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What is a salary sacrifice arrangement
12 May 16 | By: Jas Jhooty
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.
Salary sacrifice can be financially beneficial for both employer and employee. For example, when part of an employee’s remuneration shifts from cash – on which tax and National Insurance contributions (NICs) are due – to non-cash benefits that are wholly or partially exempt.
A salary sacrifice arrangement can’t reduce an employee’s cash earnings below the National Minimum Wage rates.
Changing the terms of a salary sacrifice arrangement
If an employee wants to opt in or out of a salary sacrifice arrangement, employers must alter their contract with each change. The employee’s contract must be clear on what their cash and non-cash entitlements are at any given time.
It may be necessary to change the terms of a salary sacrifice arrangement where a ‘lifestyle change’ significantly alters an employee’s financial circumstances. Examples include marriage, divorce, or an employee’s spouse or partner becoming redundant or pregnant. Salary sacrifice arrangements can allow opting in or out in the event of lifestyle changes like these.
As a general rule, if an employee can swap between cash earnings and a non-cash benefit whenever they like, any expected tax and NICs advantages under a salary sacrifice arrangement won’t apply. There are some exceptions, please read Employment Income Manual 42755 for more information.
Tax and NICs
The impact on tax and NICs payable for any employee will depend on the pay and non-cash benefits that make up the salary sacrifice arrangement. An employer’s key responsibility is to make sure that they pay and deduct the right amount of tax and NICs for the cash and benefits they provide.
For the cash component, that means operating the PAYE system correctly through their payroll. For any non-cash benefits, it means checking the tax and NICs rules that apply and implementing them correctly.
Employers’ reporting requirements for non-cash benefits
Reporting requirements for many non-cash benefits are different to those for cash earnings. In general, benefits must be reported to HM Revenue and Customs (HMRC) at the end of the tax year using forms P11D or P9D.
Tax and NICs exemptions on non-cash benefits
Some non-cash benefits qualify for an exemption from tax. Some may be disregarded before calculating NICs. If this is the case for a benefit an employer provides to an employee as part of a salary sacrifice arrangement, any conditions that apply to the exemption must be satisfied.
For example, if a benefit has to be made available to all employees in order to be exempt, then this condition must be fully satisfied, whether or not all employees have a salary sacrifice arrangement.
Guidance for employers on particular expenses and benefits is available.
Ask HMRC to confirm the tax and NICs
Once a salary sacrifice arrangement is in place, employers can ask the HMRC Clearances Team to confirm the tax and NICs implications. HMRC won’t comment on a proposed salary sacrifice arrangement before it has been put in place.
HMRC Clearances Team
21 Victoria Avenue
Alternatively they can email the HMRC Clearances Team at firstname.lastname@example.org
To be satisfied that the change has been effective at the right time and not applied retrospectively, HMRC would need to see:
- evidence of the variation of terms and conditions (if there is a written contract)
- payslips before and after the variation
However there are some disadvantages to entering into a salary sacrifice arrangement:
- If employers are providing their employees with life cover, this is usually worked out as a multiple of the employee’s salary. Employers may provide less life cover if employees sacrifice some of their salary.
- Employees’ lowered salary may affect the amount of money they are able to borrow for a mortgage. Mortgage lenders usually calculate how much employees can borrow as a multiple of their salary, although employers may agree to state the employee’s original salary when they supply a mortgage reference.
- Employees entitlement to certain State benefits, such as Statutory Maternity Pay (SMP) may be affected if their salary falls below the level at which they pay NICs.
How emTax can help
emTax consultants have extensive experience of reviewing existing salary sacrifice arrangements and have prepared successful submissions to HMRC to obtain tax clearance for them. This is definitely an area that will be looked at closely at your next Employer Compliance Review.
We can first of all review your current salary sacrifice arrangements and advise on their effectiveness as well as making suggestions on how to improve on any areas of weakness we discover.
We can then contact HMRC on your behalf to ensure that HMRC agrees the salary sacrifice is fully effective. Any submissions we make to HMRC will be carefully managed on the basis of full disclosure (i.e. cards face up on the table), to completely safeguard you against any future inspections by HMRC.
If you are interested in this or any other employment tax service, please do not hesitate to contact us.