Getting salary sacrifice right

Salary sacrifice arrangements have proved immensely popular with employers and employees. So much so that uptake has far exceeded the Treasury’s expectations. As a result, HMRC scrutinises the paperwork associated with salary sacrifice schemes very carefully and is more than willing to reject submissions that don’t meet strict government criteria. It’s therefore vital that you ensure any benefit schemes based on salary sacrifice will stand up to the taxman’s forensic gaze.

Contracts

The principles of salary sacrifice are well known. An employee agrees to a reduction in salary in return for a benefit. The reduction in wages means that the benefit is effectively subsidised as both the employee and the employer pay less tax and/or national insurance. It’s an arrangement that has been particularly popular in the case of childcare vouchers.

But there are pitfalls. It’s important to remember that it isn’t enough to simply agree a salary cut and offer a benefit in return. To comply with regulations, salary sacrifice must also involve a change in the employee’s contract.

Paperwork

The paperwork surrounding salary sacrifice schemes can also be a source of problems. This may be the fault of the benefit provider. While the scheme itself may be in line with government rules, if the paperwork is not compliant then HMRC will have grounds to reject the submission. In other words, it is vitally important to ensure that your benefit supplier has sufficient experience to produce compliant documentation. If necessary, seek advice.

Internal documentation may also be a problem. As an employer, you will have to describe the scheme and how it operates. Again, if the scheme is compliant yet your own documentation fails to reflect its quality, there could be problems.

Personal allowance

Salary sacrifice – particularly those schemes relating to pension contributions – could be of particular interest to employees facing a reduction in net income due to the introduction of personal allowance cuts for higher paid workers.

From April this year, anyone earning £100,000 a year or more will face a reduction in their personal allowance, a change that will effectively raise the rate at which higher paid workers are taxed. It’s a phased reduction, with £1 of the allowance removed for every £2 of income above £100,000, until it is nil. This gives a marginal tax rate of 60% on income just above £100,000.

For those earning just more than £100,000 it may be very tax-efficient to agree a cut in salary to £100,000 or less and a compensating increase in the employer’s pension contribution.