Fiddle tax?

MIKE TRUMAN looks at some unexpected possibilities for using the new childcare tax relief that started this year, and uncovers a succession of unannounced changes.

LEARNING THE VIOLIN was not my greatest success. I spent about a year in junior school torturing both the strings and my parents' ears before deciding that I was never going to produce anything remotely approaching music. Of course, these days, parents are lucky if their children can learn to play an instrument at school at all, and in most cases there will be fees to pay. But does the new childcare tax relief open up the possibility of getting an employer (perhaps the personal service company of one of the parents) to pay for a private music teacher tax free? I think it probably does.

Da capo

To start at the beginning … Up to 5 April 2005, tax and NI had completely different rules when it came to childcare. For tax purposes, the aim was to exempt genuine employer-run facilities. ITEPA 2003, s 318 broadly said that the benefit of registered child care facilities on the employer's premises would not be taxable, nor would childcare provided elsewhere when the employer was wholly or partly responsible for financing and managing the care. Everything else was taxable — in particular the cost of a nanny, a problem which we have previously highlighted ('Nannies Revisited', Taxation 19 June 2003, page 305).

If the benefit was not taxable, it was also not liable to NIC. However, for NIC purposes there was also no charge on vouchers that could only be exchanged for childcare. Accor Services was the first company into the market in 1989; it has since been followed by others. Employers bought the vouchers from the suppliers and gave them to their employees as part of their benefit package. The employees used the vouchers to pay for the childcare, and the childcare provider registered with the voucher company so that they could exchange the vouchers for cash again. There was no restriction on the type of childcare — childminders and nannies were fine, and vouchers were even used to pay granny to look after the grandchildren.

Accelerando

Interest in, and the need for change to, the childcare rules picked up when tax credits were introduced. Working tax credit can include an amount for childcare, and there was therefore a need to bring the tax rules in line with those for tax credits, and at the same time to eliminate the difference between tax and NI. After consultation, the new provisions were included in FA 2004, Sch 13 , amending ITEPA 2003, s 318 and inserting new sections 318A to D.

To get tax relief of any sort there is a new overriding requirement that the benefit is made generally available either to all the employees of the employer providing the facilities, or to all those at a particular location. Inland Revenue guidance makes it clear that this does not mean that everyone who asks for a place at the nursery must get one — there might be a waiting list, for example — but one group of staff cannot be excluded, or preferred over another.

However, the rules for workplace nurseries are extended by allowing employees of another employer to use the childcare facilities tax free when they work at the same location as eligible employees of the provider (the 'scheme employer'). There does not appear to be any requirement that the childcare should be open to the employees of the other company in general, even if they are at the same location.

Example

Jamie is the head chef in the staff canteen at Megabank plc. The canteen service has been contracted out, and Jamie is employed by Twizzlers Ltd. As a special arrangement, Twizzlers pays for Jamie's daughter to be looked after in the Megabank plc nursery, which is open to the employees of Megabank in general. No other employee of Twizzlers Ltd is eligible for this benefit. The benefit is still tax free because the facilities are generally available to all employees of the scheme employer (which in this case is Megabank plc).

In fact, the entire requirement to make the care generally available seems to be fairly easy to avoid. The company sets up a subsidiary to run a nursery which employs the nursery staff. Places at the nursery are made available generally to the nursery staff, thus meeting Condition D in s 318(8) that the scheme is open to the scheme employer's employees generally. Most of the places, however, are then allocated to employees of the parent company, but the 'generally available' requirement does not apply to them.

Duet

Workplace nurseries which meet the above requirements still give rise to a benefit that is both tax and NIC free, whatever the amount involved. However, there is now an alternative exemption, again from both tax and NIC, but limited to £50 a week. This is described as 'limited exemption for other care' (s 318B), and although the provision dealing with vouchers is separate (s 270A), the rules are the same, so the two can effectively be treated as one provision. Vouchers, in particular, seem to be taking off as a benefit - a survey by Accor Services showed that 11% more employers have offered childcare vouchers in the last year, and 18% more plan to this year. Anne Ross, corporate business manager for Accor, says that there has been huge interest recently from employers.

