Salary sacrifice schemes and VAT

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Overview

Salary sacrifice schemes are a popular way to provide tax-exempt benefits to employees. The idea behind a salary sacrifice scheme is that the employee gives up some of his or her salary in exchange for a non-cash benefit. Where the benefit taken in exchange is exempt from tax and NI, the employee saves the tax and NI on the salary given up. The employer also saves employer’s NI. Consequently, salary sacrifice schemes can be something of a win-win situation.

Until recently, VAT did not feature in the equation. HMRC took the view that the salary given up in exchange for the goods or services provided to the employee did not constitute a taxable supply. Consequently, the employer did not need to account for output VAT. Any input tax suffered on the purchase of the goods and services by the employer was recoverable in the normal way. By contrast, where an employee was provided with goods and services under a deduction from salary scheme (whereby an amount is deducted from the employee’s salary in return for the goods or services), HMRC has always taken the view that this constitutes a taxable supply and that output VAT is due.

However, following the decision of the Court of Justice of the European Union in Astra Zeneca UK Ltd v HMRC, HMRC has revised its view on the VAT treatment of goods and services made available under salary sacrifice arrangements. The case concerned the provision of high street shopping vouchers provided to employees as one option available under a flexible remuneration scheme. The court found that the supply of the vouchers amounted to supply of services effected for a consideration. In consequence, while AstraZeneca could recover input tax incurred on acquiring the vouchers, output tax was due on the consideration received from the employees.

Although the case concerned high street vouchers, HMRC consider the decision to be of general application and are to apply the same principles to other supplies of goods and services provided under salary sacrifice arrangements. The new arrangements will apply to goods and services provided under a salary sacrifice arrangement on or after 1 January 2011.

What does all this mean for employers?

1. The decision only affects VAT-registered employers, although the supplies made to employees via salary sacrifice arrangements will need to be taken into account in determining whether the VAT registration threshold has been reached.
2. Output VAT is only due where the goods and services provided are a taxable supply.
3. The new rules only apply where benefits are provided in exchange for a reduction in salary. It does not affect the provision of benefits generally where there is no salary swap.

As a result of HMRC’s policy change in the light of the judgment, from 1 January 2012 employers will be required to account for output tax when they provide a taxable supply to an employee under a salary sacrifice arrangement. The value of the supply will normally be the salary foregone. However, if the salary foregone is less than the true cost of providing the goods or services (as would be the case if the salary foregone was less than the cost to the employer of buying in the benefit), employers should base the value of the supply on the cost to them of providing the goods or services. HMRC’s Business Brief publicising the change of policy sets out the effect of the judgement in relation to a number of benefits commonly provided under salary sacrifice arrangements. The key points to note are:

• Childcare vouchers are exempt from VAT so they are not affected by the judgment.
• From 1 January 2012, VAT on administration fees incurred in relation to childcare vouchers can only be recovered in accordance with the partial exemption rules as the supply is directly attributable to the exempt supply of childcare vouchers. This may mean that not all the VAT on voucher administration fees is recoverable. Current policy is to allow full recovery as a general business overhead.
• Where bikes or cycling safety equipment is made available under a salary sacrifice arrangements as part of a cycle-to-work scheme, from 1 January 2012 employers must account for output VAT on salary foregone by the employee in exchange for the loan or hire of the bike or equipment. Employers can continue to recover input VAT on the purchase of the bikes and equipment. VAT remains due when the bike is disposed of.
• VAT is due from 1 January 2012 on face value vouchers provided under a salary sacrifice scheme. Input tax remains recoverable. Currently output VAT is due to the extent of the input tax claimed.
• The tax exemption for workplace meals no longer applies to meals provided under a salary sacrifice arrangement, reducing the attractiveness of such arrangements. However, where food and drink are still provided under salary sacrifice arrangements, from 1 January 2012 employers must account for output VAT other than where the supply is zero-rated. Input tax remains recoverable.

HMRC have published Business Brief 28/11 setting out the implications of the CJEU decision and the new rules on VAT on goods and services provided under salary sacrifice arrangements (as supplemented by Business Brief 36/11).