Meg Saksida explains the mechanics of how benefits-in-kind are taxed to income tax.
Employees in the UK are chargeable to income tax on their net taxable earnings. These earnings are made up of the employees’ cash earnings, such as their salaries, wages and any bonuses, as well as any benefits-in-kind they might receive.
Benefits-in-kind are non-cash earnings which are given to an employee in addition to their wages. Common examples are medical insurance and company cars.
The default rule
The value of the benefit is the ‘cash equivalent’ of the benefit. The cash equivalent is the amount that the benefit cost the employer, less any amounts that the employee contributed towards it. The cost to the employer may be an external cost, such as providing a membership to a club, or an internal cost, such as providing a product or service that the employer produces.
An example of an external cost would be the employer providing medical insurance to the employee. If this insurance cost the employer £2,000 per year, this would be the cost to the employer. If the retail value of the policy was £2,000, but the employer received a discount such that it only had to pay £1,500 for the employee's policy, the cost would be £1,500, as this is what it actually cost the employer.
Where the benefit being provided was produced in-house, the cost remains the cost to the employer rather than the external selling price or any other contrived value. This point was highlighted in the House of Lords case Pepper v Hart [1992] STC 898.
In that case, a teacher at a private school was allowed to have their own child attend the school, due to extra capacity in the year. Although both the taxpayer and HMRC agreed that there was a benefit-in-kind, it was the value of the benefit that was being debated. HMRC reasoned that the full costs for having all the pupils in the school in class should be divided by the number of students in the school, and the result would be the cost. However, the teacher argued that instead, the difference between the costs for all the students already at the school be compared with all the students at the school plus his child. In other words, the incremental costs only of having one more child in the class were the true cost of the pupil’s place. This cost would, of course, be very small as most of the other costs (premises, the teacher, heat, light, rates etc.) were fixed costs and would not increase with one more student. The taxpayer won, and the marginal cost method of valuing benefits in kind was cemented.
Other rules
Not all benefits, however, are able to use the default rule. Company cars are taxable depending on a combination of factors, including the car’s CO2 emissions. The emissions level gives a percentage which is applied to the list price in establishing the benefit-in-kind. The same percentage is used to value the fuel benefit. Living accommodation depends on whether the property is rented or owned but is generally based on the annual value. There is an extra charge where the property’s historical cost was over £75,000.
Other valuation methods are used for interest-free employee loans, employees using and being gifted employer owned assets, and employer provided vans.
Practical tip
It is important to know which benefits-in-kind are taxable and which are not. There are several benefits-in-kind that are not taxable but very useful, such as mobile phones, eye tests and glasses.
