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HMRC internal manual

Employment Income Manual

Salary sacrifice: income tax effects of salary sacrifice

Section 62 ITEPA 2003

From 6 April 2017, the Income Tax and NICs advantages where benefits in kind are provided through salary sacrifice arrangements (described in the Finance Act 2017 as “optional remuneration arrangements”) are largely withdrawn. Guidance on optional remuneration arrangements from 6 April 2017 starts at EIM44000.

Transitional provisions apply for a limited period. For further details see EIM44030.

Certain benefits in kind are excluded from the changes. For further details see EIM44130.

For an explanation of what is a salary sacrifice, see EIM42750.

For a summary of the conditions that have to be met for a salary sacrifice to be successful, see EIM42760.

If the employment contract is varied effectively (see EIM42753), the employee is liable to income tax and NICs on the elements of the new remuneration package:

  • the lower cash salary/wage is earnings within the meaning provided by section 62 ITEPA 2003
  • if any non-cash benefits are provided to the employee the cash equivalent is charged to income tax under the benefits code .

In many salary sacrifice arrangements the benefit is likely to be wholly or partly exempt from income tax and/or NIC. This is the incentive for entering into the arrangement for both employee and employer

If a salary sacrifice is not successful the employee continues to be liable under Section 62 on the higher level of cash remuneration he previously received, with no cash equivalent under the benefits code. In this case the true construction of what has happened is that the employee continues to be entitled to the higher level of cash remuneration. The employee has merely asked the employer to apply part of that cash remuneration on the employee’s behalf. For an example of the tax effect of a salary sacrifice that is not effective see EIM42786.

For an example of the tax effect of a successful salary sacrifice see EIM42785.

Heaton v Bell

Some benefits are partly or wholly exempt from charge to income tax chargeable under the benefits code. However, if the employee is able to give up the benefit at any time and revert to the original (higher) cash salary, the benefit itself comes within Section 62 following the principle established in Heaton v Bell (46TC211)(see EIM00570). The easy convertibility of the benefit to cash was regarded as giving rise to “money’s worth”. The doctrine of “money’s worth” evolved through case law but was written into the definition of earnings in Section 62(2) and (3) ITEPA 2003. It is possible for an employee to receive a benefit that is exempt from income tax under the benefits code but for a charge to arise on earnings because the terms of the employment contract allow the benefit to be given up and the former, higher level of salary/wages to be re-instated.

The benefits listed below are not chargeable to income tax. This is much wider than simply being exempt under the benefits code. In these cases no charge under the earnings rules can arise:

  • Workplace car parking - Section 237 ITEPA 2003 - see EIM01030
  • Provision of cycles and cyclist’s safety equipment - Section 244 ITEPA 2003 - see EIM21664
  • Childcare vouchers - Section 270A ITEPA 2003 - see EIM16057
  • Workplace nurseries - Section 318 ITEPA 2003 - see EIM21905
  • Other Childcare - Section 318A ITEPA 2003 - see EIM21990
  • Employer made contributions under a registered pension scheme - see EIM42775