The sting in the tail

The benefits and tax credit system can come up with some strange
results, but I’ve rarely come across anything as bizarre as the
recent introduction of “extra” help with child care costs which
could make some families worse off if they claim it.

The TUC and the Low Incomes Tax Reform Group (LITRG) have even
sent out a warning that some families can lose more in tax credits
than they gain in tax and national insurance exemption by accepting
the newly introduced child care vouchers provided by employers.

Under the scheme, introduced last month, parents can choose to
“sacrifice” up to £50 a week of their salary in exchange for
child care vouchers, exempting them from tax and national insurance
on that part of their pay. In other words, some of their child care
will be paid for out of pre-tax as opposed to after-tax income.

The scheme looks simple, appears advantageous to parents and
fits in neatly with the government’s child care strategy. There’s
just one problem: it could leave some parents out of pocket.

Consider, for example, someone who has child care costs that
come under the child care element of working tax credit but who
chooses to receive vouchers through a salary sacrifice scheme. The
amount of their child care costs that are then eligible for the
child care element of working tax credit will be reduced by the
amount covered by the voucher. This could more than offset the
gains they make on not paying tax and national insurance on the
sacrificed salary.

The LITRG has warned that the official Inland Revenue publicity
about the scheme (leaflets IR115 for employees and E18 (2005) for
employers) doesn’t give enough information about how individuals
can lose out by taking vouchers.

Also, the employee leaflet makes no reference to the potential
loss of employer or state benefits incurred by giving up salary for
vouchers. This would happen where benefits are based on salary
because sacrificed salary does not count as income.

It will be the lower-paid and middle income employees who will
have to be most careful if they are not to be disadvantaged through
the loss of working tax credit. Sellers and providers of vouchers
often don’t understand the implications for tax credit claimants,
or play down the risks if they do.

The LITRG has produced a number of examples that show how this
might work in practice. Here’s one:
Tina is a single mum working 20 hours a week in a care home for
£6,240 a year. Her employer gives her the choice of either a
pay rise of £20 a week or a child care voucher of £20 a
week. Tina currently pays £100 a week in child care costs at
an approved nursery.

If she takes the £20 a week cash, her income after tax goes
up by £786 a year. This level of increase won’t affect her
current working tax credit award. But if she takes the £20
weekly voucher and uses it to pay the nursery, she saves
£1,040 over a year, but then loses £728 of the child care
element of her working tax credit, making her only £312 a year
better off.

Given the complexity of this issue, and the difficult
“better-off” calculation involved for some workers, surely the
Inland Revenue needs to take the lead and issue proper advice
individually?

Gary Vaux is head of money advice, Hertfordshire
Council. He is unable to answer queries by post or telephone. If
you have a question to be answered please write to him c/o
Community Care.