Salary Sacrifice and Optional Remuneration Arrangements

Salary sacrifice schemes allow employees to give up part of their cash salary in exchange for non-cash benefits, which can reduce both Income Tax and National Insurance contributions. However, rules introduced in April 2017 changed how most benefits are taxed under these arrangements, meaning employers must now calculate the taxable value differently for most benefits. Understanding these optional remuneration arrangement rules is essential if you're considering offering or operating salary sacrifice schemes.

What is salary sacrifice?

A salary sacrifice arrangement is an agreement where you reduce an employee's entitlement to cash pay in return for a non-cash benefit. You set this up by changing the terms of your employee's employment contract, and your employee must agree to the change.

Each time an employee wants to opt in or out of a salary sacrifice arrangement, you must alter their contract. The contract must be clear on what their cash and non-cash entitlements are at any given time.

National Minimum Wage protection

A salary sacrifice arrangement must not reduce an employee's cash earnings below National Minimum Wage rates. You must put procedures in place to cap salary sacrifice deductions and ensure NMW rates are maintained.

Optional remuneration arrangements: the 2017 rule change

From 6 April 2017, the rules changed for how benefits provided through salary sacrifice are valued for tax purposes. These are called optional remuneration arrangements.

Under these rules, when an employee gives up salary or cash pay in return for a benefit, the value of the benefit treated as earnings from employment is the greater of:

• The amount of salary or cash pay given up by the employee
• The value of the benefit under the normal benefit-in-kind rules

This means that even if a benefit would normally be valued at a lower amount, if the employee has sacrificed more salary, they'll be taxed on the higher amount sacrificed.

Example: An employer provides an employee with private medical insurance that costs £500. The employee gives up salary of £600. The taxable amount is £600 (the greater of £500 and £600). If the employee then makes good £50, this reduces the taxable amount to £550.

Transitional protection for pre-April 2017 arrangements

If an employee entered into a salary sacrifice arrangement before 6 April 2017, transitional rules applied. These arrangements continued under the old benefit valuation rules until the earlier of:

• Variation, renewal or modification of the arrangement
• 6 April 2018

For certain benefits (cars with emissions over 75g CO2/km, living accommodation and school fees), protection lasted until the earlier of:

• Variation, renewal or modification of the arrangement
• 6 April 2021

Exempt benefits: what still qualifies for tax advantages

The optional remuneration arrangement rules do not apply to certain benefits. You do not need to value and report to HMRC:

• Payments into pension schemes
• Employer-provided pensions advice
• Workplace nurseries
• Childcare vouchers and directly contracted employer-provided childcare that started on or before 4 October 2018
• Bicycles and cycling safety equipment (including cycle to work schemes)

These benefits retain their tax and National Insurance exemptions even when provided through salary sacrifice.

Special rules for company cars

The rules differ depending on the car's emissions:

Low emission cars (75g CO2/km or less)

The optional remuneration arrangement rules do not apply to cars with CO2 emissions of 75 grams per kilometre or less. These cars continue to be taxed on the cash equivalent worked out under normal rules, without comparing to the salary foregone.

Example: An employee gives up £1,800 per year salary for a car with CO2 emissions of 70g/km. The car has a list price of £11,500 and a cash equivalent value of £1,495. The taxable amount is £1,495, not the £1,800 sacrificed.

Higher emission cars (over 75g CO2/km)

Cars with emissions over 75g/km are covered by optional remuneration arrangement rules. You must compare:

• The modified cash equivalent of the benefit (calculated under normal rules but ignoring capital contributions and payments for private use)
• The amount foregone

The taxable amount is the greater of these two figures.

Changing salary sacrifice arrangements

You may need to change the terms of a salary sacrifice arrangement where a lifestyle change significantly alters an employee's financial circumstances, such as:

• Changes arising from coronavirus (COVID-19)
• Marriage
• Divorce
• Partner becoming redundant or pregnant

As a general rule, if an employee can swap between cash earnings and a non-cash benefit whenever they like, the expected tax and National Insurance advantages will not apply. There are limited exceptions to this.

Impact on statutory payments and benefits

Salary sacrifice can affect various payments and entitlements:

Statutory payments

Salary sacrifice can affect the amount of statutory pay an employee receives. If it reduces an employee's average weekly earnings below the lower earnings limit, you don't have to make any statutory payments to them.

Earnings-related benefits

Salary sacrifice can affect entitlement to earnings-related benefits such as Maternity Allowance and Additional State Pension. The amount received may be less than the full standard rate, or employees may lose entitlement altogether.

Contribution-based benefits

Salary sacrifice may affect entitlement to contribution-based benefits such as Incapacity Benefit and State Pension, as it reduces the cash earnings on which National Insurance contributions are charged.

Workplace pension schemes

You decide whether salary sacrifice affects contributions into a workplace pension scheme. Often, employers use a notional level of pay to calculate employer and employee pension contributions, so employees participating in salary sacrifice arrangements are not disadvantaged. However, you should check with your scheme provider to ensure any such arrangements are allowable.

Reporting and paying

You need to pay and deduct the correct amount of tax and National Insurance for the cash and benefits you provide. For the cash component, operate the PAYE system correctly through your payroll. For non-cash benefits, reporting requirements differ from those for cash earnings, so check HMRC guidance on reporting and paying expenses and benefits.

Sources

• Optional remuneration arrangements (480: Appendix 12)
• Salary sacrifice for employers

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.