The plan, outlined by Gordon Brown in his speech to the Labour conference, is intended to give more than one in three two-year-olds access to free childcare for ten hours a week by the end of the next Parliament.
The Government said that the aim was to re-direct money to where it is needed most, to help disadvantaged children access high quality childcare.
Tax relief and National Insurance contribution exemptions on childcare vouchers will be scrapped to pay for the expansion of free childcare for poorer families but this will not affect those currently using vouchers to pay for nursery care, as the move does not come into effect until April 2015.
However, from April 2011 employees who join an existing scheme will not be entitled to tax relief and NI contribution exemptions. Tax relief will still be available for those parents using workplace nurseries.
The four leading childcare voucher companies - Accor Services UK, Computershare Voucher Services (formerly Busy Bees Childcare Vouchers), Grass Roots and Sodexho Pass - said childcare vouchers were an extremely popular employee benefit that must be protected - and that the Government had also previously acknowledged their popularity with employers and parents.
The group said the move would be a blow to 340,000 working families who use vouchers saving them around £1,000 a year, at a time of economic uncertainty, and called on the Government 'to protect this essential support for working parents and businesses in the UK.'
'As we move towards recovery from recession, this is not the time to be making life harder for hundreds of thousands of families. Britain's 'squeezed middle' rely on tax exempt childcare vouchers to help pay for quality childcare.'
According to the group 35,000 employers offer vouchers to their employees as a benefit. Vouchers were also an important source of income for nurseries and childminders they said.
Currently the Government said around one-third of tax relief for childcare goes towards the six per cent of parents who are higher rate tax payers, earning more than £43,000 a year.
The Government said that low and middle-income working parents will continue to benefit from childcare support through tax credits.
Reaction from the early years sector
'It is fantastic news that Gordon Brown has announced a further extension of the free childcare entitlement for two year olds. We understand that about a third of two-year-olds will be covered by the end of the next Parliament.'
Alison Garnham, joint chief executive of the Daycare Trust
'Extending the free childcare entitlement to 250,000 two year olds is a welcome move towards the type of universal approach that is needed by hard working families. All the evidence shows that early intervention has real benefits in a child's development. This support is sure to be popular with all parents who struggle daily to balance work and other commitments with bringing up young children.'
Anne Longfield, chief executive of 4Children
'The devil's in the detail. The Government previously said that the free entitlement for two-year-olds will only be in outstanding or good settings.'
Neil Leitch, director of communications at the Pre-School Learning Alliance
'NDNA welcomes the announcement by Prime Minister Gordon Brown that more parents of two-year-olds will benefit from free care and early learning. However it is essential that funding this does not come at the expense of support for families more widely by making cuts to employer supported childcare. Whilst more help is welcomed this must not impact on those families who rely on existing support to afford the cost of childcare.
It is also important to recognise that there are significant issues with free early learning for three and four year olds. An offer for two-year-olds will rely on the involvement of private, voluntary and independent nurseries. It is therefore essential that these issues are addressed. Parents and nurseries welcome more free early learning but it is essential that the vast majority of parents continue to receive support.'
Purnima Tanuku, chief executive of the National Day Nurseries Association
