By escalating the use of tax efficient benefits via salary sacrifice schemes, finance directors can make significant cuts to the payroll bill, and in doing so organisations can offer staff a greater array of perks, says Sarah Coles.
Employers are slashing tens of thousands, or even millions of pounds off their payroll through the insightful offering of benefits through salary sacrifice; many can reduce their pay bill by at least 0.5% by offering this facility to staff.
At its most simple, salary sacrifice is where an employee takes a pay cut in return for the employer buying one or more tax-efficient benefits for them. So, for example, an employee on £20,000 per annum may agree to have their salary reduced to £19,000 in return for the employer putting £1,000 of contributions into their pension. The employee profits because while their overall reward package has stayed the same, their national insurance (NI) contributions have fallen by £110, so they gain overall. The employer also wins out because its NI contributions have fallen by £128 a year for each employee in the scheme.
Salary sacrifice works when the tax and NI payable on an employee benefit is less than the tax and NI payable on salary. There are a range of tax-efficient employee benefits that come with tax and/or NI breaks to choose from (see box, page 29). The key point is that the tax and/or NI break kicks in when the employer, rather than the employee, pays for the benefit. So this break already exists on the listed benefits if the organisation currently buys them for staff. Where employers can gain is if they don’t currently offer the benefit on an employer-paid basis, but are prepared to offer them if the employee voluntarily ‘pays’ for them via salary sacrifice.
The most obvious candidate for many organisations, is the pension scheme – where contributions are tax-free. The employee sacrifices a portion of their salary, and their employer makes an equivalent contribution to their pension. The employee saves the tax and the 11% NI contributions they would have paid on that portion of their salary (assuming they’re a basic rate taxpayer), and the employer saves 12.8% of NI.
Because the sums involved in a pension are such a substantial part of the package, the savings can be dramatic too. Philip Smith, a principal at Buck Consultants, says: “The key to making a big cost saving through salary sacrifice is the pension scheme. If you have a big scheme with a high employee contribution you can save a lot of money.” In the above example, for instance, an employer with 500 employees and a £10 million payroll, could save £64,000 a year.
Robust scheme structures
Added together, tax efficient benefits can produce significant savings for employers, who then have a variety of options as to what to do with the difference. Most employers share at least some with their staff, either directly or by funding other employee benefits. They may use it to pay for flexible benefits, or plough it back into the pension scheme to help make up part of a deficit. Gary Hull, director of employment solutions at PriceWaterhouseCoopers, explains: “You can say to all members of staff ‘We will save national insurance and that will put us in a better position to fund the pension scheme’.”
None of this is compulsory: the employer can simply hang on to the savings. However, this has to be done carefully. Employees earning more than the upper earnings limit save just 1% NI contributions, which is hardly attractive, and an unattractive scheme won’t produce savings for anyone. Kendrick points out: “Most give some of the saving back to the employee.”
The right structure is therefore vital, as is careful implementation. Tony Clare, a partner at Deloitte, points out: “A lot of schemes have been put in poorly. If employees haven’t genuinely and knowingly given up salary the Revenue can impose an NI charge anyway. It’s surprisingly common.”
Even if the initial documentation and communication is right, things can go awry. Clare explains: “At the end of the year employers will send our a letter confirming a pay rise that doesn’t account for the salary sacrifice. The Revenue will use that, say it’s ineffective salary sacrifice, and ask for its NI.”
But even the best-assembled scheme will not suit every workforce. Financially unsophisticated staff, for example, may simply view a scheme as an effective pay cut. People in low-pay positions, meanwhile, may not be best served by taking salary sacrifice, because of its effect on perks such as maternity pay or redundancy payments. Clare points out that those close to minimum wage require complex schemes that include enough checks to ensure the wage doesn’t fall below minimum thresholds.
Higher-paid employees meanwhile need to think about the broader implications. Buck Consultant’s Smith says: “Employers almost always keep a shadow previous salary for life insurance reasons, but there’s no guarantees that someone like a mortgage lender will accept a shadow salary, so it can cause problems.”
