Last reviewed 19 December 2016
Benefits generally form a very significant part of an employee’s overall remuneration package but employees often perceive that a benefit should be just that and not one of which tax is payable. It was this reasoning that has led to the growth in popularity of salary sacrifice schemes in recent years, which can result in tax (employee only) and National Insurance (NI) (employee and employer) “savings” being generated. Paul Tew, Small Business Consultant and Freelance Advisor, looks at the changes coming into force from 6 April 2017, which will limit the advantages of these schemes, as the Government seeks to protect tax revenues.
What is salary sacrifice?
Salary sacrifice allows an employee’s cash pay, which is ordinarily subject to Pay As You Earn (PAYE) tax and National Insurance contribution (NIC) to be given up in return for the provision of a non-cash benefit(s), which has a different tax or NIC treatment. The “sacrifice” is achieved by varying the employee’s terms and conditions of employment relating to the remuneration package. HM Revenue & Customs (HMRC) has to be satisfied that the salary sacrifice is effective, otherwise the employee’s full salary is subject to PAYE tax and NIC, meaning there is no saving achieved.
There are two qualifying conditions that must be met for a salary sacrifice scheme to be effective.
Only future remuneration can be sacrificed by employees, meaning it must not be money received for tax or NIC purposes.
There must be a revised contractual arrangement confirming that the employee is entitled to lower cash remuneration and non-cash benefit(s) provided by the employer.
The revised contractual agreement must state that the benefit is given in exchange for the cash sacrifice. Once a salary sacrifice arrangement is in place, employers can ask the HMRC Clearances Team to confirm the tax and NICs implications. HMRC will need to see evidence of the variation of terms and conditions (if there is a written contract) and payslips before and after the variation. However, HMRC will not comment on a proposed salary sacrifice arrangement before it has been put in place.
What is changing with salary sacrifice?
The Chancellor’s Autumn Statement confirmed that the tax and employer NI advantages of salary sacrifice schemes will be removed from 6 April 2017, with a specific exception put in place for arrangements relating to:
employer contributions to registered pension schemes (including pension advice)
employer supported childcare and workplace nurseries
cycles and cyclist’s safety equipment provided under a Cycle to Work scheme
ultra-low emission company cars.
For any other tax-exempt benefits, the exempt status will be lost if provided under a salary sacrifice scheme adversely affecting benefits such as workplace parking, health screening, mobile phones and gym memberships at work.
The tax legislation will be amended so that where a benefit is provided through salary sacrifice, it will be subject to employee income tax and Class 1A employer NICs, even if it is normally exempt from tax and Class 1A NICs, at the greater of the amount of salary sacrificed and the taxable benefit set out in statute (if any). This means that where the normal taxable value of the benefit is higher than the amount of salary sacrificed, it is subject to income tax and Class 1A NICs in the normal way.
Example: Employer offers a workplace car parking scheme to his or her employees. A contract is set up by the employer with a car park provider, which allows employees to have car parking facilities near to their place of work. The employer cost of the annual contract for each individual parking space is £1200 and a salary sacrifice scheme is put in place under which the employee has a contractual right to the tax-free parking space, and in turn agrees to a reduction in his or her annual salary of £1200. The current “savings” generated are as follows.
Basic Rate Taxpayer
Higher Rate Taxpayer
Additional Rate Taxpayer
Net Pay Reduction
Although the revised legislation comes into force from start of tax year 2017/18, the Autumn Statement confirmed that arrangements in place before 6 April 2017 will be protected until 5 April 2018, and arrangements for cars, living accommodation and school fees will be protected until 5 April 2021.
So, in the example, if the contract is set up before 6 April 2017, both employee and employer will continue to be able to achieve these savings until 5 April 2018. However, if the employer enters into the same arrangement for another employee on or after 6 April 2017, then the employee NIC saving will be £144 for a basic rate taxpayer and £24 for higher and additional rate taxpayers, but this is the only saving. There will be no income tax saving for the employee and no NIC saving for the employer, as there is a taxable benefit and associated Class 1A NICs liability on the salary amount sacrificed.
Changing the terms of a salary sacrifice arrangement
If an employee wants to opt in or out of a salary sacrifice arrangement, employers must revise their contract of employment with each change. The employee’s contract must be clear on what their cash and non-cash entitlements are at any given time.
The right to return to the original contract may be inferred, in that the variation to the contract is time limited and at the end of that time, the variation will stop and the original contract be reinstated. Employers can set the frequency with which employees can opt in and opt out of salary sacrifice. Many schemes offer an annual review period.
It may, however, be necessary to change the terms of a salary sacrifice arrangement before the end of a normal review period, where a “lifestyle change” means that an employee’s financial circumstances are significantly altered. These changes are employer defined, but unforeseen life events are generally taken to mean birth of a child, death of a spouse or partner, marriage or divorce, redundancy of a spouse or partner, etc.
As a general rule, if an employee can swap between cash earnings and a non-cash benefit whenever they like, any expected tax and NICs advantages under a salary sacrifice arrangement will not apply. However, certain benefits are exempt from income tax altogether by special legislation, so it is not necessary for an employer to specify a time period for which the salary sacrifice arrangement must be entered into.
What employers need to think about now?
Employers with an existing salary sacrifice scheme or thinking of introducing one as a reward method should:
review their current employee pay and benefits strategy
check any existing contracts in place with benefit providers to establish any notice periods involved
consider the cost implications of providing benefits, both from an employer financial perspective and in terms of reduced employee morale, if certain benefits are withdrawn
decide if salary sacrifice is still the preferred option under which to offer employee benefits from April 2017 onwards
if not, work out a new pay and benefits policy that meets operational objectives and is within budget.