Introduction »

VAT’s the problem?

Salary sacrifice arrangements are where an employee agrees to their salary being reduced by a specific amount and the employee then becomes entitled to something instead of that salary. Often, the ‘something instead’ is a tax free benefit, such as employer pension contributions or childcare vouchers.

This means that the employee saves income tax and national insurance contributions (NIC) on the amount converted into a tax free benefit and the employer saves NIC so everyone gains.

Sacrifice in practice

When entering a salary sacrifice arrangement to replace part of cash pay with a benefit that is tax and/or NIC free, it is essential for employees to understand what the sacrifice will mean in practical terms. Salary is being reduced for all purposes, so employees should carefully consider the effect that a reduction in their pay may have on issues such as:

• their future right to the original (higher) cash salary
• any pension scheme being contributed to
  
• entitlement to Working or Child Tax Credit
• entitlement to state pension or other benefits, such as Statutory Maternity Pay.

Is VAT a consideration?

A recent court case has altered the VAT position in relation to salary sacrifice schemes. The case concerned the correct VAT treatment of high street shopping vouchers provided to employees as one of the options of the scheme.

The court found that the provision of vouchers amounted to a supply of services for consideration and, as a consequence, whilst the company was able to recover the VAT incurred on acquiring the vouchers, output tax was due on the consideration received from its employees.

Although this case was concerned with the supply of vouchers to employees, the principles apply to other supplies of goods and services to employees.

HMRC have previously accepted that the reduction in the salary did not constitute consideration for the benefits received and output tax was not due. This was the position even though employers were able to recover the related VAT as input tax, subject to the normal rules.

The new VAT position

Businesses providing benefits under salary sacrifice schemes must now account for output VAT on these supplies where they are subject to VAT. In order to allow businesses time to make the necessary adjustments, HMRC will not require output tax to be accounted for on taxable benefits provided under salary sacrifice schemes until 1 January 2012.

In most cases the value of the benefit for VAT purposes will be the same as the amount of salary deducted or the amount foregone under a salary sacrifice arrangement. Where this is less than the true value (e.g. where an employer supplies the benefits at below what it cost to buy them in), the value should be based on the cost to the employer.

If your business operates any salary sacrifice arrangements, please do get in touch to discuss the implications for your business.

Introduction »