Under a salary sacrifice arrangement an employee gives up some of their contractual entitlement to cash earnings. Usually this is in return for new or increased entitlements to non-cash benefits. This can lower the amount of tax and National Insurance contributions (NICs) you deduct and pay to HM Revenue & Customs (HMRC) on the employee's remuneration package - because the figure on your payroll is the one which is taxable. But there are other potentially significant implications that you should consider before agreeing a salary sacrifice arrangement.
Anything provided to an employee under a salary sacrifice arrangement does not have to be included in PAYE (Pay As You Earn) submissions - if you make arrangements of this kind there is nothing to be shown on the submissions and the taxable pay reported should be the post-sacrifice figure.
This guide provides an overview of the tax and NICs treatment of salary sacrifice. It also highlights key other ways in which salary sacrifice can affect employers and employees.
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A salary sacrifice arrangement is an agreement between an employer and an employee to change the terms of the employment contract to reduce the employee's entitlement to cash pay. Usually this sacrifice of cash entitlement is in return for some form of non-cash benefit.
In some instances, salary sacrifice arrangements can be financially beneficial for both employer and employee. This is the case, for example, when part of an employee's remuneration shifts from cash (on which PAYE tax and NICs are due) to non-cash benefits that are wholly or partially exempt from tax and NICs. For more details, see the section 'Tax and NICs on salary sacrifice arrangements'.
It's important to weigh these potential financial benefits against other effects that salary sacrifice can have. For example, salary sacrifice in return for non-cash benefit increases the non-cash benefits you're required to provide to an employee if they take statutory maternity, ordinary paternity, additional paternity or adoption leave. It can also reduce an employee's entitlement to statutory payments for sickness, maternity, ordinary and additional paternity or adoption. For more details, see the later sections of this guide.
Salary sacrifice doesn't have a set effect on the tax and NICs that are payable on an employee's remuneration. The impact will differ in each case depending on the specific package of pay and non-cash benefits that make up the salary sacrifice arrangement.
Your key obligation is to make sure that you pay and deduct the right amount of tax and NICs for the mix of cash and benefits that you provide to your employee:
Some non-cash benefits qualify for an exemption from tax and/or may be disregarded before calculating NICs. If this is the case for a benefit you're providing to an employee as part of a salary sacrifice arrangement, bear in mind that you must satisfy any conditions that apply to the exemption.
For example, if an exemption requires that a benefit be made available to all of your employees then this condition must be fully satisfied, whether or not all employees have a salary sacrifice arrangement with you.
You can check the tax and NICs rules and conditions for each type of benefit using HMRC's expenses and benefits A to Z (follow the link at the end of this section).
Remember that the reporting requirements for many non-cash benefits are different from those for cash earnings. In general, benefits must be reported to HMRC at the end of the tax year using forms P11D or P9D. Again, use HMRC's A to Z to find the specific reporting rules that apply to individual benefits.
Once a salary sacrifice arrangement is in place, you can ask the HMRC Clearances Team to confirm its tax and NICs implications. The team's contact details are below. Please note that HMRC won't comment on a proposed salary sacrifice arrangement before it has been put in place.
HMRC Clearances Team
21 Victoria Avenue
Essex SS99 1BD
In general, if you wish to allow your employee to 'opt in' and 'opt out' of a salary sacrifice arrangement, you'll have to alter their contract with each change. This is because the employee's contract must spell out clearly what their cash and non-cash entitlements are at any given time.
If a salary sacrifice arrangement allows an employee to swap between cash earnings and a non-cash benefit whenever they like, then they haven't really sacrificed their entitlement to the cash earnings, as is required. In those circumstances, any expected tax and NICs advantages under the salary sacrifice arrangement will not apply.
If an employee's financial circumstances change unexpectedly, HMRC accepts that it may be necessary to change the terms of a salary sacrifice arrangement where a 'lifestyle change' significantly alters an employee's financial circumstances. Examples include marriage and divorce, or an employee's spouse or partner becoming redundant or pregnant. Salary sacrifice arrangements can allow opting in or out in the event of lifestyle changes like these.
A salary sacrifice arrangement cannot reduce an employee's cash earnings below the national minimum wage.
Salary sacrifice affects Statutory Sick Pay (SSP), Statutory Maternity Pay (SMP), Ordinary Statutory Paternity Pay (OSPP), Additional Statutory Paternity Pay (ASPP) and Statutory Adoption Pay (SAP) in two ways:
To be entitled to receive SSP, SMP, OSPP, ASPP or SAP an employee's average weekly earnings must be at or above the Lower Earnings Level (LEL) that applies at the relevant week (Qualifying or Matching Week), which is £109 per week for the 2013-14 tax year and £111 per week for the 2014-15 tax year.
If a salary sacrifice arrangement reduces an employee's average weekly earnings below the LEL, then you won't be required to make any statutory payments to them. There's more information on calculating average weekly earning when a salary sacrifice is in place in the section 'Calculating statutory payments' below.
If your employee is entitled to statutory payments then you may need to use the average weekly earnings to work out the amount to pay.
To calculate their average weekly earnings use the remuneration package that applies under the salary sacrifice arrangement, with its reduced cash element, not the package that applied previously for example:
HMRC has compiled a series of worked examples that show clearly how this works. Use the link below and see pages two to seven of the document it opens.
As described above, payments of SMP, OSPP, ASPP, SAP or SSP must be calculated on the basis of what an employee actually earns - you can't agree between you to use a higher earnings level such as one that applied before a salary sacrifice arrangement was put in place. However, you can make non-statutory 'top-up' payments to the employee if you wish to compensate for any reduction in their statutory pay entitlement.
When an employee is on statutory maternity, ordinary paternity, additional paternity or adoption leave, all of the terms and conditions of their employment contract continue to apply, other than those relating to wages or salary.
This applies to all non-cash benefits in the contract, including any that form part of a salary sacrifice arrangement. You must continue to provide these benefits in the same way as if the employee was still at work.
For example, if you agree a salary sacrifice arrangement that involves an employee losing £50 per week of their salary in return for £50 of vouchers, you will have to continue to provide those vouchers throughout any statutory maternity, paternity or adoption leave that the employee takes.
You cannot reduce the amount of any statutory payments due to the employee to recover the cost of providing any non-cash benefits to them while they are on maternity, ordinary paternity, additional paternity or adoption leave.
Please note that these provisions apply to childcare vouchers in exactly the same way as to any other non-cash benefits.