Under a salary sacrifice arrangement the employee gives up part of his or her cash pay in return for a non-cash benefit. This can be very beneficial for both the employer and the employee.
However, the Government are unhappy about salary sacrifice arrangements. While they have yet to ban them, they are considering what to do with them and some of the newer exemptions do not apply where the benefit in question is provided by means of a salary sacrifice arrangement.
Making the most of an exemption
Salary sacrifice arrangements are frequently used to take advantage of the tax exemptions, such as that for childcare vouchers. The employee gives up taxable and NIC-able salary in return for childcare vouchers, which are exempt from both tax and National Insurance. The employer also saves employer National Insurance contributions.
Holly is a basic rate taxpayer. She swaps salary of £55 per week for childcare vouchers. The childcare vouchers are exempt from tax and National Insurance. This saves her tax of £11 per week (£55 @ 20%) and National Insurance of £6.60 per week (£55 @ 12%) – a total savings of £17.60 a week, or £915.20 per year. Her employer also saves employer’s National Insurance of £7.59 per week – an annual saving of £394.68.
Employee NIC savings
Salary sacrifice arrangements are also effective even if the benefit is not exempt. Most benefits in kind are liable to employer-only Class 1A National Insurance contributions rather than Class 1 contributions payable by both the employee and the employer. Swapping cash salary for a benefit in kind swaps the liability from Class 1 to Class 1A, saving employee contributions.
Naomi is a basic rate taxpayer. She gives up £300 of her salary in return for private medical insurance, which costs her employer £300 a year. Although she is taxed on the benefit of the private medical insurance, she saves National Insurance of £36, which she would have paid on the £300 of salary. Although the employer does not save any money, there is a cash flow benefit as Class 1A National Insurance is not payable until after the year end.
Keeping it effective
To benefit from the advantages offered by salary sacrifice arrangements, the salary sacrifice must be effective. This means that the reduction in salary must be contractual. It should be noted that a salary sacrifice arrangement cannot reduce the employee’s salary below the National Living Wage (or National Minimum Wage for employees under the age of 25). It may also impact on the employee’s entitlement to contributory benefits.
Salary sacrifice arrangements are under the HMRC radar. Some tax exemptions, such as those for trivial benefits, qualifying paid and reimbursed expenses and workplace meals, do not apply where the benefit is provided under a salary sacrifice arrangement. Further restrictions are expected. The message is to take advantage of salary sacrifice arrangements while you can.