Last reviewed 17 August 2016

Tax-Free Childcare (TFC) is part of the Government’s long-term plan to help working families throughout the UK with up to £2000 of childcare support per year, per child, through a new online account. Paul Tew looks at the changes announced in Budget 2016 outlining how the TFC scheme will work when launched in early 2017.

The new system

The TFC scheme will not be offered through employers, unlike Employer-Supported Childcare (ESC), which includes childcare vouchers and directly-contracted childcare. Instead, support for parents will be provided through an online childcare account opened up through the Government portal of GOV.UK website, into which payments can be made to cover the cost of childcare with a registered provider. Multiple parties such as grandparents, other family members or employers are also able to make payments into childcare accounts not just the child’s parents.

The level of Government support towards childcare costs will remain at 20% (equivalent to basic rate tax relief). Hence, the name “tax-free” as most individuals in the UK are basic rate taxpayers. The Government will “top-up” the individual’s account with 20% of childcare costs up to a total of £10,000. This is the equivalent of up to £2000 support per child, per year (or £4000 for disabled children). The “top-up” cap is likely to be applied on a quarterly basis, at £500 (or £1000) Government support, per child.

The scheme will be generally available for children up to the age of 12 (for children with disabilities up to the age of 17) and rolled out gradually, with parents of the youngest children able to apply first. All children can be enrolled into the scheme at the same time, when the youngest child becomes eligible, with all eligible parents being able to join the TFC scheme by the end of 2017.

The Government has designed a test to define “meaningful employment” for the purposes of eligibility to qualify for TFC. This involves setting minimum and maximum income levels for each parent. The lower limit is currently around £115 per week based on working 16 hours at the National Living Wage, so only parents who are in regular employment can benefit from the TFC, with the upper limit set at £100,000 per year. HM Revenue & Customs (HMRC) may check employees’ declared earnings totals, against information reported by employers in real time through pay as you earn (PAYE), to ensure that the income requirements continue to be met.

The scheme will also be available to parents on paid sick leave and paid and unpaid statutory maternity, paternity and adoption leave. Individuals do not have to switch to TFC if they do not wish to. However, families cannot receive support through both ESC and TFC schemes at the same time.

Impact on employers

ESC schemes can remain open to new entrants until 5 April 2018 to support the transition between ESC and TFC. This means that families who join an ESC scheme before 6 April 2018 will continue to be able to access the associated tax and National Insurance Contributions (NICs) reliefs, for as long as their employer continues to provide ESC as part of its benefits offering. However, the maximum level of support available for families under the TFC scheme will exceed that provided through ESC, so lessening the likelihood that employees will remain in their employer’s present scheme.

Tax and NICs relief for existing ESC schemes will be withdrawn for new entrants from 6 April 2018. This includes new employees who were in receipt of ESC with a previous employer, even if that employer is within the same group of employers. If an employee moves to a different PAYE scheme, he or she must be treated as a new employee.

Employers can still offer ESC to employees new to childcare vouchers and directly-contracted childcare, but these will be subject to tax and NICs. Employers can still choose to change voucher providers, even after the scheme is closed to new joiners.

When an employee decides to stop receiving ESC with a tax and NIC exemption, the intention is that his or her employer must be given a childcare account notice. This will be a written notification from an employee saying he or she wishes to permanently stop receiving the ESC tax exemption and NIC disregard. There is to be no prescribed form to use, so the notice may take any format and follow any process that the employer decides to use, provided it is clear that the employee wishes to permanently stop receiving the ESC tax relief and NIC disregard.

Once a childcare notice has been given, then if ESC is provided, then the normal tax and NIC rules apply to these payments or benefits in kind, even if the employee subsequently leaves TFC. In registering for TFC, the applicant(s) must provide a parent declaration setting out their personal circumstances, stating that no parent named on the application is in receipt of ESC tax relief and NIC disregard, or that such receipt will be brought to an end within three months of registering for TFC.

Where ESC is used in conjunction with a salary sacrifice arrangement (employee gives up part of his or her salary and, in return, the employer provides a non-cash benefit), the employer Class 1 NIC “savings” currently being realised, may be reduced as employee’s switchover to the TFC scheme. Employers generally use the substantive NICs savings resulting from salary sacrifice to pay for the cost of the benefit, so this may cause employers to reassess the financial viability of their ESC schemes. Where employees leave a “salary sacrifice” arrangement for ESC to join TFC, this will be classed as a life event. This will not have any impact on the previous salary sacrifice arrangement.

Workplace nurseries will be unaffected by the new TFC scheme. Employees will continue to be able to join workplace nursery schemes offered by their employers. Parents will be able to access a workplace nursery and receive TFC (for example, if the child attends qualifying childcare outside of the time that he or she is placed in the workplace nursery).

New role of employers in childcare support

Although childcare accounts will be delivered by HMRC and NS&I working in partnership, employers can still play a role in TFC. In supporting employees on a voluntary basis, this should reduce any potential disruption in the workplace because of childcare issues. Employers will be able to offer an information service and/or make payments on behalf of their employees.

Employers are to be encouraged to refer employees to GOV.UK for advice on TFC, for example, those employees who are going on or returning from parental leave. However, this “information” role should not extend to employer guidance as to what support best suits the employee’s needs and circumstances.

With a payment role employers could make payments into employees’ childcare accounts either through net pay or as additional payments. This could be made through one bulk payment. Employer payments into an employee’s childcare account made in addition to agreed cash remuneration are treated as earnings and liable to PAYE tax and Class 1 NICs on the amount paid.

Employer payments would simplify matters for employees who would not have to make payments themselves. Any financial support given would be an economic decision to be made by individual employers.