There are some seminal moments in the design of reward policies. Some might say we are in the midst of one of those defining moments now as we roll out of auto-enrolment to small employers, but we (if not the government) are celebrating the tenth anniversary of an equally important development: the explosion in salary sacrifice. It was in 2005 that the government introduced a new tax and NI relief for employer-supported childcare.
At the time they believed that employers would offer parents childcare support in addition to their reward package, completely missing the point that to be fair to employees who were not parents this had to be delivered via salary sacrifice. Until that point salary sacrifice as a concept was pretty much the preserve of well-advised wealthy individuals wanting to bump up their pension saving whilst saving both tax and NI. Suddenly in 2005 even the smallest employer woke up to the fact that reconstructing an employee’s contract and reward package could deliver significant savings for both parties. But even after ten years, salary sacrifice is still widely misunderstood, and given that it ought to be centre stage again as part of the delivery of auto-enrolment, what are the tips and traps?
There are two key concepts embedded in salary sacrifice: is the sacrifice effective and is it successful?
- A sacrifice is effective only if the employee has given up the right to the cash part of their reward package before it is made available to them, and in its place the employer provides a benefit in kind.
- It is successful if the benefit attracts a more beneficial tax and/or NI treatment than the cash would have done.
So let’s unpick those two statements…..
For cash to be given up the employee needs to have a new permanent contractual right to the lower cash salary. In exchange that salary is used by the employer for them to provide a benefit in kind. HMRC will expect there to be an audit trail in place that proves that the contract variation has taken place and that a benefit has been provided instead. If the sacrifice is shown on the employee’s payslip as a net pay deduction that will immediately undermine the notion that the employee has a right to less salary.
They have in fact received their full salary and are apportioning some of their salary to purchase a benefit, in such case tax and NI is due on the original salary, no sacrifice has taken place. The sacrifice if shown on the payslip and most employers wish to do this, must be shown on the additions side of the payslip as a negative adjustment.
A successful sacrifice s trying to achieve some tax and NI savings. It therefore follows that for that to happen the benefit that is provided must be subject to tax or Ni relief or both. For example, the growth of salary sacrifice after 2005 was for the most part due to the first £243 per month of employer-supported childcare being free of tax and NI (both employer and employee). Some employers operate salary sacrifice for taxable benefits such as medical insurance. This will be the case where the employer cannot fully fund the benefit.
Rather than simply providing that it can be purchased as a net pay deduction post tax and NI, the employer asks the employee to sacrifice the same amount pre-tax but this costs them up to 45% less in tax depending upon their marginal rate and saves them up to 12% NI and the employer 13.8% NI. At year end the insurance is reported on the P11D so the tax is paid in a later tax year, the employee NI is saved and the employer pays the 13.8% class 1A NICs after year end i.e. later than the Class 1 NI on the employee’s salary.
But it is the interaction with statutory payments that causes most angst for employers given the unpredictable nature of the cost burden. Once a contract has been varied the employer must continue to provide the benefit for the:
- The whole statutory leave period, both paid and unpaid, in the case of all non-cash benefits apart from pensions. For example, childcare vouchers, company cars, health insurance
- To the end of the paid statutory leave period for pensions. Pension contributions (that is the enhanced employer contributions if via a sacrifice as there are no employee contributions) must be based on the pre-leave pay
Since April 2015 and the advent of shared parental pay and leave it is even more difficult to quantify this potential cost as both male and female employees may take such leave.