Executive summary:
• Using tax and National Insurance (NI) breaks available on the provision of benefits can save employers money and help to improve cash flow. It is especially pertinent as NI is due to rise by 0.5% for both employees and employers in April 2011.
• The first most obvious way to make benefits more tax efficient is to use salary sacrifice. The benefit likely to yield the most savings through salary sacrifice is pensions.
• The next significant benefit to consider for tax savings is the company car. From April 2009, the taxation of vehicles will be based on their level of emissions. Salary sacrifice can also be employed to provide the benefit of a company car.
• Another useful benefit is the possibility of buying additional holiday. It simply means that the employer will not pay the employee for the additional days he is off, thus saving both that salary and NI.
• Salary sacrifice can also be used to fund a range of different benefits including childcare vouchers and insured benefits such as private medical insurance (PMI).
Main article:
As businesses look to pare back their costs in the recession, squeezing value out of the employee benefits package is paramount. Using tax and national insurance (NI) breaks available on the provision of benefits can save employers money and help to improve cash flow. It is especially pertinent as NI is due to rise by 0.5% for employees and employers in April 2011.
“For a typical employer, between 30% and 50% of operating costs relate to employment,” says Shawn Healy, employment tax director at BDO Stoy Hayward. “Once firms have made people redundant and reduced the workforce to the bare minimum needed to function, they will look elsewhere to make cost savings. But there are areas with potential to make savings.”
Inez Anderson, director of employment, tax and incentives at Smith & Williamson, agrees. “Historically, the cost of remuneration is one of the biggest expenses for an employer. But typically, the finance team has not really thought about how it can reduce its costs in this area.”
She says that on one hand, employers need to pay people what they appreciate, otherwise they will move – and the employer incurs the cost of additional recruitment and training. On the other hand, it is important to provide benefits in the most cost-effective way possible. She adds, “Employers want to save rather than cut jobs. If they provide rewards more tax-effectively, they can retain more jobs.”
The first, most obvious, way to make benefits more tax efficient is to use salary sacrifice. Effectively, it means that employees give up a portion of salary before tax in exchange for a non-taxable benefit of the equivalent monetary value. As a result, the employee pays no tax or NI contribution (NIC) on that part of the salary presented as a benefit, and the organisation saves the employer’s NI and, depending on the benefit, will also enjoy corporate tax relief.
The benefit likely to yield the most savings through salary sacrifice is pensions. The employee gives up entitlement to part of the salary that they previously contributed to their pension, while the employer increases the level of its contribution to compensate. For example, where the employer takes over the employee’s 5% contribution, the employer saves up to 12.8% in NIC on that 5% of salary. Multiply that by the number of scheme members and a large employer could make attractive savings. (See box opposite for how this works).
However, in setting up a pensions salary sacrifice arrangement there are one or two conditions needed around pensions schemes to make it viable. There are also certain general conditions set by HMRC for all salary sacrifice schemes. The pension schemes must be HMRC-registered, what used to be known as ‘approved’ schemes. It is really only worth doing on large schemes. Mike Moore, a director at Deloitte, recommends a minimum of 500 scheme members, otherwise it becomes too expensive to administer. Generally, pensions salary sacrifice is not recommended for anyone within three years of retirement, especially on a final salary or defined benefit scheme where the final pension depends on the level of salary in the last few years.
There are complications around the combination of pensions salary sacrifice and maternity leave, following changes to sex discrimination legislation. Employers must provide the same non-cash contractual benefits to all women on maternity leave – whether additional or ordinary leave. Some experts question whether pensions count as a cash benefit under these circumstances, but if they do, pensions salary sacrifice on extended maternity leave could prove expensive for employers.
Employees need to ensure that they do not exceed the maximum contributions to pensions schemes on which tax relief can be obtained. Currently the limits are £235,000 per annum, and a lifetime allowance of £1.65m. Punitive tax rates apply should those limits be breached.
“Any employer that hasn’t looked at pension salary sacrifice really should stop and ask why,” says Anderson. She points out that the wording of local government pension schemes makes them unsuitable for pensions salary sacrifice arrangements. Nevertheless, some local authorities are asking for it to be looked into in the hope of making use of it.
HMRC’s conditions that apply to all salary sacrifice arrangements include the need for the salary to be sacrificed before the benefit is given. For example, where employees are typically entitled to one-twelfth of their annual salary monthly in arrears, the salary must be sacrificed before the first working day of the month in which the arrangement begins. The arrangement cannot allow the employee to revert back to the pre-sacrifice gross salary at any time they choose. Usually the arrangement is made for a minimum of 12 months.
Another condition is that the minimum wage must not be breached as a result of the arrangement. The current minimums are £5.73 an hour for workers over 21 and £4.77 for 18 to 21 year olds. Obviously, employees cannot sacrifice all of their salaries. For NIC purposes, they may want to receive at least the minimum level of cash salary for class 1 NI – £5,435 pa – as breaching that level could affect benefits such as the state second pension. Also, employees also need to be aware of the impact of salary sacrifice on any entitlement they have to tax credits.
