Lindsey Wicks looks at the changes to the tax treatment of ‘salary sacrifice’ from 6 April 2017.
An increasing number of employers have been offering ‘salary sacrifice’ arrangements as a way of incentivising their workforce in a cost-effective and flexible manner. Many offer a suite of benefits for their employees to pick and choose from, recognising that each employee has different needs and aspirations.
From the employee’s perspective, if the benefit was exempt from tax, they will have saved income tax and National Insurance contributions (NICs) on the salary foregone, and the value of the benefit to them may well be worth more than the loss of net pay. From the employer’s perspective, they will not have been paying NICs on exempt benefits, and would have saved employer’s NICs on the salary forgone.
The cost effectiveness of these arrangements may need revisiting as a result of the changes to the rules.
The rules from 6 April 2017
The legislation changing the rules is contained in Finance Act 2017, s 7 and Sch 2, and refers to salary sacrifice arrangements as ‘optional remuneration arrangements’.
The legislation identifies two types of arrangement caught by the new rules. The first type of arrangement is where earnings (or a future right to earnings) are given up in exchange for a benefit. The second type of arrangement is where an employee is offered the choice of a benefit or a cash allowance in lieu of the benefit.
In both cases, the optional remuneration rules will tax the benefit as the higher of:
- the cash given up or cash allowance foregone; and
- the cash equivalent of the benefit calculated in accordance with the rules for that particular benefit.
Trap: Exempt benefits
Benefits that would otherwise have been exempt from income tax and NICs will be taxable based on the cash given up or cash allowance foregone if they are offered under an optional remuneration arrangement. Examples of such exempt benefits include car parking at or near the workplace and mobile phones.
Exemptions from the new rules
There are some benefits that are not affected, even if they are provided under an optional remuneration arrangement. These are:
- the payment of costs connected with the provision of taxable cars and vans and exempt heavy goods vehicles (such as repairs, insurance, and taxing the vehicles) (ITEPA 2003, s 239);
- cycles and cyclist’s safety equipment provided under cycle to work schemes (ITEPA 2003, s 244) and non-cash vouchers for the same (ITEPA 2003, s 266(2)(c));
- qualifying childcare vouchers (ITEPA 2003, s 270A);
- the provision of retirement benefits (ITEPA 2003, s 307);
- contributions to registered pension schemes (ITEPA 2003, s 308);
- contributions to overseas pension schemes (ITEPA 2003, s 308A);
- the provision of pensions advice (prospective ITEPA 2003, s 308C);
- statutory redundancy payments (ITEPA 2003, s 309);
- counselling and other outplacement services (ITEPA 2003, s 310);
- retraining courses (ITEPA 2003, s 311);
- workplace nurseries (ITEPA 2003, s 318); and
- directly-contracted childcare (ITEPA 2003, section 318A).
Furthermore, the provisions concerning car and van benefits are altered so that ultra-low emission vehicles (ULEVs) emitting 75g CO2/km or less are unaffected by the new rules.
The following are also excluded from the new rules, but only because those provisions already contain their own rules for calculating the benefit where there is a salary sacrifice or flexible remuneration arrangement in place:
- exemption for paid or reimbursed expenses (ITEPA 2003, s 289A);
- exemption for other benefits where an employee would be entitled to a deduction (ITEPA 2003, s 289D);
- independent advice in respect of conversions and transfers of pension scheme benefits (ITEPA 2003, s 308B);
- exemption for bonus payments from employers owned by an employee ownership trust (ITEPA 2003, s 312A);
- subsidised meals (ITEPA 2003, s 317);
- payments for recommended medical treatment (ITEPA 2003, s 320C); and
- trivial benefits provided by employers (ITEPA 2003, s 323A).
Transitional provisions
Where an employee has an arrangement in place before 6 April 2017, the existing method for computing the benefit will apply until 5 April 2018 unless the arrangements are varied or renewed before 6 April 2018, in which case the new rules for calculating the benefit will apply from the date of the change.
A longer transitional period until 5 April 2021 will apply to employer-provided living accommodation (ITEPA 2003, Pt 3, Ch 5), cars, vans and related benefits (ITEPA 2003, Pt 3, Ch 6) and school fees (ITEPA 2003, Pt 3, Ch 10).
A variation does not occur where there is a change because of accidental damage to a benefit (for example, a company car that has been involved in an accident) or for other reasons outside of the control of the parties.
In addition, a variation does not occur because of arrangements being suspended during a period of statutory leave (for example, statutory maternity leave or statutory sick leave).
The general rules concerning variation and renewal of arrangements triggering an earlier transition do not apply to school fees, provided the arrangements relate to:
- employment with the same employer;
- the same school; and
- fees in respect of the same child.
Trap: Automatic renewals
The automatic renewal of an arrangement could trigger an earlier transition to the new calculation method. This is specifically stated in the legislation (FA 2017, Sch 2, para 62(7)).
Example – Adam’s car park space
Adam is a higher rate taxpayer. He agrees to a reduction in salary of £500 in return for which his employer pays £450 for a Monday-Friday parking permit for a parking space in a car park near Adam’s workplace. The provision of car park spaces near the workplace is an exempt benefit.
Under the old rules, the cost to Adam in terms of net pay foregone would have been:
£
Salary foregone 500
Less: income tax saved @ 40% (200)
Less: employee’s NIC saved @ 2% (10)
Net pay foregone 290
Comparing the cost of paying for the parking himself out of taxed pay, Adam will have saved £160 by giving up £500 of his salary in return for his employer paying the £450 for the cost of the permit.
Adam’s employer will have saved employer’s NICs on the £500 salary at 13.8%, which equates to £69, and there will have been no Class 1A NICs payable on this exempt benefit. Overall, Adam’s employer will have saved £119 compared to paying Adam the salary foregone of £500.
Under the new rules, Adam will have a taxable benefit of £500, being measured at the salary foregone and the income tax cost of this would be £200. As the original saving for Adam had been £160, this is less than the £200 income tax cost, leading to a net cost to Adam of £40.
Under the new rules, Adam’s employer would pay Class 1A NIC @ 13.8% on the benefit of £500, so there is no employer’s NIC saving compared with paying £500 salary. The only saving to Adam’s employer would be the £50 difference between the salary and cost of the permit. However, given that Adam would be worse off under this arrangement, Adam is unlikely to want the arrangement to continue in its current form.
Practical Tip:
Pay and benefits are key to attracting and retaining employees. Flexible benefit packages will have often been driven from a human resources perspective rather than tax savings. In a market where it is difficult to attract and retain employees, employers will need to tread carefully to ensure that their reward packages continue to deliver the same perceived level of reward despite the changes to the tax legislation.
