As a concept, salary sacrifice schemes have been around for several years now and are becoming increasingly popular, mainly because of the number of scheme providers actively marketing the product. They work by enabling employees to swap taxable pay for a non-taxable benefit, so the actual value of the benefit they are gaining is far more than the drop in their take-home pay. Higher-rate taxpayers typically save up to 50% of the cost to their employers of providing the benefit, and employers benefit too because they save Class 1A NI contributions.
There is no need to report these schemes to HM Revenue & Customs because they are a contractual matter between the employer and the individuals concerned. However, if they are asked to give approval to a salary sacrifice scheme, they will want to see the both scheme details and the employee contracts, as they would need to satisfy themselves on two things:
that the employee contract has been varied and is legally binding so that he/she is no longer entitled to the same rate of pay as before; and
that the benefit gained in exchange for the salary sacrifice complies with all necessary conditions for it to be free of both tax and NI.
The employer should therefore make sure that the employee formally agrees to vary his or her contract otherwise a right to the original rate of pay will still exist. It may well be advisable to consult an employment lawyer before implementing a salary sacrifice scheme.
It is also necessary to consider carefully the impact a salary sacrifice scheme may have on pension rights, social security benefits, statutory payments and tax credits. State pension may be affected if NI contributions fall below the lower earnings limit (£5,305 per annum in 2011/12). Entitlements under the State Second Pension may also fall if salary is reduced to £14,100 per annum (2010/11 thresholds). Contributions-based social security entitlements such as Incapacity Benefit may be affected if earnings fall below the lower earnings limit. So might Statutory Sick Pay if your employer does not pay your normal remuneration whilst you are on sick leave. For pregnant women, Statutory Maternity Pay will be lower for the first 6 weeks if you volunteer to reduce your pay under a salary sacrifice scheme and may be invalidated completely if it falls below the lower earnings limit for any length of time. You may be entitled to a higher rate of Working Tax Credit as a result of taking a lower salary but if it is in exchange for childcare benefits from your employer then you may lose some or all of the childcare element.
One further point - a salary sacrifice scheme should never operate in such a way that earnings are reduced below the National Minimum Wage. Benefits from your employer do not count towards the minimum wage.
Here are some of the more popular types of Salary Sacrifice Scheme:
These are by far the most popular benefits under a salary sacrifice scheme. You are entitled to childcare vouchers or nursery payments of up to £55 per week or £243 per month free of tax and NI if you are responsible for a child aged up to 15 (or 16 if disabled). They can also be used for extra-curricular activities such as horse-riding or ballet lessons, which can be handy if your children have grown out of daytime care. However, you should note that childminders must be registered and the vouchers cannot be used to pay relatives for childcare, such as grandparents, aunts or uncles (even if they are registered) unless they provide the childcare services away from the child's home and look after non-related children at the same time. Very importantly, you should check whether childcare vouchers would affect your entitlement to the childcare element of Working Tax Credit before agreeing to accept them as part of a salary sacrifice scheme.
From 31st March 2011 higher rate taxpayers will only be able to claim the full amount of £55 per week tax free if they are already in a childcare vouchers scheme. For new schemes set up after that date, tax relief will be restricted to the basic rate of 20%. This means that your employer will need to check if you are a higher rate taxpayer when you are admitted to the scheme and either restrict you to the tax free element if you are or treat the excess as taxable pay. This change will not affect higher rate taxpayers belonging to schemes already in existence, so if your employer has not set one up yet, they need to do so by that date in order to maintain full tax benefits for all employees.
Parking at or near your place of work is a non-taxable benefit if the cost is met by your employer, either by paying the parking costs directly or reimbursing you on an expense claim. As many employees use their cars for travel to work this is ideally suited to a salary sacrifice scheme. The only difficulty is that parking costs may vary from one employee to another, and may also change over time, so it may not be possible to have a scheme whereby all employees are given the same benefit and/or sacrifice the same amount of salary. They are also not well suited to pay & display car parks as the cost is not usually known in advance. However, they are ideally suited to arrangements whereby the employer contracts with a large car park operator on behalf of all participating employees. Employers could also use such a scheme to fund a car park on their own premises, although they should check whether their local authority has any plans to charge a levy on workplace parking.
