Salary exchange or sacrifice arrangements enable employees to give up salary in return for benefits-in-kind that are often subject to more favourable tax treatment than salary.
In the 2015 Summer Budget, the Chancellor had requested the Office of Tax Simplification to examine the case for closer alignment of income tax and NI. The OTS had responded with proposals to reform National Insurance and align it with income tax, reporting that under the current system the way in which income tax and NI contributions were treated in respect of employee pension contributions were 'misaligned'.
So it was with anticipation that we waited to see if salary exchange would be ‘sacrificed’, with concerns that restrictions would be levied on both future and even existing arrangements. However, this popular way of offering benefits to employees survived the March 2016 Budget, although HMRC have commented that it remains concerned about the growth of salary exchange schemes, noting that clearance requests for salary exchange arrangements from employers to HMRC have increased by over 30% since 2010.
The Treasury also confirmed that it was considering limiting the range of benefits that attract income tax and NICs advantages when they are provided as part of salary exchange schemes, caveating that pension saving, childcare and health-related benefits should continue to benefit from income tax and NICs relief when provided through salary exchange arrangements. In a Budget that condemned sugar in soft drinks, you would hope that health-related benefits such as cycle to work would be retained; for now it does remain business as usual for salary exchange arrangements, but we cannot rule out changes in the future.
HMRC provide detailed guidance providing practical advice and examples on a wide range of issues relating to salary exchange, not least that a salary exchange arrangement cannot reduce an employee's cash earnings below the National Minimum Wage. So one thing that could affect existing salary exchange arrangements, from 1 April 2016, is the introduction of the new National Living Wage for the over 25s.
There are now five levels of minimum wage:
- The Adult Rate – applicable to 21-24 year olds
- The Youth Development Rate - 18-20 year olds
- The 16-17 Year Old Rate
- The Apprentice Rate
- From April 2016, workers aged 25 and over will be entitled to the National Living Wage
The National living Wage was introduced on a different cycle to the other rates – changing in April rather than October. Following a review, the government has concluded that the rates for all workers should be aligned in April next year. Rates from April and the six-month rate from October 2017 are as follows:
Whilst payroll providers/departments should have updated records to reflect the new levels of minimum pay, it is important to remember that whilst an employee can contribute 100% of their earnings into a pension, when using salary exchange employers are not able to reduce income to below the minimum wage, which from 1 April 2016 includes the new National Living Wage.
Other considerations There are some additional considerations required for those members looking at new salary exchange arrangements. From 6 April 2016 there is a new term called ‘relevant salary sacrifice arrangements’. These will cover salary exchange arrangements set up on or after 9 July 2015, and are to reflect the new tapering annual allowance that will affect higher earners.
From 6 April 2016, individuals who have income for a tax year of greater than £150,000 will have their annual allowance for that tax year restricted. The income definition will not be the same as taxable income, but will include the value of pension savings; this is known as adjusted income. The definition of adjusted income includes the value of employer contributions. The inclusion of employer contributions ensures any new salary exchange arrangements set up after 9 July 2015 are not used to reduce ‘income’ for the tapering test below £150,000.
Whilst the Pensions Regulator has confirmed the requirements for minimum employer and employee contributions, the company can elect to contribute the whole minimum contribution. Therefore, schemes that operate under salary exchange (where contributions are shown as company contributions only) with a minimum contribution can still qualify.
However, whilst employers do not need the consent of an employee to enrol them into a pension scheme, it is still illegal to sign up an employee to salary exchange without the employee’s consent. Therefore, when an employer reaches their staging date, they cannot automatically enrol employees into a salary exchange pension scheme without consent. Care is also needed to ensure that the communication of salary exchange information is separate to that of the information concerning automatic enrolment.
So salary exchange has survived for now but, as always, care and attention needs to be taken when any new arrangement or changes to an existing arrangement are put in place.