The next significant benefit to consider for tax savings is the company car. In an effort to promote green policies, the government has been adjusting the tax regime around cars for some time now. From April 2009, the taxation of vehicles will be based on their level of emissions.
Where the employer owns its own fleet, for cars with emissions of 110g of CO2 per km or less, the employer will be able to claim corporate tax relief on the full depreciation in the value of the car for the first year. However, while there are some 110g/km models available as company cars, very few are suitable. Dan Rees, business car consultant at Deloitte, suggests the Blue Motion Volkswagen, for example.
For cars emitting between 110g and 160g/km, there is corporate tax relief on 20% of the car’s depreciation value every year during the life of the car, while the relief on the depreciation of cars above 160g/km is only 10% per annum. Clearly, the tax regime is set around ensuring that the lowest emission cars are the most attractive tax-wise, and they can represent a significant cash flow advantage to employers.
Under the old regime, cars costing over £12,000 – effectively the 160g/km plus models – could have relief of 20% per annum capped at £3,000. As Rees points out, the removal of the cap can work in an employer’s favour. A car priced at £30,000 with emissions between 110g and 160g/km has a capital allowance of £6,000 in the first year and £4,800 in the second. That’s well above the £3,000 cap of the old regime. Cars already on the books do not change their status overnight, but after April 2009, once the fleet changes the new tax regime applies. So an employer renewing its fleet in September 2009 while ignoring the 160g/km threshold could then suddenly find its costs dramatically increased.
However, most experts question whether car ownership represents good value for employers in the current climate. Rees suggests that in most circumstances, it is more cost-effective for employers to lease cars from specialist firms for their employees. Instead, he says that the focus should be on the whole life cost of the car – all the financing costs, VAT recovery, fuel, insurance and maintenance costs need to be considered. “You can have two cars with the same leasing or rental costs, but completely different whole-of-life costs,” says Rees. He adds that while HR departments can be wary of reducing the value of the benefit of a company car, it is possible to lower emissions while still providing employees with the kind of car that they want.
Worth the sacrifice
Salary sacrifice can also be employed to provide the benefit of a company car. However, Rees says that employers should set up schemes so that the cost to the company is effectively nil. The sacrifice should cover the cost of the post tax, discounted whole-of-life cost of the car with some money retained to cover any additional costs. He points out that in the current climate non-company car holders are likely to own older models or be buying a newer model on credit – which is a much less attractive arrangement in times of economic squeeze. With car manufacturers struggling to shift stock, good discounts are available, which can mean healthy savings for employees, making cars a more attractive recruitment and retention tool than ever before.
Another useful benefit is the possibility of buying additional holiday. It simply means that the employer will not pay the employee for the additional days he is off, thus saving both that salary and NI. Ultimately, it depends on the type of work and workforce. “If you make widgets and you need a certain number of people on the production line, you’ll need to manage when people take holiday,” says Moore. “So for some employers, having people away for additional days could mean a loss of revenue.”
However, as Anderson says, in the current climate, more companies are looking to encourage employees to take a salary cut, and the ability to buy extra holiday can be one way to achieve this. “Large employers are asking people to volunteer to take sabbaticals or work fewer days. They give up salary and take the time off, so there’s no tax and NI and they’re not being paid a salary.” She adds with a note of caution that it needs to be carefully decided with an agreement drawn up between the employer and employee beforehand.
Of course, the usefulness and popularity of some benefits depends on the age, demography and location of the workforce, as well as the type of work they do. Salary sacrifice can also be used to fund a range of different benefits including childcare vouchers, and insured benefits such as private medical insurance (PMI). The vouchers will prove popular only among employees with nursery-age children. They are worth £55 a week, and can be used to pay only registered child minders. However, should the employer choose to provide, manage and fund an in-house nursery, there is no cap on the amount of salary that can be sacrificed.
PMI is likely to be more popular among older employees. Even company cars may not prove as popular among some workers as a cycle-to-work scheme or some other method of transport. John Whiting, tax partner at PricewaterhouseCoopers says that while one employee may value a company car, his colleague who lives in central London and relies on the tube does not need a car. “It won’t be an attractive benefit for him. The employer needs to look at the delivery of benefits and ensure they work. Why waste money giving both employees a car?”†
Healy says that the use of salary sacrifice is again on the increase. “It was becoming very popular until the home computer initiative was withdrawn which caused employers to shy away from salary sacrifice based arrangements, but the current economic is generating interest anew”. Currently, the use of salary sacrifice to provide free or subsidised food to employees is under HMRC scrutiny. “It has to be available to all employees, and a proper sacrifice in advance of salary,” says Whiting, “not just handing over a meal voucher.”
However, Moore says that while it appears that tax breaks are under review, HMRC is not minded to change things. “It will police salary sacrifice arrangements, so there’s a greater emphasis on compliance. If a scheme is not implemented or maintained properly, the Revenue will investigate and tax accordingly,” he says. “Provided the arrangements comply with its rules, there should not be a problem.”
For more information on total reward please visit: www.employeebenefits.co.uk
†