By David Hewison, Tax Director, Smith & Williamson
As an entrepreneur or owner of a growing business you will always be looking for ways to cut costs. With your wage bill likely to be the biggest drain on your resources, salary sacrifice can be an attractive way to reduce it.
Salary sacrifice is a contractual agreement between employer and employee. It adjusts the mix of salary and benefits in kind provided in an employee reward package. If taxable salary is replaced with one or more exempt benefits in kind – like childcare vouchers – the employee avoids tax and national insurance contributions (NIC) on the salary exchanged, and the employer avoids NIC on the same amount.
The employer’s NIC saving is 13.8% of the salary converted into tax exempt benefits in kind. The rate at which employees save tax and NIC varies according to total annual income and employed earnings, but if tax exempt benefits in kind are involved, the range is currently between 32% and 62% (the top effective rate of tax for people with income between £100,000 to £114,950).
Employer pension contributions (into a registered scheme) are probably the most familiar ‘vehicle’ through which salary sacrifice savings are achieved. This is actually an example of a benefit substitute that achieves NIC savings alone (12% or 2% for the employee, depending on salary level, and 13.8% for the employer) as tax relief is already given on the pension contributions themselves.
Benefits such as qualifying childcare vouchers, providing a mobile phone or settling congestion charges for an employee who commutes using a company car all produce the full tax and NIC savings described above.
Choose benefits in kind carefully
It’s important to choose which benefits in kind your business offers because some produce no savings at all. For instance, a choice of benefits in kind in the form of vouchers that can be exchanged by the employee for goods, services or cash (unless an exempt non-cash voucher or credit token), are fully liable for tax and NIC however paid and neither employer nor employee ends up better off (unless the vouchers are purchased at a discount to face value).
However when used in a salary sacrifice arrangement certain benefits in kind that are subject to an income tax charge can still be given in a tax efficient manner, provided they are not specifically brought within the charge to Class 1 NIC. In these circumstances, the employee’s net position is improved as there would be no employee’s NIC due on the amount sacrificed (an example of an applicable benefit would be private medical insurance provided through a contract with the employer). Apart from administration costs there would be no additional costs for the employer as the amount of employer’s NIC due would remain unchanged.
In conclusion, putting a salary sacrifice arrangement in place can save money for both you and your employees. As usual there are pitfalls for the unwary so select your benefits carefully and take advice to design and implement your arrangements.
To discover how you could be making savings in your business using salary sacrifice arrangements, call David Hewison on 020 7131 4215 or email firstname.lastname@example.org
Watch the video below featuring Nick Wallis and Sarah Winter of Smith & Williamson on how share schemes are also tax-efficient ways to reward and motivate your staff.