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Flexible rewards
Salary sacrifice; cafeteria payroll; bespoke remuneration - they all mean pretty much the same thing: some kind of arrangement whereby cash remuneration is replaced with a range of benefits from which employees select on a “mix and match” basis. With tax (and particularly NIC rates) increasing across the board, and with pressure on remuneration costs, replacing cash with one of the range of tax-free or tax-favoured benefits can make a good deal of sense both in terms of increasing the value of an employee’s package at little or no cost to the employer and in enhancing employee motivation. In this note we take a look at some tax-efficient benefits which may feature in flexible reward schemes and some practicalities of implementing a scheme.
Why do it?
Allowing an employee to pick the benefits that he or she wants rather than the ones which you’ve chosen may increase commitment, motivation and generally build employee loyalty. Replacing cash with a tax-free benefit allows your remuneration budget to go further. And even where a benefit is taxable, an employer may carry more weight with a supplier and be able to buy benefits at a price which is not available to individual employees.
What benefits are tax-free?
A surprising number of benefits are free of tax, subject in some cases to the fulfilment of further conditions. We’ve listed just a few below:
- Childcare: The provision of childcare by employers (or the provision of vouchers exchangeable for childcare) is free of tax and NIC (though the interaction of tax, NIC and the byzantine Working Family Tax Credit need to be considered at some levels of remuneration)
- Death in service cover: Life cover can be a welcome reassurance for employees with dependants: it’s not a taxable benefit
- Help to disabled employees: employers can pay commuting costs of certain disabled employees tax-free, or even provide an adapted car in some circumstances
- Eyesight tests and medical check-ups: tax-free if (broadly speaking) offered to all employees
- Holidays: not often considered as a benefit, but the fact remains that if an employee agrees to trade in part of his salary for additional days off – perhaps because he or she has responsibility for dependants – this is in effect a tax-free way of remunerating employees
- Loans: although in principle a tax is due where loans are made to employees, there is a de minimis limit of £5,000 below which no charge arises. The facility is often used for season ticket loans, but the exemption is not restricted in this way.
- Meals: the rule here is that tax is not charged on meals or other refreshments provided on the employer’s premises provided that (broadly) provision extends to all employees
- Mobile phones: this exemption still exists, regardless of the extent of business or private use of the phone.
- Pension contributions: subject to the new rules for “high earners” (and subject to the general rules limiting the amount of “pension input”) topping up an employee’s pension fund is tax-free
- Suggestion schemes: where employee suggestions can be demonstrated to lead to quantifiable financial benefit, awards of up to £5,000 per year can be exempt from tax
- Training: it will be very unusual for an employee to obtain tax relief on the cost of course which he himself pays for, regardless of how closely the course is related to the work he does. By contrast, where an employer pays for training which is “work-related” in the widest sense, it will often be tax-free even where the connection with the current employment is tenuous. For the ambitious employee, assistance with getting some qualification or skill to which he or she aspires but which is not strictly necessary to the job can be hugely motivational as well as very tax-efficient
What are the financial benefits?
Take childcare, for example. Assume an employee is spending £50 per week on after-school care for her child. This will have to be financed out of after-tax income. Typically, to get £50 net after payment of all tax and NIC the employee will need to earn about £72 (which will cost the employer some £81 gross after adding on employers’ NIC). By contrast, if the employer gives vouchers for the childcare, there will be no tax or NIC: the cost to the employer will be just £50 - a weekly saving of £31 for the employer to use as he will to share with the employee or pass on in full, as he wishes. Note that we have assumed here that the level of income is such that payment of Working Family Tax Credit is not affected by the provision of childcare.
How does it work?
In smaller businesses, it may simply be a matter of consulting with individual employees and agreeing individual packages of cash and benefits. In larger businesses, more formal systems may be appropriate, typically involving the attribution of “points” to each of a range of benefits (including cash) and inviting employees to choose from a menu.
Anything else to look out for?
HMRC’s approach to restructuring a cash remuneration package into a more tax-efficient mix of cash and benefits is surprisingly and refreshingly relaxed. Provided there is a genuine variation of the employment contract (as distinct from, for example, an arrangement which the employee may unilaterally reverse at any time so as to reinstate the original cash salary) HMRC accept that the restructuring has the required effect.
Other issues which may arise in connection with flexible reward schemes include:
- Credit status: In theory, the lower cash salary may constrain the extent to which an employee can borrow. In practice, it seems that most lenders have been prepared to look at the value of the package as a whole (to the extent that in the past lenders have looked at income at all: the position nowadays may be less certain!)
- National minimum wage: Generally, non-cash benefits do not count when working out national minimum wage: so at the margins, care must be taken to check that replacing cash with benefits does not drop the employee’s income below the level of the national minimum wage.
- Overtime, sick pay and percentage increases: Will these be computed by reference to the (reduced) cash pay or the value of the package? Often it will be possible to agree a “notional salary” which will apply for these purposes. Happily, HMRC do not normally object to this, agreeing that “The use of the reference or notional salary does not invalidate the salary sacrifice. If the employment contract has been effectively varied that is conclusive for the employee's entitlement to basic salary/wages and benefits. The employer and employee may agree pay for other purposes. Overtime, holidays, sick pay on whatever basis they choose.”
- Pensions: For employer-funded schemes a notional salary, as above, can be agreed. For state benefits which depend upon levels of income (such as pension, maternity pay and so on) there may be an impact in some cases which would need to be individually considered.
As always, for more information and to see if flexible rewards might work for your business please get in touch with your usual contact partner.
