Salary Sacrifice Q&A
(You are advised to read the full
guidance on salary sacrifice (PDF 61K) before the following questions and answers.)
Does HMRC require an employee to sign up for a salary sacrifice scheme
for a set period of time, or can they opt in and out?
- Salary sacrifice is about varying the employee’s terms and conditions
as it relates to remuneration. It is, therefore, a matter for agreement
between the employer and employee. HMRC is only concerned that the correct
amount of tax and NICs is paid in respect of each element of the remuneration
package that the employee receives from the employment.
- If the employer allows some ‘opting in and out’, each time
there is a change there should be a legally enforceable variation to the
employee’s terms and conditions. At any given time it must be clear
what the employee is actually entitled to – either cash pay or some
other form of remuneration, for example a benefit in kind or non-cash
vouchers. The employer must apply the correct tax and NICs treatment to
what is actually due to the employee.
- If the terms and conditions provide the right to revert to cash within
the period of time they are set to cover, any tax exemption may be lost.
In the case of Heaton v Bell, the House of Lords decided that the benefit
of a company car provided through a salary sacrifice arrangement was chargeable
to income tax as earnings instead of by reason of the benefits code. The
key feature of the arrangement was the ease with which the employee could
give up the car and revert to the higher cash salary.
- Special legislation has been enacted to prevent this happening for
the following exempt benefits:
- Employer provided childcare
- Workplace parking
- Employer provided cycles and cycle safety equipment
In consequence, these benefits are exempt from income tax altogether. It
is not necessary to stipulate a period for which the arrangement must be
entered into or to set out “lifestyle changes”.
The principle established in the case of Heaton v Bell is not relevant
for NICs. NICs liability will be determined according to what the employee
actually receives.
When can an employer disturb an employee’s existing terms &
conditions because of a ‘lifestyle change’ and what constitutes
such a change?
Other benefits, apart from those listed above, may be only exempt from
charge to income tax under the benefits code. The issue of “ease of
convertibility” giving rise to a charge under the “earnings”
rules is still, therefore, relevant. HMRC accepts that certain “lifestyle
changes” may justify changing a salary sacrifice arrangement before
the intended period has elapsed.
- HMRC does not define ‘lifestyle change’. Generally this
term is used to refer to unforeseen life events (e.g. redundancy of a
partner, pregnancy of employee or partner, marriage or divorce of employee)
where an employer might agree to revisit an existing contractual arrangement
to take account of a change in circumstances.
- This may happen if an employee has agreed terms and conditions for
a set period and within that period an event happens that means the arrangements
are no longer suitable.
- The arrangements could include an agreement for the employer and employee
to end the existing terms & conditions early in the event of any defined
lifestyle change. These would be up to the employer to define. The new
terms & conditions could be agreed to suit the employee’s new
circumstances.
What information does HMRC need to see after a salary sacrifice scheme
is set up?
Can an employer put taxable benefits through payroll for tax purposes?
- There is no provision in PAYE Regulations for non-cash benefits to
be taxed through payroll. We can, by informal agreement, accept such arrangements
if we are satisfied the correct tax and either Class 1 or Class 1A NICs
is paid and reporting obligations will be fully met (recording the sum
and tax paid on the P11D/P9D).
- If we agree to such arrangements, the value of the taxable benefit
in kind should not only be included in the pay figure shown on the P60/P14.
The employer should also tell the employee that their benefits in kind
have been included in their gross pay and must provide details of those
benefits separately to the employee and HMRC. This is to ensure for example,
that employees have the information they need for their SA Return or to
claim tax credits (not all benefits in kind count towards income for tax
credit purposes).
- We expect any request to informally agree such arrangements to include
proposals on how the employer plans to provide details of the value of
the benefit both to HMRC and to the employee.
Does it matter if an employee’s payslip still shows the old salary
as gross pay and the sacrificed salary as a deduction?
- In the event of any dispute about the pay and benefits an employee
is entitled to, the employment contract is the first thing to consider.
If the employment contract has been effectively varied and the employee
is entitled to a reduced level of salary and specified benefits it is
not important what data is shown on the payslip. However, if changes to
the employment contract have not been made or are ambiguous, HMRC will
consider all available information when making a decision about the earnings
an individual is entitled to. The payslip may be a piece of evidence that
would be considered in these circumstances.
- Some payroll software can only hold one value as gross pay. This causes
problems when overtime and other pay is calculated on the basis of the
pre-sacrifice, higher salary. However, if the contract is clear this does
not invalidate the salary sacrifice. (See EIM42770)
- There are some important points that employers are advised to consider
though:
- Non-taxable benefits-in-kind must not be carried forward to the
P60/P35 and the system must be capable of separating these out for
end of year reporting to HMRC.
- Taxable benefits in kind still need to be reported to HMRC on form
P11D, P9D or approved substitutes.
- Does the payslip format help the employee to understand what they
are entitled to and what their earnings are for the purpose of earnings-related
state benefits (e.g. state pension, SSP, SMP) and tax credits?
Do earnings-related payments have to be impacted by a salary sacrifice?
- Statutory earnings-related payments such as SMP and SSP are calculated
on cash earnings so will be affected by reductions in cash pay in return
for non-cash benefits-in-kind. Whilst SMP and the other statutory payments
must be based on cash earnings, employers can, of course, make payments
over and above any statutory entitlement and may chose to base those additional
payments on the original salary (often referred to as the "notional"
salary). The employer can only reclaim statutory amounts calculated on
cash pay in accordance with the statutory payment rules.
- How other salary-related payments are calculated is usually up to the
employer to decide, for example occupational pension contributions, overtime
rates, pay rises etc. It is up to the employer to decide whether such
payments should be based on a figure of notional salary or on the new,
reduced cash salary. It is important that employees understand how a salary
sacrifice may affect other payments and, where appropriate, unions are
consulted in the construction of salary sacrifice scheme rules.
Can a salary sacrifice affect Occupational Pension Scheme contributions
or retirement benefits?
- Whether contributions into an occupational pension scheme are affected
by salary sacrifice is up to the employer. A notional level of pay –
often equal to the pre-sacrifice level of pay – is often used to
calculate employer and employee pension contributions so that employees
who participate in salary sacrifice schemes are not put at a disadvantage
to those who don’t. This is not a factor of whether the sacrifice
is effective or not for tax and NICs purposes.
- Employers should always, however, check their occupational pension
scheme rules with their scheme provider to make sure the salary sacrifice
scheme does not fall foul of these.
- The issue of what pension benefits can be paid can be problematic.
In the period before 6 April 2006, HMRC rules set a limit on pensions
linked to final taxable earnings. Benefits that were exempt from tax could
not be included in this calculation and employers needed to make sure
that they did not exceed the limit.
- However, this situation changed when measures to simplify the taxation
of pension schemes came into effect on 6 April 2006. From that date, limits
on pensions are no longer linked to final taxable earnings. If scheme
rules allow, pension scheme members who leave after the 6 April 2006 date
will not have their benefits restricted in consequence of any salary sacrifice
arrangements in place at the point of leaving.
- Employers who have specific enquiries about their occupational pension
schemes can contact HMRC on 0845 600 2622 (9am – 5pm Monday –
Friday).
Can a salary sacrifice take pay below National Minimum Wage rates?
