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The tax and NIC savings of salary sacrifice have grown in popularity over the last few years. The January 2012 decision of the First Tier Tribunal in Reed Employment plc v HMRC has highlighted the need for salary sacrifice arrangements to be effective in the eyes of HMRC if they are to deliver the intended tax and National Insurance (NIC) savings.
The Reed case concerned travel and subsistence payments made to employees under what was purported to be a salary sacrifice arrangement. The arrangement was intended to take advantage of the tax exemption for travel to a temporary workplace. However it failed on several counts.
The First Tier Tribunal found that there was no salary sacrifice arrangement in place as the workers had not sacrificed any of their salaries. In reality they were paid their salary in full, even if the figures shown on the payslip suggested that they received a combination of salary and travel and subsistence payments. Further, the tribunal found that the temps in question were employed on job-by-job contracts rather than under a continuing contract of employment. As such the temporary workplace rules were not in point as regardless of whether the assignment was for less than 24 months, the workers worked at the location in question for the duration of the assignment. As a result the travel expenses were expenses of ordinary commuting and were taxable.
The error was costly. The tribunal calculated the tax and NIC owing at £158m. However, it is likely that Reed will appeal. Dispensations were in force but the First Tier Tribunal did not rule on whether Reed had a legitimate expectation that the allowance was covered by the dispensation and tax and NIC was not due. This question was left for any further proceedings in the Upper Tribunal.
Making it effective
A salary sacrifice arrangement is a popular mechanism of taking advantage of tax and NIC exemptions for certain benefits and expenses. The employee gives up some of his or her salary (which is subject to tax and Class 1 NIC) in exchange for a benefit that is exempt from tax and NIC and saves the tax and Class 1 NIC that would have been payable on the salary foregone. The employer also saves the associated employer’s Class 1 NIC.
HMRC are happy as long as the salary sacrifice arrangement in effective in their eyes. If it is not, the employee is taxed and NIC calculated as if the employee had continued to receive his or her original (pre-sacrifice) salary.
For a salary sacrifice arrangement to be effective there must be a contractual change, the effect of which is that the employee has given up some cash salary in return for a benefit in kind. The employee’s contractual right to pay is reduced as a result.
The following conditions must be met:
- the employee’s potential future remuneration must be given up before it is received for tax or NIC purposes, and
- the true construction of the revised contractual arrangements between the employer and the employee is that the employee is entitled to a lower cash remuneration and a benefit
The arrangement fails if it allows the employee to continue to receive the higher salary. An arrangement whereby the employee has merely asked the employer to use part of his salary in a particular way, for example to purchase a benefit such as childcare vouchers, is not an effective salary sacrifice arrangement. The employee has not given up any salary, merely asked that part of it be spent in a particular way. There must be a contractual reduction in the employee’s salary for there to be a salary sacrifice.
While the employee cannot swap back to a higher salary at will without jeopardising the effectiveness of the arrangement, HMRC will allow an annual review. At the review date the employee is able to alter the salary benefit mix. However, once again, any changes must be properly reflected in the contract.
HMRC have published guidance on what constitutes an effective salary sacrifice scheme. See also ‘Salary sacrifice schemes and VAT’.
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