Alternatively, a scheme may not be right for the company. Alistair Kendrick, a partner with Bourne Business Consultants, explains: “Large corporations are looked at for risk assessment by the Revenue.” Those considered less risky may receive less attention than those perceived to be skating on thin ice. “Finance directors are concerned that this sort of thing may mean they would be considered a risky company by the Revenue, and they would therefore generally take more interest in their affairs.”
These issues mean it’s worth weighing up the pros and cons before you take a leap. One major potential downside, is that the schemes may not last forever. In a shock move in April 2006, the then Chancellor Gordon Brown withdrew the favourable tax breaks on one popular scheme, the home computing initiative (HCI). And proving there’s nothing to stop the government from doing the same for other perks, the pre-Budget report last month removed the NI exemption on holiday pay funds within all sectors, except the construction industry, with effect from 30 October 2007. Chancellor Alistair Darling’s announcement gives the construction industry another five years before they lose this tax-efficient perk. So although these removals were widely expected, most employers using holiday pay funds to cut NI costs were making opportunistic savings knowing that this area has an ever changing landscape.
There are already rumours of a threat to pensions, which some commentators feel could be excluded from salary sacrifice schemes with the introduction of personal accounts in 2012. Smith says: “There’s nothing in the personal accounts legislation that mentions salary sacrifice, but it’s not clear what that means. It’s too uncertain at the moment.”
PricewaterhouseCoopers’ Hull isn’t worried: “There have always been rumours about salary sacrifice coming to an end, but we’re not concerned. The Treasury came out a few years ago saying salary sacrifice for pensions was fine, as long as there were changes to the employee’s terms and conditions. No-one could ever say they will never change the legislation, but it’s difficult to change as salary sacrifice is an employment law concept not an income tax one.”
Clare points out that the Revenue has issued guidelines for how best to implement a salary sacrifice scheme, which would be an odd move if it was intending to close them down.
But commentators agree that the situation is uncertain, so employers should go into salary sacrifice with their eyes open to the risks. Kendrick says “You need to take account of how much it is going to cost to set up and the saving you will make, and value it against the cost of unwinding it if legislative change occurs. If you can make a million in a year and it cost £100,000 to put in, then it might be viable. If it takes too long to pay for itself it’s not worth doing.”
HMRC’s embrace of salary sacrifice
HM Revenue and Customs (HMRC) has given the official seal of approval to a number of tax-efficient benefits for many years now. The pension is one, but there has been burgeoning interest around childcare vouchers, gaining a boost in 2004 when the government ruled that employees could be given £50 a week for childcare free of tax and NI contributions.
The attraction is limited to parents, but given that the average cost of childcare in the UK is £124 a week, employers report take-up among parents is high. PriceWaterhouseCoopers, for example, says 5% of all its staff take the vouchers. Working parents save both tax and NI on the value of the childcare vouchers, while the employer saves £6.40 a week in NI, or £332.80 a year. Assuming you have 1,000 members of staff and a take-up rate of 5%, that’s £16,640 a year. And while it’s minimal compared with the savings available through pension salary sacrifice, it all adds up over time.
HMRC also gives approval for a bicycle leasing scheme. These schemes were introduced by government legislation in 1999, to promote green travel. They allow employers to buy bikes and lease them to staff, tax and NI free. So again, if you want to offer this benefit on a voluntary basis, this can be set up as a monthly salary sacrifice scheme, saving the employer NI contributions.
At the end of the 12-month lease, the employee can buy the bicycle for a nominal fee. These schemes are commonly offered, and Deloitte’s Clare, says they can be, “surprisingly popular, people also tend to buy more expensive models through the scheme too”, so the national insurance savings can be much more than first expected.
A similar scheme allows employers to offer one mobile phone per employee for personal use through salary sacrifice. Flexphone, a provider in this market, claims it can offer an annual saving of £51 for every participant in the scheme, while an employee with a typical monthly tariff can save up to £172 a year. It’s relatively small beer for an employer, and Clare says it’s a niche offering, but will add to the savings pot.
