A salary sacrifice arrangement involves an employee (or director) giving up the right to part of the cash salary due to them, usually in return for the employer providing the employee with a non-cash benefit. Depending on the nature of the non-cash benefit, these arrangements can be beneficial to both the employer and employee through income tax and national insurance contributions (NICs) savings.
Childcare provision may offer a tax efficient solution for many employees. The first £55 per week (£243 per month) of childcare costs may be provided by an employer free from both income tax and NICs.
A basic rate taxpayer earning £20,000 per annum who sacrifices £2,916 for childcare vouchers of equal value would save £904 in income tax and NICs. Their employer would also save £373 in employer's NICs. If, instead, the employee earned £45,000 per annum, they would save £1,196 in income tax and NICs. The employer saving would remain at £373.
Childcare provision can, subject to a number of conditions, be made either by way of childcare vouchers or by the employer contracting with the childcare provider direct.
Salary sacrifice arrangements for pension contributions can also be tax efficient, allowing NICs to be saved on the salary forgone. This represents an 11% saving for a basic rate taxpayer and a 1% saving for a higher rate taxpayer. The employer also saves NICs on the sacrificed amount paid direct to an approved pension scheme (a 12.8% saving).
Before entering into such an arrangement an employer should consider whether they will be eligible for income tax relief on additional pension contributions. Broadly, income tax relief could be restricted for individuals with income exceeding £150,000, following the changes enacted in Finance Act 2009. Salary sacrificed under arrangements entered into on or after 22 April 2009 must be added back to determine income in assessing whether the £150,000 threshold for restricting tax relief on contributions has been breached.
Other Tax Efficient Benefits
Other tax efficient benefits which could be offered under salary sacrifice arrangements include car parking spaces at or near the employee's place of work, extra holidays, mobile phones and bikes for work. A flexible package of benefits may have the advantage of giving employees more choice which may encourage a greater uptake, and potentially result in increased savings.
To secure potential tax savings, salary sacrifice arrangements must be implemented with care. Two key requirements must be satisfied.
- The employee's future salary must be sacrificed before the employee becomes entitled to it.
- The contract between the employer and employee must be amended to provide that the employee is entitled to a lower cash salary plus a benefit.
If the modified contract, in practice, permits the employee to opt to return to the higher salary any potential tax relief may be lost.
A salary sacrifice is an arrangement between an employer and employee. There is no requirement to seek permission from Her Majesty's Revenue & Customs (HMRC) as HMRC do not generally regard such arrangements as tax avoidance.
Employers should consider the cost of operating salary sacrifice arrangements and compare these against the potential tax savings.
Employees should consider the impact a sacrifice may have on them. A sacrifice arrangement could negatively affect an employee's entitlement to state benefits while entitlement to tax credits could be increased or reduced depending upon the benefits provided by the employer. A lower salary may also make it more difficult for an employee to obtain a mortgage or other borrowing.
In all cases, care should be taken to ensure any arrangement does not contravene the minimum wage legislation.
Legal advice should be sought to ensure that all potential pitfalls are avoided.
Salary sacrifice arrangements may be beneficial to employers and employees alike because of the potential tax savings. These savings are likely to become even more attractive with NICs set to increase by 0.5% from 6 April 2011 and income tax rates to rise for some individuals to 50% from 6 April 2010.
If you think your business may benefit from any of the above, please contact:
Head of Tax
0141 303 2497
0141 303 2427
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This update is a general guide only. It is not intended to contain definitive legal advice which should be sought as appropriate in relation to any particular matter.