The changing face of salary sacrifice

If you’re employed and have fairly straightforward tax affairs, then you have relatively little opportunity to plan or take action to mitigate the tax you pay. That’s because salaries and bonuses are processed through the PAYE system and deductions of Income Tax and National Insurance happen before any payment is made.

Over the years, as employers have tried to find methods to reward or incentivise their staff tax efficiently, the popularity of salary sacrifice schemes has grown considerably.

Under a salary sacrifice scheme, Benefits in Kind or certain non-taxable items/expenditure (Benefits) are offered in exchange for the employee formally giving up an amount of salary.

Smaller employers may have entered into irregular one-off arrangements for particular employees, while larger businesses with significant workforces may have offered flexible benefit arrangements to try to give their staff some control and choice over the structure of their remuneration packages.

There has also been the growth of third-party advisers specialising in operating or advising on such schemes. In certain cases, the arrangements have been taken too far for the liking of HMRC.  Some schemes, for example, arranged for employees to sacrifice elements of their wages/salary in return for travelling and subsistence allowances/expenses, which were to be treated as non-taxable.

HMRC took action to close down schemes involving salary sacrifice and travel expenses with effect from 6 April 2016.  However, they have also been monitoring this area generally and state that they are losing out on significant amounts of Income Tax and NIC because of the increasing use of such arrangements.

Additionally, HMRC also believe that salary sacrifice schemes present an uneven playing field between employers who use them and those who don’t.  As a result, they are now undertaking a consultation, which proposes further changes to the rules. This may impact on salary sacrifice arrangements which until now have been perfectly acceptable (provided the appropriate documentation is in place).

The full wording and consultation can be viewed at the following link –

https://www.gov.uk/government/consultations/salary-sacrifice-for-the-provision-of-benefits-in-kind

Currently, once a portion of salary is given up, it is not liable to Income Tax or Employee/Employer’s NIC.  If low or non-taxable Benefits are offered in exchange for the salary, then both the employee and employer may achieve overall savings.

Most commonly, salary sacrifice arrangements have been offered in combination with childcare, pension contributions and occasionally mobile phones.    A growth area has been low emission company cars, which in some cases may now include mid-level executive saloons (particularly because of the many apparent low cost/favourable business lease offers that are often only available to business-users such as an employer).

Fortunately, because the government wants to encourage employers to provide such Benefits, the consultation is clear that pension contributions, employer-supported childcare – as well as the cycle-to-work scheme – should continue to benefit from tax relief when provided through salary sacrifice arrangements.

The government does however propose to change the tax rules so that where other Benefits are provided via salary sacrifice, they will be taxed even if they would normally be exempt.  The ‘taxable’ amount will in future need to be declared annually on forms P11D and will be calculated as the greater of:

  • the amount of salary sacrificed; or
  • the cash equivalent ‘Benefit’ (if any) as calculated in the normal manner.

 

This would mean that where the normal taxable value of the ‘Benefit’ is higher than the amount of sacrificed salary, then it would be taxed in the normal way.  But, if an exempt benefit had been provided, then the sacrificed salary would be treated as the taxable amount.

Here are a couple of possible scenarios:-

  1. A two-year iPhone contract might typically cost an employee, say, £1,000 in total, which they would have to fund out of their net pay.They could instead sacrifice approximately £40 of their monthly gross pay in return for their employer providing them with the same phone.Employer-provided mobile phones are exempt from tax, so this would only represent a cost of around £28 per month to an employee paying basic-rate tax, which gives them a reasonable saving, as well as a reduction in NIC for the employer.In future, the proposals mean a taxable amount would arise on the higher of £40 per month or the cost to the employer of providing the phone (eg the contract value, plus additional call charges etc).

 

  1. The ‘small print’ needs to be examined, but there are currently many ‘business-user’ lease deals available for mid-level executive saloons (such as a 3 Series BMW or C Class Mercedes) in the range of approximately £299 – £399 + VAT per month. Such deals are often not available to private buyers, where the monthly finance payment for such vehicles would be somewhat higher and possibly require a fairly large deposit.An employee could therefore sacrifice monthly gross pay of say £350 in return for their employer providing them with a mid-level executive saloon.Under current rules, the employee would be taxable on the benefit in kind, the value of which would possibly be in the region of £5,000 – £7,000 pa – Income Tax being charged on that at typically either 20% or 40%.In such a scenario, even if HMRC’s proposals do come into force, the position should not change, because the value of the ‘Benefit’ is higher than the sacrificed salary (£350 x 12 = £4,200 pa).However, if the ‘Benefit’ was only say £4,000 pa, the taxable amount would then increase and be equal to the sacrificed salary of £4,200pa.

Therefore, although HMRC’s proposals do not prevent employers from providing Benefits to their employees through salary sacrifice, it will often remove the taxation advantages that have come from doing so.

The consultation ended in early October and further announcements may follow in the Autumn Statement in late November.  In the meantime, it would be advisable for employers to review any salary sacrifice arrangements they currently operate, to consider the impact (and cost) of the proposals and perhaps discuss the potential impact with their employees.