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
- Employer made contributions under a registered pension scheme
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).
Workplace Pension Schemes and Auto-enrolment
Over a period beginning in October 2012, with the start date depending
on the size of the organisation, employers will begin automatically
enrolling employees into a workplace pension scheme if the employee:
- is not already in a pension scheme at work
- is aged 22 or over
- is under the State Pension age
- earns more than £7,745 a year
- works in the UK
Every employee who meets the eligibility criteria must be enrolled
into a workplace pension scheme. The government has set a minimum
percentage (of an employee's qualifying earnings) that has to be
contributed into a workplace pension scheme over certain pay periods.
It is made up of the employer's contribution, the employee's contribution
and includes tax relief for the employee's contribution. As part
of the overall percentage, the government has set a minimum that
has to be contributed by the employer but the employer may pay more
than the minimum required.
Employees can opt out of the workplace pension scheme they are
enrolled into by completion and return to the employer of an opt-out
form. If the opt-out form is returned before the appropriate deadline,
the employee will not become a member of the workplace pension scheme.
Alternatively, an employee may decide to stop paying into the workplace
pension scheme but the employer will then probably also stop paying.
An employee who has previously opted out or stopped paying may
request to be enrolled again although the employer only has to accept
enrolment once in any 12 month period. Otherwise the employer will
automatically enrol the employee into the workplace pension scheme
at a later date, usually every 3 years. Similar to the initial auto-enrolment,
the employee may choose to stay in the workplace pension scheme
or opt-out.
An employer can use salary sacrifice arrangements for its workplace
pension scheme. HMRC understands that some employers are planning
to enrol employees into the workplace pension scheme in combination
with salary sacrifice arrangements. In that case, the employer should
ensure that an effective variation of the contractual terms and
conditions has taken place reducing some of the employee's cash
earnings. For example, the employer might agree to pay as the employer's
contribution an amount that exceeds the minimum required from the
employer to cover some or all of the amount that would otherwise
be required as the employee's contribution but the employee may
then become entitled to a lower cash salary. If the employee subsequently
opts out of the workplace pension scheme or decides to stop paying
into the workplace pension scheme then the salary sacrifice arrangement
may be revised, varying the terms and conditions relating to remuneration.
A workplace pension scheme into which an employee has been automatically
enrolled on the basis bulleted above will be a registered pension
scheme for tax purposes. Special legislation exists to prevent a
charge to tax as employment income arising in relation to contributions
that the employer pays to a registered pension scheme in respect
of an employee. Even if a salary sacrifice arrangement relating
to a workplace pension scheme provides for the remuneration to revert
to a higher cash salary on request, the tax exemption on the employer's
contributions will not be affected. Consequently, it is not necessary
to stipulate a period for which the arrangement must be entered
into or to set out "lifestyle changes" in relation to salary sacrifice
for the workplace pension scheme.
In the case of an employee who opts out before the appropriate
deadline, such that the employee will not become a member of the
workplace pension scheme, it is possible that the employee will
have received a payment of cash earnings reduced under the salary
sacrifice arrangement. If the employer pays an amount to the employee
to make good that shortfall then the payment should be made subject
to the deduction of tax under PAYE and NIC.
Can a salary sacrifice take pay below National Minimum Wage rates?
