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HMRC internal manual

Employment Income Manual

HM Revenue & Customs
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The benefits code: cash equivalent of benefits: inhouse benefits: marginal additional expense: Pepper v Hart

Section 204 ITEPA 2003

Sometimes an employer, who sells goods or services in the course of their business, will provide the benefit of those goods or services to their employees free or at a lower price than they are normally sold. This sort of situation was considered in Pepper v Hart.

Pepper v Hart (65TC421)

A number of schoolmasters at Malvern College had their sons educated at the College and paid concessionary fees of no more than 20% of those paid by other parents for their children’s education. The schoolmasters’ sons occupied surplus places and their right to do so was entirely at the College’s discretion.

The education of the children at reduced fees was a benefit to the schoolmasters; the point at issue concerned the amount of that benefit.

The House of Lords held that the expense of providing the benefit of the children’s education was the marginal additional expense of its provision and not, as the Inland Revenue contended, a proper proportion of the full costs of providing an education to all pupils at the College.

In reaching this decision, Lord Browne-Wilkinson distinguished two types of benefit (page472):

  • a kind bought in from outside the employer’s business (“external benefits”), or
  • services or facilities which it is part of the employer’s business to sell to the public (“in- house benefits”).

The cost of an external benefit is normally easy to recognise because the employer has to pay an amount to a third party, for example, to buy medical insurance or purchase a car for an employee.

On the other hand the cost of an in-house benefit is more difficult to quantify because the employer already incurs costs on providing the goods or service to the public and the cost of providing the same service to an employee is only a marginal additional expense. For example, in the case of a school, the fixed costs to the employer of the classroom and teacher are the same whether the class comprises 19 pupils paying full fees, or those 19 plus one child of an employee paying reduced fees. The only additional costs to theemployer are those relating specifically to the extra child, for instance, his books and writing materials.

Consequences of Pepper v Hart

The expense which has to be included in the calculation of the cash equivalent of an in-house benefit under Section 203(2) and Section 204 ITEPA 2003 is the marginal additional expense of providing the benefit. This is the expense that the employer would have saved if the benefit had not been provided to the employee. Note in this connection that where the provision of the benefit involves the supply of goods or materials there will almost invariably be some additional expense. Were it not for the provision of benefit, the provider would have saved the cost of the goods or materials consumed or used by the employees. However where the benefit is the provision of a service there may not be any additional expense. See the examples at EIM21111.

The marginal additional expense principle applies only to the expense of providing the benefit within Section 204. It does not apply to the annual value of an asset where the benefit is the placing of an asset at the employee’s disposal, (EIM21630).