Over the last few years, salary sacrifice schemes have surged in popularity. More and more employees are willingly accepting a reduction in their salaries in exchange for non-cash benefits such as pensions contributions, private healthcare, cars, gym membership or mobile phone contracts.
These salary sacrifice arrangements, although popular with employers and employees, have become unpopular with the treasury and caused them to propose changes to tax law to change the way in which tax is paid on benefits under salary sacrifice schemes.
The root of the treasury’s discontent lies in the tax advantages that salary sacrifice schemes attract. For example, if an employee earns £20,000 per year and agrees to reduce their salary by £1,000 per year so that they can buy a company car, they are currently only liable to pay income tax on £19,000. Likewise, their employer only has to pay National Insurance contributions on £19,000. HMRC are therefore missing out on income tax and National Insurance on that additional £1,000.
The treasury also argues that these schemes are inherently unfair. An employee cannot make a salary sacrifice if this would result in their salary falling below the National Minimum Wage or National Living Wage. For this reason, as a general rule, it is the higher earners in society that are able to benefit from salary sacrifice tax advantages, while the lower earners have to pay all the tax that they are liable for.
In an attempt to level the playing field between earners of all levels and ensure that HMRC are not being short-changed, the government has proposed to change the tax legislation for salary sacrifice schemes. Under the new regime, employers and employees will have to pay National Insurance and income tax respectively on salary sacrifice benefits. Tax will be charged on the higher of the actual amount of salary sacrificed and the cash equivalent as set out in statute (if any).
Using the example above, this will mean that even though the company car only cost the employee £1,000, if there is a statute that states the cash equivalent value for a company car is £2,000, tax must be paid on the higher value of £2,000.
However, it is not all doom and gloom for all salary sacrifice schemes. The government has decided not to change the taxation, at least for the time being, of salary sacrifice schemes that are in the public interest. These are:
- Employer pension contributions
- Employer-provided pension advice based on the recommendations of the Financial Advice Market Review (FAMR)
- Employer-supported childcare and provision of workplace nurseries
- Cycles and cyclist’s safety equipment which meet the statutory conditions
- Health related benefits such as cycle to work schemes
- Health screenings
- Benefits for which there is likely to be difficulty in ascribing a value to each individual employee, for example, workplace gyms
- Salary sacrifices for intangible benefits such as extra annual leave or flexible working hours
- Payroll Giving where employees are able to donate a certain amount of their salary to charity before income tax is deducted.
New legislation is intended to apply from 6 April 2017. This should give employers and employees enough time to decide whether their salary sacrifice schemes need changing and a few more months to enjoy the existing tax advantages while they can!
As salary sacrifice schemes form part of an employee’s contract of employment, we can advise employers on how the legal steps that need to be gone through to change existing arrangements.
The latest news on Pensions for your business
September 2016
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