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HMRC internal manual

Employment Income Manual

Employment income: flexible benefit plans: contractual reduction in gross pay


As EIM01140 suggests, the first point to look at in relation to a flexible benefit plan is: do the arrangements amount to a reduction in the amount of the cash pay that the employee is contractually entitled to receive?

If the answer to that question is yes, the employer need only operate PAYE, and account for NICs, on the reduced contractual pay. The benefits in kind that the employee receives will be taxed as earnings within Section 62, or treated as earnings under the benefits code, as appropriate (see EIM01142). From 6 April 2000 employers have been required to account for Class 1A NICs on most benefits in kind.

If the answer is no, the employer should continue to operate PAYE, and account for Class 1 NICs, on the original gross pay. The amount deducted from the employee’s net pay in respect of the benefits is simply an amount “made good” by the employee which will be taken into account in calculating the cash equivalent of the benefits (see EIM21120).

So how do you know if there has been an effective reduction in the employee’s contractual pay? There is guidance on dealing with “salary sacrifice” arrangements at EIM42750 onwards.

Whether or not there has been an effective salary sacrifice (as distinct from a deduction from the employee’s gross pay) depends on the nature of the agreement between the parties. This is a question of contract law, not tax law. In order to decide the point you will need to obtain a copy of all the relevant documentation, including:

  • the employee’s contract of employment as it appeared both before and after the employee entered the scheme
  • the scheme documentation, and in particular any “options” form which the employee is required to complete
  • a copy of an employee’s payslip for a month before, and a month after, the employee entered the scheme.