Changes to Salary Sacrifice

The basic idea is that an employee gives up a portion of their salary in return for a non-cash benefit. This works particularly well if the benefit provided is wholly or partially exempt from tax and National Insurance contributions (NICs). Popular arrangements currently involve employer pension contributions, childcare vouchers, cycle to work schemes, low emission company cars, mobile telephones and workplace parking spaces.

For example, an employee with a salary of £35,000 gives up £2,000 of this in return for the employer making £2,000 of pension contributions on their behalf. The employee’s income tax is reduced by £400, and both the employee and the employer save NICs – £240 for the employee and £276 for the employer. The saving is at an employee’s marginal tax rate, so the above employee – as a basic rate taxpayer – benefitted by an overall 32% saving, a higher rate taxpayer would save 42% and an additional rate taxpayer would save 47%.

Salary sacrifice can be especially beneficial where employees find themselves at just above one of the fault lines in the tax system, such as the 60% marginal income tax rate applicable when the personal allowance is tapered away. However, lower earnings can reduce the level of an occupational pension, affect entitlement to earnings-related state benefits, impact on mortgage applications and reduce any life cover based on salary.

Of course, many benefits are not tax-free, so sacrificing salary for the likes of private medical insurance, home technology or a wine plan only saves employee NICs – which are just 2% where earnings exceed £43,000. The main advantage here comes from the employer being able to negotiate bulk discounts.

New rules from April 2017

The government has become concerned about the increased popularity of salary sacrifice arrangements. Apart from the cost to the Exchequer, there is the matter of the uneven playing field which has developed. Lower-paid employees are often excluded because salary sacrifice cannot reduce cash earnings to below the rate of the national living wage or national minimum wage. Also, smaller employees are unlikely to be able to offer the same range of benefits as larger employers.

The government is therefore proposing to restrict the use of salary sacrifice arrangements by removing most of the tax and NIC advantages. The change will be implemented from 6 April 2017, although the following benefits will NOT be affected:

  • Employer pension contributions
  • Employer-provided pensions advice
  • Employer-supported childcare (including childcare vouchers)
  • Cycles and cyclists’ safety equipment provided under the cycle to work scheme

Where any other type of exempt benefit is provided in conjunction with salary sacrifice, the exemption will no longer apply. Income tax and employer’s class 1A NIC will then be payable on the greater of the salary sacrificed and the value of the benefit calculated using normal valuation rules.

For example, a salary of £600 is sacrificed for workplace parking. The taxable benefit will be £600. For non-exempt benefits, the change is less drastic, but it does mean that tax and class 1A NIC will be due on the amount of salary sacrificed if this turns out to be higher than the normal benefit valuation. So there will be no advantage from company bulk discounts, but still an employee NIC saving.

Now is a good time to review the tax effectiveness of current or proposed arrangements. Exempt benefits offered outside of a salary sacrifice arrangement will be unaffected by the change. We, as always, are happy to help.