Is paying VAT on benefits worth the salary sacrifice?

Wednesday, August 24, 2011 | Posted by: Graham Brearley
Categories: Business advice, Tax, Thought Leadership | Tags: tax, HMRC, income tax, VAT, NIC, salary sacrifice, national insurance contributions, National Insurance, childcare vouchers, Cycle to Work, AstraZeneca, employee benefits, VAT liability, ECJ, vouchers, European Court

That’s the question employers will be weighing up following the recent AstraZeneca (AZ) case ruling that raises the possibility of substantial VAT liabilities on employee benefits, such as retail vouchers, meals and Cycle to Work Scheme (CWS) rentals. How will the balance of payments fall? Senior VAT Manager Graham Brearley reviews the issue and asks: ‘Is this the end for salary sacrifice arrangements?’

I can remember when salary sacrifice schemes were first introduced, employees were a little sceptical and suspicious. The notion of giving up some salary when you had worked so hard for it seemed strange. It was only when the whole thing was explained with diagrams and calculations that attitudes began to mellow.

What is a salary sacrifice scheme and how does it work?
In simple terms, the employer provides a benefit (or benefits) to the employee and, in return, the employee gives up part of their salary. The benefit of doing it this way is that the employer saves National Insurance contributions (NIC), and the employee saves both NIC and income tax as the amount sacrificed no longer forms part of the salary. In terms of the direct tax consequences, it was a ‘win-win’ for all concerned.

AstraZeneca’s VAT problem
The range of benefits available under salary sacrifice arrangements has expanded over the years, and in the case of AZ, high street retail vouchers were provided.

Although AZ’s arrangement saved the requisite NIC and income tax, the company created a VAT problem by trying to argue that it was entitled to the best of both worlds: an input tax claim on the purchase of the vouchers, but no output tax liability on their provision to the employees.

The European Court of Justice (ECJ) could not accept that proposition. Last year it confirmed that because the vouchers had been purchased for a business purpose, AZ was indeed entitled to reclaim the VAT charged to it when they had been purchased from a third party.

But the ECJ added that the company should also have been accounting for VAT on the amount of salary given up by the employees in return for the vouchers. In other words, the amount sacrificed by each employee had to be treated as the payment for the vouchers – just as if they had been purchased in a shop.

Despite the victory, the case created a problem for HM Revenue & Customs (HMRC) because it had always drawn a distinction between deductions from salary (made after income tax and NIC had been paid) and salary sacrifices. HMRC had collected VAT on the former, but not on the latter, even though it could be argued that they were just different means of making payment.

Finally a solution…
It has taken HMRC a year to consider the repercussions of the decision and finally conclude that, with effect from 1 January 2012, it can no longer treat deductions and sacrifices differently. 

From that date, all salary sacrifices will be treated as consideration or payment for the underlying benefit. That means that the employer will have to account for output tax where the benefit is:

• liable to VAT (such as in the case of retail vouchers, meals or assets provided under arrangements such as CWS rentals)
• the employer can reclaim input tax (subject to the normal rules).

If the salary sacrificed is less than the cost to the employer of providing the benefit, the employer will have to account for VAT on the cost to him. The revised policy will not affect benefits that are provided free of charge to all employees.

Where the underlying benefit is not subject to VAT, such as in the case of childcare vouchers, the employer will not have to account for the tax on the amount ‘paid’ by the employee. Employers should note that HMRC may expect to see a restriction on any administration or ‘overhead’ VAT incurred in providing those sorts of benefits.

The end of salary sacrifice schemes?
Although this change of policy is a significant development, it does not necessarily mean the end of salary sacrifice schemes. In the case of vouchers, for example, there may be little difference (if any at all) between their purchase and ‘selling’ price. The position may therefore be VAT-neutral if the amount incurred on the purchase is the same as, or similar to, the amount due on the sale.

That will not be so in respect of all benefits, however, and where the policy change creates an overall liability in any particular case, the employer will need to make decisions about the scheme.

For example, will any VAT liability simply be borne by the employer? Or will it be passed on to the employees? If the latter, there may have to be significant changes to how the scheme works. What about the VAT incurred on the costs of running the scheme?

Although 1 January 2012 may seem a long way off, specialist advice should be sought sooner rather than later to ensure that any existing or planned arrangements continue to be tax-efficient beyond that date.

For further information and help on VAT issues, please visit our VAT and Indirect Taxes page.

Image: © Dave McLear

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