Business tax – guidance

Salary sacrifice and the effects on PAYE

A salary sacrifice might be made in return for non-cash benefits and can affect the tax and National Insurance contributions (NICs) payable.

The basics

A salary sacrifice arrangement is an agreement between an employer and an employee to change the terms of the employment contract to reduce the employee’s entitlement to cash pay. This sacrifice of cash entitlement is usually made in return for some form of non-cash benefit.

Salary sacrifice can be financially beneficial for both employer and employee. For example, when part of an employee’s remuneration shifts from cash, on which tax and NICs are due, to non-cash benefits that are wholly or partially exempt.

A salary sacrifice arrangement can’t reduce an employee’s cash earnings below the National Minimum Wage rates.

Salary sacrifice – tax and NICs

The impact on tax and NICs payable for any employee will depend on the pay and non-cash benefits that make up the salary sacrifice arrangement. Your key responsibility as an employer is to make sure that you pay and deduct the right amount of tax and NICs for the cash and benefits you provide.

For the cash component, that means operating the PAYE system correctly through your payroll.

For any non-cash benefits, it means checking the tax and NICs rules that apply and implementing them correctly.

Reporting requirements for non-cash benefits

Reporting requirements for many non-cash benefits are different to those for cash earnings. In general, benefits must be reported to HM Revenue and Customs (HMRC) at the end of the tax year using forms P11D or P9D.

Tax and NICs exemptions on non-cash benefits

Some non-cash benefits qualify for an exemption from tax. Some may be disregarded before calculating NICs. If this is the case for a benefit you’re providing to an employee as part of a salary sacrifice arrangement, you must satisfy any conditions that apply to the exemption.

For example, if a benefit has to be made available to all of your employees in order to be exempt, then this condition must be fully satisfied, whether or not all employees have a salary sacrifice arrangement with you.

Ask HMRC to confirm the tax and NICs

Once a salary sacrifice arrangement is in place, you can ask the HMRC Clearances Team to confirm the tax and NICs implications. HMRC won’t comment on a proposed salary sacrifice arrangement before it has been put in place.

HMRC Clearances Team
Alexander House
21 Victoria Avenue
Southend-on-Sea
Essex
SS99 1BD

Alternatively you can email the HMRC Clearances Team.

To be satisfied that the change has been effective at the right time and not applied retrospectively, HMRC would need to see:

  • evidence of the variation of terms and conditions (if there is a written contract)
  • payslips before and after the variation

Changing the terms of a salary sacrifice arrangement

If your employee wants to opt in or out of a salary sacrifice arrangement, you’ll have to alter their contract with each change. The employee’s contract must be clear on what their cash and non-cash entitlements are at any given time.

It may be necessary to change the terms of a salary sacrifice arrangement where a ‘lifestyle change’ significantly alters an employee’s financial circumstances. Examples include marriage, divorce, or an employee’s spouse or partner becoming redundant or pregnant. Salary sacrifice arrangements can allow opting in or out in the event of lifestyle changes like these.

If an employee can swap between cash earnings and a non-cash benefit whenever they like, it’s not a salary sacrifice. In these circumstances, any expected tax and NICs advantages under a salary sacrifice arrangement won’t apply.

Examples of salary sacrifice

Salary Salary sacrificed Non cash benefit received Consequence
£350 per week £50 of that salary Childcare voucher to the same value Only £300 is subject to tax and NICs, childcare vouchers are exempt from both tax and Class 1 NICs up to a limit of £55 per week
£350 per week £100 of that salary Childcare vouchers to the same value £295 is subject to tax and NICs, childcare vouchers are exempt from both tax and Class 1 NICs up to a limit of £55 per week
£5,000 bonus £5,000 £5,000 employer contribution to registered pension scheme No employment income tax or NICs charge to the employee - the full amount is invested in the pension fund

You usually decide how earnings related payments such as occupational pension contributions, overtime rates, pay rises, etc are calculated. Such payments can be based on the notional salary or the new reduced cash salary, but this must be made clear to the employee.

Statutory payments and salary sacrifice

Salary sacrifice can affect the amount of statutory pay an employee receives. It can cause some employees to lose their entitlement altogether. If a salary sacrifice arrangement reduces an employee’s average weekly earnings below the lower earnings limit, then you won’t be required to make any statutory payments to them.