I am currently receiving tax credits from the Government. How will these be affected by the salary sacrifice scheme?

A salary sacrifice scheme can affect tax credit entitlement. Parents are strongly advised to find out to what extent any tax credits they receive will be affected before they commit themselves to receiving childcare vouchers through a salary sacrifice scheme. Many people may be better off claiming support fully through the tax credit system and not accepting childcare vouchers offered. It is therefore very important to fully understand the implications before making a decision.

In April 2003 the Government introduced Working Tax Credit (WTC) and Child Tax Credit (CTC) to help working families on low to middle incomes.

WTC also has a childcare element to it, enabling families to receive support for eligible childcare that is registered or approved.

The amount of WTC a family receives is dependent on several factors, including the number of hours worked, the level of earnings received, how many children are in the family and the amount of eligible childcare costs.

Working Tax Credit is calculated on gross household income (either for the current tax year or the previous tax year depending on your circumstances), so if household income is reduced through a salary sacrifice scheme this may lead to an increase in an individual’s WTC entitlement.

However, if an individual has childcare costs that are eligible for the childcare element of the Working Tax Credit and chooses to receive childcare vouchers through a salary sacrifice scheme, their eligible childcare costs for tax credit purposes will be reduced by the amount received in vouchers. This reduction will probably need to be notified to HMRC within a month.

For example, if childcare costs are £100 a week and they receive £55 a week in vouchers, they can only claim £45 a week as their average weekly childcare cost for tax credits.

This can lead to a decrease in WTC entitlement. It is also important to note that including childcare costs (or increasing and decreasing them) in a calculation can have an impact on the amount of Child Tax Credit received where income is too high to actually receive any WTC. For this reason, it is important to check your situation before taking childcare vouchers.

Due to the complicated interaction between the two systems, often parents will be better off receiving support for their childcare costs through WTC rather than through childcare vouchers.

Although not a comprehensive list, the following categories of people are most likely to benefit from taking childcare vouchers:

• people who pay a significant amount of tax at 40% on their income, both before and after accepting vouchers,
• people whose average childcare costs exceed £175 a week for one child or £300 for two or more children,
• couples whose joint income is too high to benefit from the childcare element of working tax credit,
• people who are not entitled to claim working tax credit, for example, because their hours worked are too low or because they are subject to immigration control,
• people whose employer is only prepared to give an increase in pay by means of childcare vouchers with no cash alternative.

However, these are not absolute rules, and are still subject to some exceptions as they depend on individual circumstances.

The only way to be certain is to perform a complex calculation. The 'Tax credits' section of the HMRC website provides more information on the interaction between childcare vouchers and tax credits, including a “better off calculator” which will help you decide the best option for you.