Broader range of tax breaks
Health screening recently hit the headlines in the benefits press due to confusion over its tax efficient status. An amendment to the Income Tax (Exemption of Minor Benefits) Regulations 2002, which came into force on 14 August 2007, stated that health screening must be offered to all employees and must be paid for by the employer in order for tax exemptions to apply – the government would then allow employers to offer a health screening per person per year, tax free. It’s also a useful perk to help highlight health problems that could result in costly sick leave.
To date, many employers have offered this benefit only to senior staff. Under new rules this would now be subject to tax as it’s an exclusive benefit, but by rolling it out to all staff through salary sacrifice it can keep its tax-free status.
Although the holiday pay fund NI break is now gone, another way to reduce tax and NI costs on holiday is to allow staff to buy annual leave. Bourne’s Kendrick, explains: “If you have 25 days and you want 30, the organisation can sell you another five and you take a salary sacrifice. The employer saves national insurance on that.” However, he adds that leave needs to be carefully valued to avoid too many people buying it, causing staff shortages.
Company car schemes are also on the increase. Hull explains:”You can offer low-tax cars with [better] CO2 emissions, and employees pay less tax than on the salary they’ve given up.” This not only constitutes a NI contribution saving for the employer, but, Hull adds: “The employer has the peace of mind that their employees are in a suitable car, helping to control risk.”
Travel schemes are another relatively newly-rediscovered tax break, allowing bus passes to be bought from gross pay. It exploits a clause in the Finance Act 1985, allowing employees tax-free travel on company buses, as long as the journey is no more than 15 miles.
There are also potential tax-boosts for some fairly traditional benefits through salary sacrifice. If you offer a subsidised or free staff restaurant, for example, you can do it tax-free as long as it’s to all staff. Salary sacrifice enables organisations to do this without taking a financial hit.
It can also be used to make staff discounts more tax-effective. Hull explains: “The law says that if something is offered to staff at cost there’s no tax to pay. Some employers will offer a 10% discount, so the employee can reduce their salary to cover the difference, so there’s no tax to pay.”
Similarly it can work with accommodation. “If a member of staff is in accommodation, for example a nurse in a nurses’ home, they could give up some of their salary in exchange for accommodation, and would pay only a small amount of tax on that,” says Hull.
Training costs can also be covered. A number of employers will pay for training and exams if they are essential for the job, but if the employee fails they have to pay for the re-sit out of their after-tax income. Employees can do this through salary sacrifice instead, saving NI contributions.
So the right scheme for the right employer can save a fortune in NI, boost total reward for staff and stay on the right side of the Revenue – for now. So it pays to work out exactly what you have to gain, over what time period, and if you can really afford not to take advantage of salary sacrifice.
- Employers can reduce their pay bill by at least 0.5% by offering tax efficient benefits through a salary sacrifice mechanism.
- Tax efficiencies on benefits apply when the employer, rather than the employee, pays for the benefit. Under salary sacrifice an employee gives up a portion of pay in exchange for an employee receiving a benefit. It saves money when the tax and NI payable on the employee perk is less than the tax and NI payable on salary.
- Beware of not falling foul of HMRC rules when implementing a scheme especially when dealing with staff nearing the national minimum wage. Also check that you are not negatively affecting employees’ tax credits.
- Tax breaks on benefits can be withdrawn at short notice and all are constantly reviewed by HMRC. So balance set-up costs and savings against the cost of unwinding it if legislative change occurs. If you save £1 million in a year and it cost £100,000 to put in, then it might be viable. If it takes too long to pay for itself it’s not worth doing.
Benefits that can be provided through salary sacrifice
- Childcare vouchers
- Mobile phones
- Bicycle leasing
- Health screening
- Car schemes
- Bus travel
- Carbon offsetting
- Staff discounts
- Staff canteens