Salary Sacrifice Q&A
You are advised to read the full
guidance on salary sacrifice (PDF 34K) before the following questions
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. HM Revenue & Customs (HMRC) is only
concerned that the correct amount of tax and National Insurance contributions
(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
When can an employer disturb an employee's existing terms and 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 (eg 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 and conditions early in the event of any defined
lifestyle change. These would be up to the employer to define. The new
terms and 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 Self Assessment
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
- 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 (eg 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 0300 123 1079 (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 (NMW) rates?
- No. Benefits provided in return for a reduction of cash pay (a salary
sacrifice) cannot take pay below NMW rates. The only exception is the benefit
of accommodation provided by the employer. Further guidance can found on
the GOV.UK website.
about national minimum wage: accommodation on the GOV.UK website (Opens