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Salary Sacrifice

The basics:

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.

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. 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.

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.

Tax and NICs:

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.

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. 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.

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.

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

Earnings related payments

Employers usually decide how earnings related payments such as occupational pension contributions, overtime rates, pay rises, etc are calculated. Such payments can be based on the notional salary or the new reduced cash salary, but this must be made clear to the employee.

Earnings related benefits

Salary sacrifice can affect an employee’s entitlement to earnings related benefits such as Maternity Allowance and Additional State Pension. The amount they receive may be less than the full standard rate or they may lose the entitlement altogether.

Contribution based benefits

Salary sacrifice may affect an employee’s entitlement to contribution based benefits such as Incapacity Benefit and State Pension. Salary sacrifice may reduce the cash earnings on which NICs are charged. Employees may therefore pay – or be treated as paying – less or no NICs.

Statutory payments

Salary sacrifice can affect the amount of statutory pay an employee receives. It can cause some employees to lose their entitlement altogether. If a salary sacrifice arrangement reduces an employee’s average weekly earnings below the lower earnings limit, then the employer doesn’t have to make any statutory payments to them.

Workplace pension schemes

The employer decides whether salary sacrifice affects contributions into a workplace pension scheme. Often, employers will use a notional level of pay to calculate employer and employee pension contributions, so that employees who participate in salary sacrifice arrangements are not put at a disadvantage.
However, employers should always check with their scheme provider to make sure any such arrangements are allowable. Other salary sacrifice arrangements are possible. For example, an employer might agree to pay more than the minimum amount required, to cover some or all of the employee’s contribution. The employee may then become entitled to a lower cash salary.

Auto-enrolment

Where an employee has been automatically enrolled into a workplace pension scheme, it will be a registered pension scheme for tax purposes. No tax is charged on the contributions an employer pays to a registered pension scheme in respect of an employee.
Where an employee opts out of a workplace pension scheme, it is possible that they will have received reduced earnings under the salary sacrifice arrangement. If the employer ‘makes good’ that shortfall to the employee then the payment should be made subject to tax and NICs.

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