The Cycle-to-Work scheme was introduced in 1999 and allows employers to give bicycles to their staff tax free for the main purpose of getting to work. Employers can also pass on VAT savings to their staff, thus making it even more tax-efficient. The scheme must be available to all employees to qualify for the tax exemption. The bicycles must actually belong to the employer who hires them to the staff in exchange for equal instalments by salary deduction. After 18 months the employer can sell them to the users for a notional sum reflecting their second hand value, typically 5-10% of the original price. This means that there must be a hire contract between the employee and the employer as well as the salary reduction agreement. There are a few other hoops to jump through. The employer must apply for a group consumer credit license from the Office of Fair Trading and the loan period cannot exceed 18 months. Also, the employer cannot hire bikes worth more than £1,000 each unless they apply for an individual consumer credit license. Staff aged under 18 are barred from the scheme as they cannot legally enter into a credit sale agreement, and if an employee leaves before the end of the loan period the employer is responsible for collecting any outstanding payments. To qualify for the tax exemption, the bike must be used for at least part of the journey to/from work (or between different workplaces) although it is not clear who is meant to police this given that you do not need to record your trips or mileage. It is also very important that there are no cash top-ups by employees otherwise it could invalidate the scheme. One last point - you cannot claim mileage for use on company business during the hire period as it is not legally your bike.
Personal pensions are ideally suited to salary sacrifice schemes as they already lend themselves to employer contributions. They are often used to replace existing net pay agreements whereby employees pay tax on their normal gross pay but get a tax credit from the Government via the pension provider. By turning them into employer contributions, the amount going into your pension plan will be much higher than before, especially if the employer passes on their NI savings, although your take home pay will remain the same.
As an example, let us suppose a man earning £30,000 per annum pays £240 per month into a stakeholder pension. His monthly pay after deducting tax and NI (based on 2009/10 rates and allowances) but before pension would be £1,885. After deducting pension he would take home £1,645. His pension plan would gain £3,600 per annum after adding the tax credit.
If the employer paid his pension contributions instead under a salary sacrifice scheme, he would only need a salary of £25,826 to achieve the same monthly net pay of £1,645. His employer would pay the salary sacrificed of £4,174 into his pension plan and top it up by 12.8% for NI saved, giving him £4,708. Therefore, his pension plan would go up by £1,108 even though his take home pay remains the same - an increase of 31%.
As mentioned above, you do need to consider the effects of a lower salary on your state pension rights, and this is a rather esoteric calculation because the State Second Pension (S2P) is based on a revaluation of your earnings for each tax year from 2002/3 up to the year you retire by reference to increases in national average earnings. The resultant figures are then divided by the number of years in your working life since 1978 to arrive at the amount of additional pension accrued for each year. Obviously you cannot know any of this until you retire, so it is necessary to estimate how much S2P would be worth. However, as all pay above the Secondary Earnings Threshold (£31,800 in 2009/10) will only accrue additional pension at 10% per annum from 2010 onwards (rather than at the current 20%) and earnings below the Lower Earnings Threshold (£14,100 in 2010/11) will accrue at a flat rate of £1.60 per week from some unspecified future date (rather than at the current 40%) you can assume that sacrificing salary for benefits will do much less harm to your pension rights than it used to.
All things considered, switching from a net pay agreement to a salary sacrifice scheme for pension contributions would appear to be a no-brainer.
Employers are already allowed to give mobile phones to their staff and pay the bills as a tax free benefit, whether they are used for business or not, provided the handset remains the property of the employer and the contract with the service provider is in the name of the employer rather than the employee. The only restriction is that they can only give one handset to an employee or his/her immediate family for it to be tax free. Mobiles that are provided exclusively for business use (and have only insignificant private use) are exempt in any case. As many employers only give mobile phones to staff who really need them, it can be cost-effective to take advantage of their tax free status and issue them to other staff as part of a salary sacrifice scheme. The monthly bills can then be deducted from salary and the employee will only pay tax and NI on their pay net of this deduction. However, due to the rapid changes in mobile phone technology, there are fears that this exemption could soon go the same way as the Home Computer Initiative, which was scrapped a few years ago. The constant threat of phones being lost, stolen or broken are also deterrents to their use in salary sacrifice schemes for both employers and employees.
Food and drink provided by employers to staff on their own premises in canteens has always been tax free, although many companies prefer to sell it at a concessionary rate using smart cards topped up occasionally with cash payments. From 6 April 2011 it will no longer be possible to use staff canteens as part of a salary sacrifice scheme.