The conditions for the new relief are primarily that the care which is either paid for by the employer or for which the vouchers can be exchanged must be 'qualifying child care' (examined further below) and again that the care or the vouchers must be available to the employer's employees generally, or generally to those at a particular location. This time there is no provision for employees other than the scheme employer's to benefit, so it is not possible to use the tactic outlined above to avoid the requirement.

The £50 limit is per employee, it is not increased for more than one child. However, if both a husband and wife operate separate businesses through separate companies, but each does enough work for the other to justify a £2,600 a year benefit package, there seems to be nothing stopping both companies paying £50 a week each for childcare as a benefit to both parents, a total of £10,400 a year.

Obbligato

So what are the requirements for 'qualifying child care'? Before we can ask that question, we first have to know what a 'child' is, and what 'care' is. The answers to both questions are in s 318B.

A person is a child until the last day of the week containing the 1 September following their 15th birthday. The definition is not based on tax years because, again, it has to also tie in with tax credits. If the child is disabled, this is extended for a further year. Disability is mainly defined by reference to disability living allowance. 'Care' is any form of care or supervised activity that is not provided in the course of the child's compulsory education (italics added). 'Qualifying child care' therefore needs to be read as including 'qualifying supervised activities for a child'.

The reference to education is very different from the one that applied before 6 April 2005. The old s 318 still referred to both care and supervised activity, but excluded the latter when provided 'primarily for education purposes'. This led to the bizarre situation where childcare that did nothing to stimulate the children's imagination qualified, but a nursery school that tried to teach them did not.

Finally, 'qualifying' care is care which is registered or approved, but which is not excluded by s 318C (7). Care is registered or approved if it is provided by people who are registered or approved under certain specified provisions, but there appears to be no requirement that such registration was either necessary or appropriate for the care they are actually providing.

Example

Mother Hubbard is a registered childminder because she looks after Alice, who is three. She also looks after Benjamin, aged nine, between the end of school and the time his parents get home from work. Because of Benjamin's age, she would not need to register if it were not for Alice. However, the fact that she is registered is sufficient to bring her within the definition in 318C(2)(a), a person registered under Part 10A of the Children Act 1989, and that in turn is enough to make her care of Benjamin 'qualifying child care'.

Scherzo

Let's take a slight detour at this point,. What would Mother Hubbard do if she was not registered as a childminder, still wanted to look after Benjamin, and Benjamin's parents either wanted to claim tax credits for the cost or pay for it using vouchers provided by their employers? The answer is that a new scheme has been set up to provide 'light touch' regulation. If you look at s 318C(2)(e), you might think you could identify this, assuming Mother Hubbard is in England — it is clearly the system set up by the regulations in Tax Credits (Approval of Home Child Care Providers) Scheme 2003. Wrong. There was a scheme set up under those provisions, but it has since been superseded (although there are some transitional provisions which still apply for a while).

The scheme which now applies was set up by a further set of regulations, Tax Credits (Approval of Home Child Care Providers) Scheme 2005 (SI 2005/93). So how does care provided by those approved under this scheme get tax relief, when the section still refers to the old one? Because another set of regulations, the Section 318C ITEPA 2003 (Amendment) Regulations 2005 (SI 2005/770) has amended s 318C, removed subsection (2)(e) and the reference to the old regulations, and introduced subsection (2)(ea) which has a reference to the new ones.

The whole concept of secondary legislation amending primary statute law is peculiar, but if it were only to update the reference to regulations it would not be problematic. However, SI 2005/770 goes further than that. An item by Liz Lathwood in Tax Adviser , March 2005, page 4, highlights a further change made for tax credits purposes by SI 2005/93. Care provided by a partner (either married or unmarried), and also care provided in the child's own home by any other relative, has always been excluded from tax credits. However, it used to be the case that if granny were to become registered or approved as a child carer, she could look after her grandchildren in her own home and tax credits could be claimed for the cost. SI 2005/93 limited this with effect from 6 April 2005 — care provided by relatives who are approved or registered is excluded even if provided elsewhere than the child's home, unless they also look after unrelated children.

