In summary
For some, salary sacrificing for flex seems a little too good to be true, with warnings abound of the government eventually closing this ‘loophole’ which reduces tax and NI liabilities. This has led to fears of becoming reliant on the tax break and then losing it. Allowing staff to take benefits such as bicycles and mobile phone from their gross pay is a great perk, but beware of falling foul of minimum wage rules, and make sure staff know the impact it may have on other benefits, such as maternity pay and state pensions. Case study: HBOS
Article in full
Most things that seem too good to be true normally are. This is one of the main reasons why employers and staff may harbour reservations about offering salary sacrifice through a flexible benefits scheme. The salary sacrifice mechanism used by some flex schemes allows employees to opt for a lower contractual salary in return for the equivalent value in benefits. This enables staff to gain from a reduction in income tax and NI charges of up to 33%, or 41% if the benefits themselves are not liable for tax or NI. Employers can also save up to 12.8% NI on gross salary sacrificed. Some therefore conclude that the practice will inevitably become a victim of the Treasury’s current preoccupation with clamping down on tax avoidance.
Annika Haslett, flexible benefits adviser at Gissings Advisory Services, says: "The biggest potential pitfall is for employers to become reliant on ongoing NI savings to fund the administration of flex schemes and then one day to find that this is [being] taken away for the future. As more and more companies move to flex, the Chancellor might clamp down on salary sacrifice." Other experts, however, feel there is a fuss being made about nothing. Among these is Andy Lister, head of employee benefits at The Grass Roots Group, a provider and administrator of salary sacrifice schemes. "All the Inland Revenue is concerned about with salary sacrifice is that employees have given up the right to some pay, otherwise it is entirely an employment issue.
I don’t believe that it is something the Chancellor could do anything about, even if he wanted to, because to change employment law would require a change in primary legislation. Even then, it couldn’t be done because any employee is free to agree their salary level with their employer as long as they observe the national minimum wage." This line of thinking is confirmed by an Inland Revenue spokesperson, who says: "Salary sacrifice relates to employment law and is a matter between the employer and employee. It is the outcome of such arrangements that often has tax or NI consequences." But such statements are not satisfying everyone and it is possible that the "loophole" could be closed without interfering with employment law.
Alastair Kendrick, director of PAYE and NI solutions at Ernst & Young, says: "I wouldn’t rule out the government having a go at salary sacrifice despite what it says. It may just say you are free to reduce your salary but that for taxation purposes it won’t count if it feels it has been done to reduce the tax bill." Even if this happened it would not necessarily make flex an unattractive proposition. A scheme’s ability to communicate the full extent of the benefits package to staff and to create goodwill by empowering employees to pick and mix from a range of competitive options should not be underestimated. Helen Freeman, principal at Towers Perrin, says: "Employers may be able to get better terms from providers via flex than via voluntary schemes because providers have a more reliable annual income. With insured benefits some have also had better claims experience via flex. Communications around flex also tend to be better as there is a new communications programme at least every year."
Even without salary sacrifice, flexible benefits schemes can still be an attractive proposition for organisations. "Furthermore, the fact that most employers have a get-out clause in their communications material saying that terms are subject to current Inland Revenue rules also protects them against such a change," adds Freeman. Employees are unlikely to be seriously inconvenienced either, because past tax changes have allowed them to retain benefits to which they are already committed.
The Grass Roots Group’s Lister explains: "This was the stance taken with profit-related pay schemes in the late 1990s and there was plenty of notice given. Computers, which have a three year tie-in, are the only flexible benefits to commit you for more than a year and they are unlikely to be withdrawn until the government has achieved its objectives." Smaller tweaks to taxation laws should be taken care of by the fact that schemes typically allow members to change their flex choices once a year or in response to a life-changing event. From April, for example, childcare vouchers, which currently offer NI savings on unlimited amounts but no income tax relief at all, will provide both NI and tax relief on up to £50 a week.
