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Contractor Doctor: Can I still claim for childcare costs through my limited company?

Dear Contractor Doctor,

I’m an engineering contractor and trade via my own limited company. I’ve just secured a new contract after taking a year out on maternity leave to take care of my first baby. I’ve been researching Contractor Calculator to find out how I can use childcare vouchers paid for by my limited company to save tax, and I found out that I can claim up to £55 a week.

However, I have also found out that there have been some changes to tax relief on childcare costs introduced in the 2011 Budget.

Can I still claim for childcare costs through my limited company?

Thanks

Elena

Contractor Doctor says:

Elena’s limited company can continue to benefit from tax relief by providing her with childcare vouchers, according to Abbott Moore LLP’s head of tax James Abbott. However, the amount that can be claimed has changed since April 2011 and depends on each contractor’s individual tax status.

“Prior to April 2011, all contractors could claim up to £55 per week in childcare vouchers provided by their limited company,” explains Abbott. “The 2011 Budget introduced new allowances for higher rate and top rate taxpayers.

“Contractors who had a childcare voucher scheme in place before 5 April 2011 remain unaffected. Because Elena is starting a new childcare voucher scheme, if she is a higher or top rate taxpayer, the amount she can claim may be less.”

Childcare voucher allowances – what has changed?

“The amount of relief that a contractor’s limited company can claim is restricted for individuals who join a voucher scheme provided by their company after 5 April 2011,” explains Abbott. “Whereas previously all contractors could claim up to £55 a week tax-free, there is now a weekly cap for higher and top rate taxpayers.”

The weekly amounts depend on the contractor’s ‘marginal rate’, with the amounts that can be claimed are as follows:

  • Up to £55 per week for a contractor paying tax at the basic rate
  • Up to £28 per week for a contractor paying higher rate tax (40%)
  • Up to £25 per week for contractors paying the additional, or top, rate of tax (45%).

Despite the changes, because of the way that HMRC determines whether the contractor is a higher or additional rate taxpayer, many contractors can still claim the full amount. “In the context of childcare, HMRC only looks at employment income, which is calculated as salary plus taxable benefits in kind minus the personal allowance.

“Crucially, it excludes dividend payments, and, as most limited company contractors take a low salary and the balance of their remuneration as dividends, for childcare voucher purposes they won’t be a higher rate or additional rate taxpayer.”

HMRC’s eligibility criteria have not changed

Abbott continues: “HMRC has not changed its eligibility criteria, so tax-free childcare only applies to vouchers or direct payment of childcare costs. There are two main options. In the first, a contractor’s limited company must set up a properly administered voucher scheme and issue vouchers to the contractor, which can be redeemed with a childcare provider.

“The second option is for the contractor’s limited company to pay the childcare provider directly, with invoices in the company’s name. If a contractor pays childcare costs directly and then tries to claim them back as expenses, or takes a childcare allowance on top of their salary and dividends, the payments will not be eligible.”

If a contractor pays childcare costs directly and then tries to claim them back as expenses, or takes a childcare allowance on top of their salary and dividends, the payments will not be eligible

James Abbott, Abbott Moore LLP

Abbott also warns contractors against trying to circumvent or fudge the rules by paying a family member for childcare services. Relatives are specifically excluded, even if they are registered or approved childcare providers. “HMRC’s guidance clearly states that care provided by a relative in the child’s own home does not qualify for tax-free childcare vouchers. So training up the grandparents to become registered childminders is not an option!”

Umbrella company contractors can qualify too, but will probably receive less

Abbott suggests that umbrella company contractors ask their umbrella company whether it operates a childcare voucher scheme, as many solutions providers do. “Umbrella company contractors can opt to receive childcare vouchers as a ‘salary sacrifice’. This means that their weekly childcare allowance is deducted before tax and will be reimbursed to them as a childcare voucher, or the umbrella company may pay the childcare provider direct.”

But because umbrella company contractors receive all their remuneration as salary, ie employment income, then it all contributes towards calculating the amount they can claim. Potentially many more umbrella company contractors will find themselves receiving the higher rate tax allowance of £28 per week because all of their earnings are counted by HMRC as employment income.

Good luck with your contracting!

Contractor Doctor

Updated: Sunday, June 30, 2013

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