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New VAT regime triggers rethink of salary sacrifice employee benefit schemes

Having secured status as one of the most popular options for employers and employees to tailor remuneration packages, salary sacrifice may come under pressure, with forthcoming changes to VAT legislation, says Lorna McCaa (pictured).

From 1 January 2012, employers will be obliged to account for VAT on the provision of employee benefits that attract VAT, increasing the cost of providing such benefits.

A salary sacrifice arrangement is an agreement between an employer and employee to reduce the employee's gross salary, usually in exchange for a non-cash benefit. In certain circumstances, such arrangements can offer valuable income tax and national insurance contributions savings. In practice, the benefits may include childcare vouchers, employer pension contributions, car parking, gym membership or retail vouchers.

Following a European Court judgement, the value added tax position relating to salary sacrifice arrangements is changing.

At present, salary sacrifice arrangements are treated as outside the scope of VAT. This means an employer does not need to account for VAT on benefits provided under a salary sacrifice arrangement. Generally, the employer will be able to reclaim any VAT incurred in the provision of such benefits under normal VAT recovery principles. From January, employers must account for VAT on the provision of benefits that attract VAT. For example, an employer will incur VAT in purchasing retail vouchers and, in providing these to employees, will be required to account for VAT. This could mean an additional cost to many employers .

Ahead of the changes, employers must consider whether benefits provided under a salary sacrifice arrangement attract VAT. If so, there will be a VAT cost. The question is whether the employer will absorb this cost – or will the scheme have to be altered to, in effect, put this cost on to the employee? The employer's real cost of the scheme may differ significantly after the new regime is in place and this cost may even threaten to outweigh the perceived benefits in offering particular salary sacrifice arrangements.

If the benefit provided by an employer to an employee attracts VAT, the employer should, as currently, be able to recover VAT incurred in the provision of such benefit. However, if the benefit provided does not attract VAT, under the new system, the employer may not be able to recover VAT in providing the benefit.

While employer pension contributions and childcare vouchers do not attract VAT, where the employer has incurred VAT in providing such benefits, for example relating to administration fees, they may not be able to recover the VAT incurred from 1 January 2012. Previously, employers would usually have been able to recover such VAT.

For salary sacrifice schemes signed or otherwise agreed on or before 27 July 2011 and which extend beyond 31 December 2011, HM Revenue & Customs will allow the benefits provided under those schemes to continue to be made free of VAT, until the earliest of the following dates:

  • the date that a fixed term agreement expires or the fixed number of salary sacrifice payments specified within the agreement is completed;
  • the date of an employee's annual salary or benefits review; and
  • the date of any other review or renegotiation that leads to a change in the provision of benefits under a salary sacrifice scheme or to a change in an employment contract.

These 'grandfathering' provisions will, it is hoped, allow employers some time to alter their arrangements, if necessary, to take the VAT changes into account.

The popularity of salary sacrifice arrangements is unlikely to recede, despite the forthcoming changes. In particular, arrangements involving childcare vouchers, where income tax and NIC savings are available, and employer pension contributions, where NICs savings are available, should still be attractive. Crucially, neither of these benefits attracts VAT. In the run-up to the changes, employers operating salary sacrifice arrangements should review their current schemes to ensure they are prepared for the implications of the new regime and potential additional VAT costs. Employers should also consider adopting preventive measures, which would make the transition to the new regime as seamless and cost-effective as possible.

Lorna McCaa (pictured) is an associate in the tax department at Maclay Murray & Spens