Many organisations are therefore allowing employees to have a lifestyle event to coincide with this new tax regime to help those who wish to alter their arrangements. Some employers also fear that flex plans are too good to be true in their ability to offer mobile phones. These have been tax-free since 1999 but only actually available via flex since the July 2004 launch of Flexphone, a joint venture between accountancy firm BDO Stoy Hayward and Isis Telecommunications. Unlike tax-efficient benefits such as pensions, computers and bicycles, this has no link with government strategy. Shawn Healy, senior tax manager at BDO Stoy Hayward, says: "People doubt mobile phones because there is no government department supporting us. But the pre-1999 tax system was scrapped because it was felt to be impractical. It led to a lot of administrative hassle for employers and employees, was virtually impossible to check from a compliance point of view, and the Revenue was collecting very little tax from it."
Ernst & Young’s Kendrick, disagrees: " I don’t believe the Revenue could possibly challenge the law as it is at present but there is no doubt that tax inspectors I’ve discussed this with do regard it as an abuse of the system. It’s against the spirit of the tax exemption which was given on the assumption that mobile phones would be used for business purposes, but they are basically being used as consumer products. In the long-term therefore the Revenue could seek to clamp down on this, especially if mobiles really catch on as a flexible benefit."
Most other potential downsides of offering salary sacrifice should be avoidable by allowing a decent window before launch, taking suitable advice, and communicating effectively with employees. Catherine Redmond, head of benefits at Barclays, says: "Tax inspectors won’t actually give you formal approval before the launch of a scheme but it is important to engage with them in advance. If you are offering home PCs it is also advisable to get expert help to ensure you are compliant with the requirements of the Consumer Credit Act and you may need to allow time to get exemptions from the Office of Fair Trading."
All arrangements should be structured as a reduction in salary rather than a deduction, which means that staff actually give up their right to salary. Employers must ensure that they put agreements in writing and spell out what will happen should staff take leave of any kind. Other possible pitfalls include complications for low earners as a result of having technically reduced their income. Earnings must not fall below the national minimum wage (currently £4.85 per hour – for adults) and when NI contributions fall below £4,745 (£4,888 after April 5th) it can affect entitlements to certain state benefits such as statutory maternity pay and statutory sick pay. If no preventative action is taken, earnings levels can also have an effect on death-in-service benefits and, for staff in a defined benefit scheme, on pension entitlements because both are calculated in relation to the size of employees’ salaries.
Mike Ashton, principal in human capital at Deloitte, says: "Problems can be avoided by incorporating a salary reference point, which an adviser should mention. But a reference point cannot be used for calculating the maximum pension benefits permitted from a company scheme, although only a minority of people are affected because most are below this limit anyway. Some employees may decide that it’s cost-effective to take salary sacrifice because they want a computer or a bicycle and to accept a hit on their pension. But it is important that employees are actually aware of the situation, so it’s primarily a communication issue."
What is NI or tax free? Free of tax and NI (within limits)
• Childcare vouchers (up to £50 pw) • Home PC plan (up to £500 pa) • Pension (up to approved limits) • Health screening • Approved life assurance • Holiday purchase • Group income protection • Bicycles • Mobile phones Free of employees’ NI • Private medical insurance • Critical illness insurance • Dental insurance • Personal accident insurance • Travel insurance • Cinema tickets • Wine club Tax and NI payable • Cash taken in place of benefits • Retail vouchers CASE STUDY As all of HBOS‘s 65,000 UK employees are eligible for its flexible benefits scheme there are inevitably a proportion who could find themselves vulnerable to some of the potential pitfalls. But Jacqui Anderson, manager (flex and affinity), emphasises that the key to avoiding this problem is communication. "It’s important to use a range of different media and we use everything from booklets and the internet to line manager’s meetings and editorial in company newsletters. The diversity of methods ensures that all types of workers are catered for. We don’t use the term salary sacrifice in communication but typically refer to flexing and we tend to use diagrams giving pictorial representations of how it works." She adds that HBOS’ communication approach is vindicated by the fact that nearly half of its employees choose to vary their package from the norm.