As well as providing their employees with a salary, many employers wish to offer other benefits-in-kind (BIKs) as a means of further incentivisation or simply out of care for one’s workers.
That benevolence may be a little more affordable if an employee was able to make a contribution by having the cost deducted from their wages; by deducting the cost before tax and lowering the salary subject to income tax and National Insurance contributions (NICs), the employee will enjoy some savings too. If the salary is reduced below £100,000, income tax savings can be even greater with the personal allowance being restored; below £60,000, one’s child benefit might be restored too.
How Did Salary Sacrifice Work?
Before 6 April 2017, the employee would agree to the salary within their employment contract being lowered for at least 12 months (except for pension contributions) and in return, a BIK would be provided, with the employee being subject to income tax (with only NICs for the employer) on its value. Ideally, the BIK will be exempt from income tax, but even if the tax on that BIK is simply less than that of the salary foregone, the exercise was still worthwhile.
A common example of salary sacrifice being employed is with pension contributions; as well as the employer making their contributions directly to the employee’s pension pot, they will pay the employee’s contribution on their behalf after deducting it from their gross salary. As pension contributions are tax-free, the tax saving is given to the employee through the reduction in their taxable salary. Other common examples include provision of extra holiday or childcare vouchers (tax-free), medical or dental insurance and company cars (both taxable).
For example, £1,000 of salary is subject to income tax at (say) 20% (i.e., £200) and NICs at 12% (i.e., £120); if a salary is reduced by £1,000, that tax is saved. If the salary is replaced by £1,000 pension contributions, then equivalent benefit is received, but with no tax.
What Happened in 2017?
Instead of income tax being subject to the (lower) value of the BIK which substituted the salary reduction, HMRC will subject to income tax the higher of the BIK and the sacrificed income; in other words, for income purposes, the benefits are totally negated. The only employee saving now is with the NICs, as that remains unaffected by these changes.
Using the same example as above, if someone signs up for a £1,000 salary reduction in return for a tax-free BIK, the income tax will be on the £1,000 reduction, as that reduction is higher than its replacement (zero). The income tax position will be exactly the same; the only saving remaining intact is the £120 NICs.
An important exception to this change is that if the BIK consists of pension contributions (and advice), provisions of ultra-low emission (i.e., less than 50g/km) company cars, childcare vouchers, workplace childcare, or cycle-to-work bicycles, the pre-2017 regime stays in place. In the example above of pension contributions being given in lieu of £1,000 salary, the income tax savings would still stand.
What are the Pitfalls?
With salary sacrifice, an employee’s contract has been amended, the salary has been reduced and that new figure will appear on someone’s form P60. These documents will be necessary for mortgage and other loan applications; entering salary sacrifice does mean taking an official pay cut with all the consequences involved to one’s lifestyle, as well as benefit or tax credit entitlements.
Any employee should give careful thought as to the consequences of taking a reduction in salary as part of receiving a BIK. Income tax savings are no longer available, except for the provision of a few benefits; the NICs savings may be useful otherwise, but the potential wider consequences to lifestyle changes, loan applications and benefits claims cannot be ignored.