A) In order to obtain tax relief on the bonus payment, the salary sacrifice rules need to be followed. A salary sacrifice happens when an employee gives up the right to part of the cash remuneration due under his or her contract of employment. Usually, the sacrifice is made in return for the employer’s agreement to provide the employee with some form of non-cash benefit. The sacrifice is achieved by varying the employee’s terms and conditions of employment relating to remuneration.
An employee may also sacrifice a one-off item such as a bonus.
In the past, the term salary sacrifice was mainly used to refer to the giving up of rights to future cash remuneration in return for the employer’s contributions to a registered pension scheme. Now it is used to describe any situation where an employee gives up a right to future cash remuneration in return for a benefit in kind.
Where pension contributions are involved, the income tax liability of the employee will often not be affected whether or not the salary sacrifice succeeds. If it does not succeed the pension contributions will be treated as employee contributions. The employee will get full tax relief at his or her top rate of tax on the contribution. This is the same overall income tax liability as if the salary sacrifice had succeeded.
Where such a salary sacrifice is accepted as successful, the potential future cash remuneration sacrificed is not taxable. The pension contribution made by the employer in return for the sacrifice will be an employer’s contribution. This employer’s contribution is not taxable on the employee.
Where such a salary sacrifice is not successful, the employee continues to be taxed under Section 62 ITEPA 2003 on the higher level of cash remuneration received prior to the ineffective salary sacrifice. The employee continues to be entitled to the higher level of cash remuneration and has merely asked the employer to apply part of that remuneration on the employee’s behalf.
The pension contribution made by the employer as part of the ineffective salary sacrifice is an employee’s contribution. The employee will get full tax relief on the contribution.
Ben Chaplin is managing director of Taxwise