Guide to Salary Sacrifice Arrangements
This employment law briefing highlights the various salary sacrifice arrangements that can be used by a business.
What is a salary sacrifice arrangement?
A salary sacrifice arrangement involves an employee giving up part of their entitlement to salary which is subject to income tax and National Insurance contributions (NICs), in exchange for a new or enhanced non-cash benefit, which benefits from a full or partial exemption from tax or NICs (or both).
What are the VAT implications of salary sacrifice arrangements?
From 1 January 2012 businesses must account for VAT on the supply of VATable benefits provided to employees under salary sacrifice schemes. Therefore, from that date, a business must account for output tax on the supply of VATable benefits provided under salary sacrifice as well as salary deduction arrangements.
What are the most commonly used salary sacrifice arrangements?
Employer-supported childcare
- Two forms of employer-supported childcare benefit from exemption from tax and NICs:
- childcare vouchers provided by the employer for qualifying childcare (the exemption covers the first £55 a week, equivalent to £243 a month); and
- directly-contracted or employer-contracted childcare, where an employer arranges for the provision of qualifying childcare (the exemption covers the first £55 a week).
- In addition, childcare facilities provided by an employer on site are usually entirely exempt from tax and NICs without limit. Provided the conditions for exemption are met, employees will save tax and NICs on the salary sacrificed.
- For childcare vouchers (assuming the full amount is sacrificed) earners who pay tax at 40% (and are in the scheme before 6 April 2011) will make a combined tax and NICs saving of £1,225 a year. The business will be able to save up to £402 a year for each employee through reduced employer NICs.
- From autumn 2015 a new tax-free childcare voucher scheme that will replace employer-supported childcare schemes. The new scheme will not depend on participation by employers and will therefore not involve any form of salary sacrifice. Once the new scheme has started, employer-supported schemes will be closed to new entrants. However, employees already in an employer-supported scheme will have a choice to remain in the scheme or to join the new scheme.
VAT implications
Childcare is exempt from VAT. VAT incurred by an employer on administrative fees must be attributed to the exempt supply of childcare vouchers. Accordingly, VAT is recovered under the normal partial exemption rules.
What conditions have to be met for the childcare voucher exemption to apply?
- The voucher must be for childcare for a child (or stepchild or person under the parental responsibility) of the employee.
- The voucher can only be used to obtain qualifying childcare (this means the carer must have the appropriate registrations and approvals).
- The vouchers are available to all of the employer’s employees.
- Employees joining employer-supported childcare schemes after 6 April 2011 are only entitled to basic tax relief.
Cycle to work schemes
The cycle to work scheme allows a business to loan cycles and cyclists’ safety equipment to employees as a tax and NICs-free benefit. This means employees will save tax and NICs on the salary sacrificed and the business will save employer’s NICs.
VAT implications
The business must account for output tax based on the value of the bicycle and any associated equipment. The business can continue to recover VAT on the costs of purchasing the bicycle and associated equipment.
What conditions have to be met for the cycle to work exemption to apply?
- The cycle or equipment (or both) are loaned to the employee. The exemption is not available if the agreement between the business and the employee provides for the automatic transfer of ownership of the bike to the employee at the end of the hire period.
- The employee uses the cycle or equipment (or both) mainly for qualifying journeys.
- The cycles or equipment (or both) are available generally to employees.
- If there are employees who cannot participate in the scheme (because, for example, a salary sacrifice would take the employee below the national minimum wage) the business could make a pool of bikes available. As long as the pool of bikes was large enough, the condition would be satisfied.
- As the business will be lending the bike to the employee, a formal hire agreement is required. From 1 April 2014, provided the value of the cycle or the cyclist’s safety equipment made available by the employer under the scheme does not exceed £1,000 (including VAT), the employer is exempt from the requirement to be an authorised person for consumer credit purposes in relation to the credit extended to the employee.
- At the end of the hire period, the business can sell the bike or equipment (or both) to the employee. This will be a taxable supply for VAT purposes. If the business sells them to the employee for less than market value, it will create a taxable benefit on which income tax and Class 1A NICs are payable.
Enhanced employer contributions to registered pension schemes
Salary sacrifices to increase pensions contributions and save NICs
- When an employee makes a pension contribution from salary actually paid, there is no NICs saving because employer and employee NICs are calculated on gross earnings. However, by replacing an entitlement to an amount of salary with an entitlement to an employer pension contribution, gross earnings are reduced, which reduces both employer and employee NICs. As there are no employer NICs on employer pension contributions, implementing a sacrifice scheme is an attractive way for a business to make NICs savings.
At current rates, most employees will save NICs at only 2% by using the sacrifice route instead of by making an individual contribution to the pension scheme. However, businesses’ savings are likely to be much greater, currently 13.8%. The business can pass on some or all of the saving by way of a higher special pension contribution. A fairly common arrangement is to share the NICs saving 50:50.Enhanced employer contributions to registered pension schemes
Salary sacrifices to increase pensions contributions and save NICs
- When an employee makes a pension contribution from salary actually paid, there is no NICs saving because employer and employee NICs are calculated on gross earnings. However, by replacing an entitlement to an amount of salary with an entitlement to an employer pension contribution, gross earnings are reduced, which reduces both employer and employee NICs. As there are no employer NICs on employer pension contributions, implementing a sacrifice scheme is an attractive way for a business to make NICs savings.
- At current rates, most employees will save NICs at only 2% by using the sacrifice route instead of by making an individual contribution to the pension scheme. However, businesses’ savings are likely to be much greater, currently 13.8%. The business can pass on some or all of the saving by way of a higher special pension contribution. A fairly common arrangement is to share the NICs saving 50:50.
Other possible attractions of salary sacrifice to increase pensions contributions
- The simplicity and cost efficiency for the employee of using a pension scheme already set up by the employer and, if a higher or additional rate taxpayer, not having to claim tax relief on personal pension contributions.
- The level of the working tax credit and child tax credit available to low or middle earnings employees may be increased by a salary sacrifice arrangement. However, employees will need to be warned that state benefits can be reduced if the salary is sacrificed in return for certain employer benefits.