Tax-free childcare proves more taxing than first thought

  • May 2022

Justine Riccomini Sc FFTAAIPA Chartered MCIPD ChFCIPP, head of taxation at the Institute of Chartered Accountants of Scotland (ICAS) explains what led the payrolling of tax-free childcare to the tax tribunal

Key points

  • a recent case highlighting the interaction between employment taxes and welfare payments was decided

  • the case decision clarified how tax-free childcare payments should be calculated

  • the judge ruled in favour of the taxpayers who were deemed to be eligible for the payments.



A recent decision on a case concerning payroll and welfare benefits provides an interesting insight into the anomalies which can appear when employers dovetail welfare benefits with payroll. Both tax-free childcare and the Department of Education scheme to offer 30 hours of free childcare are administered by Her Majesty’s Revenue and Customs (HMRC) under a joint online application process. Even though the legislation underpinning the two schemes is different, the decision-making process for determining eligibility is the same. Details of the case in question can be found here:

In HMRC v JS and Others, three cases were being decided which all centred around the same principle – a dispute in relation to the qualifying eligibility criteria for 30 hours of tax-free childcare per week. All three appeals by HMRC were dismissed because under sections 11 and 12(1), (2)(a) of the Tribunals, Courts and Enforcement Act 2007, a judge can, but isn’t compelled to, set aside first-tier tribunal (FTT) decisions on an error on a point of law. The judge declared that: “In this case, the issues have become academic, and to set the decision aside would be futile.” The claims had been rejected by HMRC in all three cases but were upheld at the FTT.


What were the issues for the court to resolve?

The court was asked to resolve two issues:

In the first two cases, the assessment of income under Regulations 5 and 6 of The Childcare (Early Years Provision Free of Charge) (Extended Entitlement) Regulations 2016:

  • the calculation issue; and

  • in the third case, whether the tribunal decision must be ‘prospective only’ under Regulation 15 (the ‘prospective decision’ issue, considered when assessing the timescale used when the claimant makes their declaration on submitting the claim).

To qualify for tax-free childcare, an individual must work at least 16 hours a week and earn at least the national minimum wage or national living wage. If the individual has a partner, they should have the same expectation.


Assessing the income

The way in which eligibility was calculated was instrumental in deciding the outcomes. HMRC had taken the monthly received cash value as the reason for classing claimants as ineligible for the benefit. However, if the value of pay earned was spread across the period the claimant had worked, the result was different. The tribunal took the view that the purpose of the legislation wasn’t to trip people up, but to give people assistance, and the claimants were being denied something which was technically their right to claim.

The FTT hadn’t completed the same calculations as the upper tribunal for the claimants and reviewed the spread of the payments over a year, rather than the actual periods worked. However, by aggregating the payments from both sources of income for each person over the year, it was still concluded that an entitlement existed, as the payments exceeded the threshold on a quarterly basis.

HMRC had argued the expected income under Regulation 6 (1) should be calculated by reference to the amount the person expects to receive during the 13-week period, not the amount the person has actually earned during that time. The claimants argued the periodic earned income approach gives a more equitable result because it offers entitlement to free childcare during the periods when the person needs the childcare the most – i.e., when they are working. Surely this was the purpose of the regulations.

In his commentary, the judge stated:

”The approach advocated by HMRC would defeat the purpose of the scheme itself, which is to provide childcare for those who work at least a minimum number of hours at the minimum wage.”

The judge also felt compelled to point out the FTT judge had erred in her classification of one of the claimants as self-employed. In fact, she should have been classified as an employee, which meant the criteria for assessment of eligibility were slightly different.

He went on to clarify: “Even if DL had been self-employed in that work, however, the judge’s approach was wrong because the regulations limit the way in which self-employed income is calculated where it is to be amalgamated with the expected income from employed earnings. A wholly self-employed person’s expected income can be calculated under regulation 5 (1) (b) (i) with its reference to the relevant threshold within the declaration period as for an employed person; alternatively, it may be calculated under 5 (1) (b) (ii): (ii): ‘The person’s expected income from the work in the period specified in paragraph (5) is greater than or equal to four times the relevant threshold’.”

The judge referred to the case of Johnson and Secretary of State for Work and Pensions v Johnson, which he considered bolstered his own arguments for how eligibility should be calculated because it, “considered the rationality of regulations under the universal credit scheme in the context of difficulties arising out of double payments from employers in some months due to the movement of pay days due to public holidays”. This caused difficulties in the calculation of otherwise regular benefit payments of universal credit to affected employees. The point was made that, “it is…no part of the policy underlying universal credit to encourage claimants to base their employment choices on the salary payment date offered by a prospective employer. Yet that is what is happening for these Respondents”.


Prospective decision – were the claims time-barred?

When considering the period for which the claimant’s declaration has effect, Regulation 15 of the Childcare (etc.) Regulations 2016 provides that where a tribunal decides a case under regulation 24, the date of that tribunal decision counts as being the first day of the first period in which the declaration has effect. Basically, it’s treated as if the claim has just been made on the date of the decision. The judge concluded that, in accordance with Evans LJ in Chief Adjudication Officer v Woods reported as R(DLA) 5/98, “exceptionally, decisions may be made that are prospective in effect” and the claims could therefore stand, and the claimants’ entitlement to the funds would remain valid as if the expiration date had not yet passed or become time-barred.



There is an intricate mix of welfare and employment taxes legislation in this case. This highlights the need for different government departments to align their policies and legislation to avoid anomalies arising.

Tax-free childcare proves more taxing than first thought

May 2022