Much has been said in the press, online and in tax circles in recent weeks around VAT changes to salary sacrifice, much of it questioning whether salary sacrifice is still viable for employers. So we thought that it would be useful this month to take stock of where we are with salary sacrifice and consider how things may look going forward and what the practical implications may be for employers and employees.

Q1. What's the big fuss been about in recent weeks on salary sacrifice ?

A: On 28 July, HMRC issued their long awaited views on the VAT implications of salary sacrifice following last year's European Court of Justice case involving Astra Zeneca. Basically this confirms that HMRC will be following the judgement made in the Astra Zeneca case in that normal VAT rules must be followed when employees are paying for employment benefits via salary sacrifice arrangements. In other words, the employer can recover any VAT paid to the benefit supplier but employees must be charged VAT on the payment to the employer (the pay sacrificed).

Q2. When does the new changes come in ?

A: This new rule is effective from 1 January 2012 and applies to all salary sacrifice payments made from this date onwards,  irrespective of whether the arrangement was started before or after 1 January.

Q3. Does it apply to all salary sacrifice schemes ?

A: No, benefits currently exempt from VAT will not be affected, e.g. childcare vouchers or onsite nursery places. However, other face value vouchers and Cycle to Work schemes will be caught and there may also be implications for leased/company car salary sacrifice schemes, certain inhouse benefits and other schemes such as those involving car parking costs. We say MAY here as VAT specialists are still working hard to decipher exactly what is caught and when in these other schemes and so we are cautious about what we say around this until this is bottomed out (reminder - we are not VAT specialists and we are happy for it to remain this way !!)

Q4.Do the VAT changes affect the income tax and National Insurance position ?

A: No, there is still an NI advantage to the employer and the employee, and often PAYE savings as well for the employee, in doing salary sacrifice and these VAT changes do not affect this at all. What it does mean, however,  is that when the new rules are applied, the overall savings of the arrangement will be up to 20% lower compared to the position at the moment as there will be a VAT cost going forward.

Q5. Does this mean that salary sacrifice isn't going to be financially worthwhile ?

A: We still believe that salary sacrifice has "shelf life" and that the savings to both employers and employees will be enough to justify doing it in the vast majority of cases beyond January 2012. However, the change to the VAT position does mean that  it will be even more important for all parties to do the "number crunching" before going ahead as there will be some situations where the VAT cost could virtually wipe out the majority of savings for the employee (assuming that the employer will not be picking up the VAT cost).

This could be particularly problematic for Cycle to Work schemes given that HMRC are now insisting on more realistic pricing for bicycles to be sold on to employees at the end of the hire agreement (including VAT) which is already "eating into" the employee tax/NI savings before the latest VAT change is taken into account.

Some employers may ultimately decide that it is too much hassle to provide bikes, or any other benefit under salary sacrifice  arrangements, if take-up is reduced because the tax advantages are not as attractive. After all, high take-up by employees is normally a pre-requisite for the employer to generate enough NI savings to make it a worthwhile investment of HR and finance resources. So we could see less new schemes going forward and some employers closing down their existing schemes if the financials don't stack up..

Q6. Is HMRC trying to close salary sacrifice down completely ?

A: Not as far as we are aware. It is true that some salary sacrifice arrangements have been closed off by HMRC in recent years, e.g. Home Computers and Staff Canteens, as they were viewed as being too aggressive and outside the spirit of the legislation and we have also seen a much harder stance taken by HMRC on employers who set up the more popular schemes incorrectly. However, in fairness to HMRC, their hands have been pretty tied with the Astra Zeneca ruling and so they are simply following the judgement made by a much higher authority in confirming their views on the VAT side. They could have applied the rules retrospectively to the Astra Zeneca judgement, or to the date their views were finally published, if they had wanted to make life difficult for employers and claw in extra revenues.

Q7. So what are the key issues for employers to be thinking about just now ?

A: For those employers with existing salary sacrifice arrangements they key thing to be sorting out is managing the change to the VAT position on employee payments post 1 January, i.e.

  • Who is going to effectively pay the extra VAT cost ?
  • If the employer, how does this tie in with existing budgets and will lower salary sacrifice savings for the business mean other planned projects may be affected ?
  • If the employee, does the contractual terms allow an increase to the employee's cost mid agreement ? If yes, how will this be managed and communicated to staff ? If no, can something be agreed with employees to share "the pain" in a tax efficient and legal manner ?
  • What other implications need to be considered in meeting VAT payments on behalf of employees , e.g. in terms of P11D reporting, etc ?
  • If salary sacrifice is going to be even more scrutinised by HMRC post 1 January, is the employer satisfied that all other elements of the arrangements would "pass muster" if reviewed by HMRC ?

For those employers planning on starting salary sacrifice after January, it will be key to factor in the VAT rules to any material and documentation used to roll-out the scheme, ensuring that any financial models or examples shown to employees are 100% accurate in terms of savings and the end cost to employees.

Q8. What is Optimum PAYE's key message to employers around these changes ?

A: Quite simply, extreme care MUST be taken by employers when introducing salary sacrifice schemes for the first time or in operating existing arrangements. The complexities around PAYE, National Insurance, employment law and VAT cannot be underplayed and it will be even more important for employers to avoid costly errors once these new VAT rules kick in after 1 January.

We still see some employers either not seeking professional advice at the outset, or completely ignoring arrangements that have been in place for some time. It is almost certain that any employer doing salary sacrifice on a DIY basis now, i.e. without  tax technical support, will be making mistakes which could ultimately prove costly to the business. This will be even more certain once the VAT complexities ramp up in the months ahead.



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