The exclusion was mirrored in s 318C(7), including the reference to a partner whether married or unmarried. The subsection has now been changed, before it ever came into force, by SI 2005/770, to again exclude care provided by relatives unless they look after unrelated children. Both changes were made without any significant publicity, which is particularly problematic when secondary legislation is amending the primary provisions in ITEPA 2003. Any adviser seeing the legislation in FA 2004, Sch 13 introducing the new s 318C would be forgiven for thinking that unless it had been amended by this year's Finance Act it was still as originally enacted. Since the changes this year relate to some minor tidying up on administration charges and salary sacrifice, there would be no reason to appreciate that a significant change had been made until the publication of the Tolley's Yellow Handbook in the autumn.

Crescendo

Back to the main point that I made at the start of the article: can an employer pay directly for an employee's child to receive violin lessons, or can vouchers provided by the employer be used to pay the violin teacher, without a benefit in kind charge? Provided the right steps are taken to make the care 'qualifying' it seems that they can — at least if the care is being provided in England. As previously explained, care includes supervised activities, and does not now exclude a primary purpose of education, it only excludes activities that are part of the child's compulsory education, which violin lessons are not. So if they are provided by someone who is within the definition in s 318C(2) they should be qualifying child care. The most obvious solution is the scheme already mentioned in subsection (2)(ea). This requires the individual concerned to have a basic level childcare qualification or attend an induction course, to have recently completed a first aid course, and to have a clean enhanced criminal records check. Any enterprising music teacher should surely be incurring the few hundred pounds expense that this will entail so they can advertise that their lessons can be paid for by employers or by vouchers.

Will the voucher providers pay for lessons such as this? Anne Ross confirmed that they only need to check that the vouchers have been given to someone who is properly approved, but that using them to pay for music lessons is not something they would promote, because the vouchers are really meant to pay for child care and not education. However, when Taxation approached the Revenue, we got a very helpful answer that, if all the other conditions were met, 'if then the childcarer offers different activities in the course of providing that childcare, the exemption will still be due'.

If the lessons are provided through the school, there are other possibilities: subsection (2)(b), care provided by a school which does not need to be registered, or possibly (2)(c), out of hours care provided for a child aged eight or over by a school on school premises, or by a local education authority. There is something similar for Wales and Northern Ireland, but Scotland has a different set of provisions, and only England currently has the 'light touch' approval scheme now contained in subsection (2)(ea).

What else would qualify? Private tutors in school subjects might — although the subjects themselves are part of the compulsory school curriculum, arguably the care itself is not. Shawn Healy, a Tax Director with BDO Stoy Hayward, points out that the restriction on compulsory education in s 318B(1) refers to 'the child', not children in general, so the fact that some schools might include learning to play an instrument in their curriculum does not invalidate the use of vouchers by others. In theory, ballet classes etc. ought also to qualify. Even though they are typically given in a village or church hall, there would be nothing stopping the ballet teacher from being approved, and then any supervised activities she provides ought to qualify, even if not provided in the child's home. The same would go for sports classes such as karate. The problem comes when the activities are being provided by an organisation. Although the original intention was to have a light touch regime for groups as well as individuals, this was dropped after consultation.

Coda

Ultimately, should these issues be seen as errors in the law that need changing, or a proper (though perhaps unexpected) result of the relaxations that have been made?

The failure to ensure that employees of other employers using a scheme employer's childcare facilities have to fall within the 'generally available' requirement seems to me to be a straightforward omission, which should be corrected — the intention is to prevent this being a benefit for the few not the many, and that is a decision which government is perfectly entitled to take. However, the extended range of activities which the rules apply to seems to be no more than a necessary consequence of limiting the exclusion to compulsory education. Trying to find a dividing line on a spectrum that runs from a playgroup where the toddlers bang on drums and tambourines to piano lessons given by a teacher in his or her home seems to me to be a fruitless exercise. Now please excuse me while I go into the loft and try and find my old violin case …

Issue: 4004 / Categories: Comment & Analysis