As working parents struggle to afford childcare, employers will be tempted to take advantage of nursery schemes offering employees tax/NIC free care, and rightly so. Shawn Healey, an employment tax principal at BDO, sounds a note of caution as he highlights a number of qualifying conditions employers need to meet.
In recent months interest has grown in schemes offering nursery places funded by an arrangement involving employers, independent nurseries, a scheme provider and an employee (and parent).
Commonly marketed schemes claim to provide nursery childcare on a tax/national insurance contribution (NIC) free basis. This is possible by accessing a tax exemption that allows uncapped provision. However, the nursery tax exemption (s318 ITEPA 2003) contains a number of qualifying conditions which are subject to interpretation.
How the exemption works
The nursery exemption was first introduced to provide tax relief for employers who could provide suitable premises where a nursery could be set up. But there are four conditions in S318 that need to be met before the exemption applies.
One key condition covers the premises used for the nursery. To be fair to the many employers that would not be able to use their own premises, this premises condition allows for “partnership arrangements” to enable employers without suitable premises to take advantage of the exemption. It is this element of the exemption many of the current commercially available schemes seek to use.
For a partnership arrangement to qualify, the employer must be responsible for all or part of the ‘financing and management’ of the nursery in question.
Commercially marketed schemes
There are many ways in which third party providers have sought to offer employers an arrangement that can offer tax/NIC-free nursery-based childcare. The current schemes appear to contain the same key components:
- An employee enters into a salary sacrifice agreement which covers the cost of the childcare at a nursery of their choosing (i.e. not on premises provided by or chosen by the employer);
- The salary sacrificed includes an additional financial contribution, typically £100 – £150 per month, which the scheme provider purports will meet the employer financing requirement – presumably because these funds are paid to the nursery by the employer;
- The employee then acts as the representative of their employer and attends meetings (real or virtual) to fulfil the ‘management’ requirement of the tax exemption, and
- The scheme provider enters into a commercial arrangement with the employer and acts in a co-ordination role to ensure the arrangement runs smoothly.
Financing and managing the nursery
The legislation (s318 (7) (c)) states “that under the arrangements the scheme employer is wholly or partly responsible for financing and managing the provision of the care”. Applying this statement to live situations can be difficult.
In the government’s Agent Update (Issue 121) published on 17 July 2024, HMRC outlined that for such marketed schemes it does not consider that a monthly payment meets the financing test. Similarly, HMRC now describes “managing” (not further defined in the legislations), as meaning that employers must play a real part in the management of the nursery, or nurseries concerned.
Interpreting the conditions
The Agent Update expands on pre-existing guidance in the HMRC Employer Income Manual (section EIM22007) which gives examples of how HMRC sees the exemption applying.
Stepping back from the detail, one can see that the points it raises are open to subjective interpretation and, while HMRC’s guidance is clear, it is only HMRC’s view of the law.
Unhelpfully, the only case law in this area is Lotus Group Ltd v RCC. The taxpayer won its case at the First Tier Tribunal on the basis that:
- The employer had agreed to undertake maintenance, improvements and redecoration of the nursery as well as paying £500 per child – i.e. made an identifiable financial commitment (rather than a “token gesture” mentioned in HMRC’s guidance).
- It was also the third party agent that met with the nursery on behalf of the employer (rather than the employee).
These differences mean the ruling has limited application to the current schemes. For example, in the context of the financial commitment, the employer was directly funding the places rather than simply passing on the monies collected from employees via salary sacrifice. The ‘management’ circumstances are also different. This emphasises an employer-focused involvement in, and financial commitment to, a nursery rather than the employee-focused approach taken by current marketed schemes.
What are the options now?
Employers who are approached by an employee that wants the organisation to implement one of the current schemes or that are thinking of adding this to their employee benefits offering, should take care. As the rules are interpreted by HMRC, they will likely challenge the use of third party schemes as they do not believe they will qualify for the exemption.
Of course, that doesn’t mean that nursery provision is impossible. Each childcare scenario can be different, and some arrangements will definitely qualify for the exemption – benefiting all parties. So, the best approach is to involve employment tax specialists at an early stage to help employers take a measured view of their specific circumstances and the options available for providing this valuable benefit.
