Salary sacrifice arrangements are an effective way of taking advantage of tax and National Insurance exemptions. Under a salary sacrifice arrangement, the employee gives up some of his or her cash salary in return for a benefit-in-kind. The benefit-in-kind does not have to be exempt from tax and National Insurance, but where it is, the employee and employer both benefit from the salary swap. Popular benefits taken in exchange for salary include childcare vouchers and mobile phones.
Example 1: Salary sacrifice for childcare vouchers
Jessica is a basic rate taxpayer. She has a small daughter. In 2015, she entered into a salary sacrifice arrangement with her employer, under which she gave up cash salary of £55 per week in return for childcare vouchers. The childcare vouchers are exempt from tax and National Insurance.
By reducing her salary, she saves tax of £572 (£2,860 @ 20%) and employee’s National Insurance of £343.20 (£2,860 @ 12%). Her employer saves employee’s National Insurance of £394.68 (£2,860 @ 13.8%). No tax or National Insurance contributions are payable on the childcare vouchers taken in exchange for the salary.
A salary sacrifice arrangement can still be effective if the benefit taken in exchange is not exempt from tax and National Insurance, as benefits-in-kind are generally liable to Class 1A (employer only) National Insurance rather than Class 1, so taking a benefit in exchange for salary moves the liability from Class 1 to Class 1A, thus saving employee National Insurance.
For the salary sacrifice to be effective, the employee’s contract must be amended to reflect the new arrangements (i.e. lower salary and benefit). If the employee can revert to the higher salary at will, HMRC will continue to tax the employee by reference to the higher salary.
HMRC have become increasingly concerned with the use of salary sacrifice arrangements and the cost to the Exchequer in terms of lost revenue as a result. The new exemptions for qualifying paid and reimbursed expenses and trivial benefits do not apply if the benefit is made available under a salary sacrifice arrangement. At the time of the 2016 Budget, HMRC announced that they would be looking at limiting the range of benefits that attract tax and National Insurance advantages when provided by means of a salary sacrifice or flexible benefits arrangements.
Under proposals set out in a consultation document published in August 2016, from 6 April 2017, unless the benefit is of a type permitted by HMRC, the tax exemption would be lost if the benefit was made available under a salary sacrifice arrangement. The benefits for which the tax exemption would be retained where provision was made under salary sacrifice are as follows:
- employer pension contributions;
- employer-provided pension advice based on the recommendations of the Financial Advice Market Review (FAMR);
- employer-supported childcare and the provision of workplace nurseries; and
- cycles and cyclists’ safety equipment.
Benefits on the above list are unaffected by HMRC’s clampdown, and it remains potentially beneficial to continue to provide them under a salary sacrifice arrangement.
Where a benefit is not on the above list, the tax exemption will be lost from 6 April 2017 if the benefit is made available under a salary sacrifice arrangement. Instead, the benefit will be taxed and will also be liable to Class 1A National Insurance.
The amount charged to tax and National Insurance will be the higher of the salary foregone and the cash equivalent value of the benefit calculated in accordance with normal rules, if any. This means that where a benefit is exempt from tax, under the proposals set out in the consultation document, from April 2017 the benefits will be liable to tax and Class 1A National Insurance contributions if made available under a salary sacrifice arrangement. Examples where the benefits would be taxed by reference to the foregone salary include mobile phones, employer-provided bus services and health screening.
Example 2: Mobile phone (under HMRC’s proposals)
David has entered into a salary sacrifice arrangement with his employer, under which he gave up £500 of salary in return for an employer-provided mobile phone. The provision of a mobile phone is exempt from tax and National Insurance. Prior to April 2017, David will continue to benefit from this exemption where the phone is made available under the salary sacrifice arrangement.
However, under HMRC’s proposals, from April 2017 the benefit of the exemption would be lost and David would be taxed on the provision of the mobile phone. The amount charged to tax would be the salary foregone of £500.
Where the benefit is not on HMRC’s approved list, the benefit of the tax exemption will be lost if the benefit continues to be provided under a salary sacrifice arrangement from April 2017.
Review all salary sacrifice arrangements prior to April 2017. From that date, it is better to provide employees with benefits in addition to salary, rather than as part of a salary sacrifice or flexible benefit arrangement.
This article was first printed in Tax Insider in November 2016.