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Law for Business

Knowhow - guidance - precedents

Loch Employment Law , 08 JUN 2014

Salary Sacrifice Schemes

Pam Loch

Managing Partner


Salary Sacrifice Schemes

        What is “Salary Sacrifice”?

        Many organisations are now offering their employees Salary Sacrifice Schemes. The idea behind this is quite simple. You give up part of your salary and, in return, your employer gives you a non-cash benefit that is ideally exempt from tax and National Insurance. However care needs to be taken in setting them up and safeguards should be put in place.

        How does it work?

        The 'sacrifice' is achieved by varying the employee's terms and conditions of employment relating to pay. The most common schemes involve Childcare Vouchers or additional employer pensioncontributions.

        Will I need to make changes to the employee’s contracts of employment?

        Strictly speaking, yes. Employees will probably have a contractual entitlement to their current salary. If it is reduced as part of a salary sacrifice, whether through existing Childcare Vouchers or another benefit, then this amounts to a change in their contractual terms. If this is done without the employees' explicit agreement then this could amount to a breach of contract.

        Employers should ensure that employees are kept fully informed about all aspects of the salary sacrifice and its impact on employees both before and after implementation.

        What is the benefit of salary sacrifice for employers?

        The benefit is in the saving the employer achieves in National Insurance Contributions (NIC). The employer pays NIC on the employees' salaries but not on pension contributions. The higher the salary, the more the employer has to pay in NIC. Reducing the employees' salaries would therefore allow the employer to pay less in NIC. Collectively, across a large workforce, an employer can achieve a substantial saving in NIC.

        What is the benefit of salary sacrifice for employees?

        Like the employer, the employees pay NIC on salary, so the lower their salaries, the lower their NIC will be. This should produce an overall saving for employees. However, when entering a salary sacrifice arrangement to replace part of cash pay with a benefit that is tax and/or NIC exempt, it is essential to understand what the sacrifice will mean in practical terms. Employees should consider carefully the effect, or potential effect, that a reduction in their pay may have on:

          their future right to the original (higher) cash salary;
          any pension scheme being contributed to;

          any insurance policies they may have that have been calculated on the basis of their original salary e.g. life cover, mortgage protection etc.;

          entitlement to Working Tax Credit (WTC) or Child Tax Credit (CTC);

          mortgage applications; or ·entitlement to State Pension or other benefits such as Statutory Maternity Pay (SMP) which are calculated on basis pay.

        When is salary sacrifice effective?

        Salary sacrifice arrangements are effective when the contractual right to cash pay has been reduced.

        For that to happen two conditions have to be met:

        1) The potential future remuneration must be given up; and

        2) Contractually the employee must now been entitled to a lower cash remuneration.

        When is salary sacrifice not effective?

        A salary sacrifice is not effective if, in practice, the arrangement enables the employee to continue to be entitled to the higher level of cash remuneration.

        What is the role of HM Revenue & Customs (HMRC)?

        Salary sacrifice is not tax avoidance; it is tax mitigation and as such is permitted by HMRC. Salary sacrifice arrangements do not have to be approved by or notified to HMRC but it is open to employers to consult HMRC on the correct tax treatment of the arrangements.

        HMRC are careful to point out that the nature of an employee's contract of employment is a matter for the employer and employee. HMRC’s interest therefore is limited to determining how the tax and NIC legislation applies to the various elements in the employee's remuneration package.

        HMRC strongly advises employers and employees who are thinking of entering into these arrangements, to obtain employment law advice on whether their proposed arrangements achieve the desired result.

        Should I speak to an Employment Lawyer before introducing Salary Sacrifice Schemes?

        Yes. Salary Sacrifice Schemes are a matter of employment law, not tax law.

        Where an employee agrees to a salary sacrifice in return for a non-cash benefit, they give up their contractual right to some of their future cash pay in return for the benefit cash remuneration.

        Any salary sacrifice arrangement must be planned and implemented carefully with full communication, and employers should seek detailed financial and legal advice so that they and their employees are fully aware of the benefits and possible pitfalls in advance.

        To find out more about Salary Sacrifice Schemes please feel free to contact us on 01892 773970.

          Pam Loch, Managing Partner of niche employment law practice, Loch Associates Employment Lawyers and Managing Director of HR Advise Me Limited.

          For more information on Loch Associates Employment Lawyers please go to www.lochassociates.co.uk and for HR Advise Me go to www.hradvise.me

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