and NIC exemption for employer-contracted childcare and employer-provided childcare vouchers has been very popular with both employers and employees alike. The exempt amount is currently £55 per (tax) week.

Salary sacrifice
Many employers use these childcare exemptions as part of salary sacrifice arrangements; for example, the employee gives up pay, which is taxable and NIC-able, in return for childcare vouchers, which are not. This may save tax and NIC for the employee and NIC for the employer.

In light of the fact that all rates of NIC increased from April 2011, such arrangements can be attractive. However, as always, care needs to be taken when implementing a scheme to ensure that it is set up correctly. Also, for those on low rates of pay, such arrangements may not be appropriate.

If the employer-contracted care exceeds £55 per week the excess will be a benefit in kind and subject to Class 1A NIC. However, with vouchers, although any excess is also a benefit in kind it is subject to Class 1 NIC via the payroll. As the tax and NIC issues are complex many employers limit their employees’ potential entitlement to a maximum of the exempt limit (currently £55 a week).

The exempt limit of £55 applies to the full face value, rather than the cost, of providing a childcare voucher, which would normally include an administration fee.

An employee is only entitled to one exempt amount even if care is provided for more than one child but it does not matter that another person may also be entitled to an exempt amount in respect of the same child. As always, there are various conditions to meet but these rules have led to many employers providing such care, particularly childcare vouchers, to their employees.

Who do the changes affect?
The changes apply to employer-contracted childcare and childcare voucher schemes but only affect individuals joining a scheme from 6 April 2011. The existing tax and NIC exemptions for workplace nurseries remain.

Employer-contracted or childcare voucher schemes offered through salary sacrifice arrangements fall within the new provisions.

What are the changes?
From 6 April 2011 (2011/12), the limit on the amount of exempt income associated with childcare vouchers and employer-contracted childcare for employees joining an employer’s scheme will be restricted in cases where an employee’s earnings and taxable benefits are liable to tax at the higher or additional rate.

Anyone already in a scheme before 6 April 2011 will not be affected by these changes as long as they remain within the same scheme.

What do employers have to do?
To identify the rate of tax an individual employee pays in any one tax year, an employer needs to carry out a ‘basic earnings assessment’ for any employee who joins an employer-provided childcare scheme on or after 6 April 2011.

From 6 April 2011, employers who offer or provide employer childcare are required, at the beginning of the relevant tax year, to estimate the ‘employment income amount’ that the employee is likely to receive during that year.

This is basically the contractual salary and benefits package (not discretionary bonuses or overtime) less the personal allowance which appears in the PAYE code for the tax year in question.

Employers must keep a record of the basic earnings assessment. These records do not need to be sent to HMRC but must be available for inspection by HMRC if required.

What is the position for the employee?
For 2011/12, the personal allowance for most employees will be £7,475 and the basic rate limit will be £35,000, a combined figure of £42,475. The higher rate limit is £150,000.

If the level of estimated earnings and taxable benefits is equal to or below the equivalent of the sum of personal allowances and the basic rate limit for the year (generally £42,475 as explained above), the employee will be entitled to relief on £55 exempt income for each qualifying week.

If the level of estimated earnings and taxable benefits exceed the equivalent of the sum of personal allowances and the basic rate limit for the year (generally £42,475 as above) but falls below the limit at which tax becomes payable at the 50% rate limit for the year (currently £150,000), the employee is entitled to relief on £28 exempt income for each qualifying week.

If the level of estimated earnings and taxable benefits exceed the equivalent of the 50% rate limit for the year (currently £150,000), the employee is entitled to relief on £22 exempt income for each qualifying week.

Similar changes will be made to the NIC rules to mirror the above.

New starters
The rules are modified where employees join the scheme part way through a tax year. In that case, the earnings review has to be carried out at the point of joining. Basically, the joining employee’s salary and taxable benefits need to be pro-rated upwards to estimate the notional annual earnings figure for the employee.

Gaps in payment
An employee can ask to stop receiving childcare vouchers temporarily whilst staying in the employer’s scheme; for example, if an employee only works during school term time and doesn’t need the vouchers during the school holidays. Basically, as long as the gap in providing the vouchers doesn’t exceed 12 months the employee can still be classed as an existing member of the employer’s scheme.

This also applies to employees who are on maternity leave, sick leave and those who wish to take a career break, provided that the total length of absence does not exceed 12 months.

Further information
HMRC have provided many questions and answers on their website to help both employees and employers and these can be viewed at www.hmrc.gov.uk/thelibrary/esc-qa.htm

How we can help
Procedures need to be put in place to meet the new rules where either employees join an existing employer–contracted or childcare scheme on or after 6 April 2011, or for those employers who set up a scheme after that date.

If you would like to discuss these opportunities and changes in further detail, please do not hesitate to contact us.

For information of users: This material is published for the information of clients. It provides only an overview of the regulations in force at the date of publication, and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material can be accepted by the authors or the firm.