Making sense of the salary sacrifice review

As announced in the Budget of March 2016, HM Revenue & Customs has launched a consultation paper to examine the use of salary sacrifice for the provision of benefits in kind.

While the closing date is 19 October 2016, the consultation is likely to lead to a reduction in the types of benefits that could be offered through this tax-efficient arrangement.

What is salary sacrifice?

Before expanding further on the HMRC consultation, it is worth establishing the basics of salary sacrifice – who the beneficiaries are, why it is so popular in the workplace, and how the system works.

In the words of HMRC itself: “A salary sacrifice arrangement is an agreement between an employer and an employee to change the terms of the employment contract to reduce the employee’s entitlement to cash pay. This sacrifice of cash entitlement is usually made in return for some form of non-cash benefit.”

It seems the government has taken the view there are benefits being structured through salary sacrifice that do not actively form part of any policy

In practice, this arrangement often allows employers to purchase goods and services in bulk and offer them to staff at a reduced price paid from their gross salary.

While the reduced price is appealing, the main benefit is the saving of income tax and National Insurance Contributions (NICs) for both the employee and employer.

Salary sacrifice was purposely introduced as a vehicle for employee pension contributions, childcare vouchers and cycle-to-work schemes.

More recently, it has become the deduction method for a wider range of employee benefits, from the more traditional dental insurance and critical illness through to mobile phones, laptops and other technology items.

It is this broadening of the scheme that has caught the Treasury’s attention, leading to a review.

Case study

To illustrate the advantages of salary sacrifice, let us take a look at how this applies to pensions. The example in the table below shows how the taxes differ for the employer and employee in three scenarios: (A) there are no pension contributions, (B) the contributions are paid from the net salary, and (C) the contributions are paid through salary sacrifice.

We chose for this case study someone earning £30,000 a year, assuming they have a standard tax-free allowance of £11,000, and contribute 5 per cent of their salary to their company pension scheme.

The employer matches their contribution by paying in the same amount. All values below are monthly.

Employee