Salary sacrifice: what benefits offer the best savings and what are the common pitfalls?

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On the face of it, a salary sacrifice arrangement may seem like a straightforward concept. But appearances are deceptive. Not all benefits can be provided using salary sacrifice and some deliver more savings than others, for both employers and employees. Senior Manager Dan Kelly, explains how to get the best from the arrangement.

Salary sacrifice is an arrangement that can be used to generate tax and NIC savings by giving up cash in return for a benefit. Although salary sacrifice can be used for the provision of any benefit to an employee in return for a reduction in their salary, since 2017 only certain benefits deliver a tax and/or NIC saving.

The Optional Remuneration rules were introduced to stop the widespread use of salary sacrifice as a means of giving employees choices in their remuneration package. The benefits employees could choose from would often incur less tax and NIC than the cash would, and the loss to the Exchequer was not insignificant.

The Optional Remuneration rules effectively shut down most salary sacrifice arrangements. Where employees have the choice of either a cash amount or a benefit, the rules stated that the greater of the taxable value of the benefit or the amount of salary sacrificed was the amount subject to tax and National Insurance – in other words there was no difference between the cash or benefit charge.

The government did however make certain benefits exempt from the Optional Remuneration rules so that they could continue to deliver tax and NIC reductions. The benefits exempt from the rules are:

  • Employee Pension Contributions
  • Child Care Vouchers
  • Cycle to Work schemes
  • Ultra-low emissions vehicles.

Of these, the two most popular arrangements are:

Pension Contributions

Using salary sacrifice for employee pension contributions accelerates the tax relief for employees so that it is received in full when the contribution is made and for higher rate taxpayers there is no need to claim additional relief through Self-Assessment. More importantly though, the employee contributions move from being a post-tax/NIC deduction to a pre-NIC deduction. This saves employees either 2% or 12% NIC on their contributions and the company saves 13.8% in NIC.

Companies which are not already using salary sacrifice for their employee pension contributions may like to consider moving employees onto an arrangement (with their agreement) as soon as possible as this is one of the last remaining ways that employers can legitimately reduce their liabilities on employee remuneration.

Company cars

A newer benefit that an increasing number of companies want to offer employees using salary sacrifice is electric company cars. The current tax savings are associated with electric cars being the “driver” so let’s look at why these are so appealing to employees at present.

Purely from a tax perspective, employees are able to generate significant savings if they swap part of their salary for an electric company car. This is because company cars are not taxed by reference to how much the lease (which most company cars are provided under) costs but based on their list price and a fixed percentage scale rate set by HMRC by reference to the CO2 emissions of the vehicle.

A comparison of the tax payable on a £5,000 car allowance, if taken in cash vs. opting for an electric company car makes the point:

List price of car £45,000
Scale rate per HMRC guidance   2%
Annual benefit value£900

Taking the benefit

A 40% taxpayer would incur £360 tax on this benefit whilst the employer would pay £124 in Class 1A NICs. The total tax and NI cost is £484.

Opting for the £5,000 as a car allowance

Tax £2,000
Class 1 NI employee £100
Class 1 NI employer£690
Total tax and NI cost is £2,790

That’s over £2,000 saved on £5,000 of remuneration. It is no wonder employees are once again demanding their employers start giving them the option to have a company car (that the employee will fund themselves).

There’s more to salary sacrifice than just a name

Some companies are falling into the trap of thinking that salary sacrifice is simply a matter of deducting an amount from an employee’s taxable pay and calling it salary sacrifice on the payslip. Employees see the narrative and assume all is in order. If only things were that simple!   

Under salary sacrifice an employee has the option of being paid an amount in cash, or ‘sacrificing’ their entitlement to that cash and receiving instead a company provided benefit.

The key element is the “giving up the right to receive cash and instead be provided with a benefit”. It is this point that many companies miss. Employees can be subject to income tax on money they do not receive where there is a legal right to receive it, but it was agreed (between employee and employer) that it would not be paid.

Section 18 ITEPA 2003 states that a payment is treated as received by an employee at the earlier of the date the money is paid, or the date on which the employee is entitled to receive the payment.

Without the correct paperwork in place the employee is still legally entitled to the cash and therefore it is taxable. The agreement with the employee must be in writing, stating that they are giving up the right to the cash. Simply stating something will be a salary sacrifice on a payslip is not sufficient to meet HMRC’s definition.

So, do employees using salary sacrifice need a new employment contract?

Thankfully, no. There are several ways that an employee’s entitlement to the payment of earnings can be changed without needing to issue new employment contracts whenever someone wants to join the scheme, or there is a change in how much they have to/wish to contribute.

By far the most common way that the contractual change is facilitated is using an addendum to the employment contract. These can be as simple, or as comprehensive as your organisation wishes, but at a minimum, one should clearly state that the employee agrees to the variation in the terms and conditions of their employment, states how much the employee agrees to their monthly salary being reduced by and the date that they wish the change to take effect from. The addendum will need to be signed by the employee for the variation to become legally binding.

Given the importance of the change in entitlement, we strongly recommend seeking advice from an employment lawyer. With salary sacrifice being the key to unlocking the tax savings for cars (and the NIC savings for pension contributions), companies should not risk their arrangements not achieving what they intended.

If you would like further information about how a salary sacrifice arrangement could benefit your business, please contact Stephen Kenny.