Some outdated tax rulings – including a 50-year old precedent – underpin our current childcare tax deduction regime. Is it time to reconsider?
With the ongoing impact of COVID-19 highlighting the crucial role of childcare, there’s no better time to rethink Australia’s current tax treatment of that industry.
Employees, particularly women, are sick of footing a massive childcare bill.
For many, the bulk of their income goes to paying for childcare expenses, but they consider it ‘worth it’ to keep themselves in the game and in line for career promotion.
Amanda Selvarajah, PhD candidate and lecturer with Monash Business School’s Department of Business Law and Taxation, and co-author Dr Lydia Thiagarajah, believe its time to reconsider childcare expenses as tax deductible, and say that employers should also be allowed to play an important role in subsidising childcare.
That is, if the Australian Taxation Office (ATO) would shift its current view and allow employers to offer employees childcare benefits without a “burdensome” Fringe Benefits Tax (FBT), Ms Selvarajah says.
“Currently employers pay 47 per cent tax on any childcare services they offer employees that don’t fall under the exemption for childcare offered on ‘business premises’. If childcare expenses were tax-deductible, employers would pay no FBT on their childcare offerings under the ‘otherwise deductible’ rule.
“But Australia has chosen not to allow that either,” she says.
What the pandemic meant for childcare
The critical importance of childcare was emphasised during COVID-19, when it was recognised as an essential service.
While emergency employees were able to access childcare during lockdowns, many parents were left with the impossible task of looking after children, trying to do their jobs and make time for schooling as well.
The ‘great resignation’ in 2022 also left employers scrambling for talent. If employers could offer childcare benefits, it could be a huge drawcard for employees, especially women. After all, for many parents, childcare is not just a benefit but a necessity.
History of the tax deductibility of childcare
To investigate ways in which childcare could be made more accessible to parents, the researchers revisited several key historical legal decisions.
The first one was a 50-year-old High Court ruling that has formed the basis for denying tax deductions for childcare expenses.
In 1971, Law Clerk Ann Margaret Lodge attempted to claim $647 in “nursery fees” she incurred to have her daughter cared for while she worked, which was disallowed by the ATO.
Her subsequent High Court appeal proved unsuccessful, and the Lodge v Federal Commissioner of Taxation judgement has formed the precedent for denying tax deductions ever since.
The judgment included a British case with similar facts, that was used to support the narrow interpretation – that an expenditure needs to directly relate to Ms Lodge’s income-earning activities to be deductible.
Since then, various ATO rulings have simply echoed the denial of childcare expense deductions on the basis that childcare expenditure is neither ‘relevant nor incidental’ to gaining or producing assessable income and is also of a private or domestic nature.
In other words, the issue is considered settled in Australia.
But the researchers argue this single High Court judgment on this important issue was inadequate, and that reliance was incorrectly placed on this British case.
“I believe that today a statutory and contextual interpretation would support a different outcome,” says Ms Selvarajah.
“The blanket characterisation of the expenditure as personal or domestic in nature even when incurred for work-related purposes is not reflective of a contemporary view.
“This was emphasised by COVID-19, which showed how essential childcare is to a person’s income earning capacity.”
In their article in the Australian Tax Review in 2021, the researchers argued it was time to revisit the Lodge judgment and “unsettle” the issue.
“By shining a light on an issue that was decided so long ago we hope to get it back on the table for discussion. The upcoming expansion of childcare subsidies is a welcome improvement and in time perhaps free, universal childcare may make the deductibility of childcare expenses obsolete.
“But in the meantime, a tax deduction alongside subsidies could appropriately acknowledge the role childcare plays in allowing parents to earn their income,” she says.
“It would also lessen the financial penalty many women face in earning a living because their tax liabilities go up while their childcare subsidies and other benefits go down, often making the whole thing altogether not worth it.”
Fringe benefits tax exemption for childcare
Most recently, the researchers investigated the ATO’s stance on the Fringe Benefit Tax (FBT) exemption for employers that offer childcare on ‘business premises’.
Their paper published late last year in the Australian Tax Forum journal argues there are significant discrepancies between the ATO’s stance on this issue and a 1998 Federal Court ruling.
The ATO currently specifies that if employers want to offer their employees childcare facilities without paying FBT, they must have sufficient property rights and control over the childcare facility, with all the agreements and difficulties this entails.
This was not always the case. When the FBT exemption for childcare on business premises was first introduced in 1986 it was interpreted broadly.
However, following the so-called Federal Court’s Esso decision (involving a childcare centre funded by the oil giant), the ATO issued a tax ruling in 2000 that cemented a different, narrower test that it said was in line with the Court’s judgment.
Revisiting the case, the researchers say there are discrepancies between the ruling and the findings of the Court.
“For example, the word ‘control’ shows up nowhere in the Esso decision. The tax ruling uses the word ‘control’ more than 10 times. In fact, the control an employer has over childcare premises is presented as a key test to decide if an employer’s childcare offerings will be exempt from FBT in the ruling,” says Ms Selvarajah.
“But how many employers are interested in ‘controlling’ a childcare centre or are even able to?”
What this means post-COVID-19
Should these matters be re-tried in the courts, or can the government make changes that would help families, particularly in the current environment?
In the past, Parliament has been reluctant to act. But with support for balancing work and caregiving on the federal government’s agenda and COVID-19 highlighting the central role of childcare, the researchers argue that now is the perfect time to revisit these policies.
“We propose a deduction with a clear baseline test and deductibility parameters alongside generous subsidies to change the narrative surrounding deductions as an unfair mechanism that benefits only high-income earners with the potential for abuse,” says Ms Selvarajah.
As for the FBT exemption on childcare, she believes the exemption should apply to all employer-involved childcare arrangements to capitalise on this time when companies are scrambling to incentivise people to come back into the office.
“While conducting research for my PhD, I interviewed HR professionals and asked them how the FBT exemption influenced their decisions to offer childcare benefits,” she says.
“Many didn’t know what I was talking about. Others said there was too much red tape. If we could get an expansive interpretation of the exemption back on the policy agenda, perhaps employers may be more inclined to get involved.”
“Ultimately I think anything we can do to lighten the load for parents, especially women, and keep them in the workforce in this post-COVID economy is worth doing.”