Salary sacrifice - unlocking tax and NIC savings for you and your employees

Salary sacrifice arrangements are nothing new and have been available as a means for financial services organisations to provide certain benefits to their employees whilst generating tax and NIC savings on the amount sacrificed for many years.

However, taking account of recent economic and tax policy trends such as frozen income tax thresholds, cost pressures and the increasing importance of environmental, social and governance (ESG) issues in boardrooms, the incentives have never been greater for financial services organisations to introduce salary sacrifice schemes in the workplace.

How does salary sacrifice work?

Salary sacrifice involves an employee agreeing irrevocably to give up a portion of their gross salary in exchange for receiving a benefit from their employer.

The amount sacrificed is shown as a reduction from gross pay on the employee’s payslip before the calculation of tax and NIC. As a result, the tax and NIC liability in respect of the employee’s remuneration is reduced for both employee and employer in accordance with the marginal rate of tax due on the portion of the salary sacrificed.

For example, an employee earning £80,000 per year agrees to make an annual contribution of £6,000 (£500 per month) in exchange for receiving an electric company car. The employee is a higher rate taxpayer, meaning they will save tax at 40% and NIC at 2% on the contribution made, resulting in a total annual saving of £2,520. This in effect reduces the annual cost of the car to the individual from £6,000 to £3,480 plus the taxable benefit of the company car. Assuming the list price of the car is £50,000, the taxable amount will be £1,000 and tax will be paid in this example of £400 for the year taking the total cost for the employee to £3,880.

Meanwhile, the employer saves NIC at a rate of 15%, reducing their NIC liability by £750 after taking into account the Class 1A NIC due on the benefit-in-kind. This applies to all employees participating in the scheme, so if 100 employees across the business make the same contribution, the total cost saving would be £75,000. There will also be Apprenticeship Levy savings for employers with an annual payroll bill in excess of £3m, resulting in a further 0.5% (£3,000) saving.

What salary sacrifice arrangements qualify for tax and NIC relief?

The appropriate tax and NIC treatment of salary sacrifice arrangements is governed by the Optional Remuneration Arrangements (OpRA) legislation. This carves out exemptions from tax and NIC on contributions made from salary in respect of the following benefits:

• Pensions
• Ultra-low emission vehicles (ULEVs) – These are any vehicles with CO2 emissions of less than 75g/km
• Cycle to work
• Childcare vouchers (where these were provided through salary sacrifice prior to 4 October 2018)

What are the implications of the employer NIC increase announced in the Autumn 2024 Budget for salary sacrifice?

The increase in the rate of employer NIC from 13.8% to 15% means the incentives are now even greater for employers to utilise salary sacrifice arrangements due to an increase in the cost savings available. The increase in the National Minimum Wage (NMW) announced will also result in rising costs for many employers, therefore, it is more important than ever to maximise cost-saving opportunities such as salary sacrifice. We explore this further along with other cost reduction strategies in our article on employee reward.

My workplace already has a pension scheme, so why should we consider introducing salary sacrifice?

Employee contributions to a registered pension scheme will usually qualify for tax relief This is typically achieved in two ways:

• Tax relief via payroll directly, reducing taxable pay at the highest marginal rate
• Through ‘relief at source’ (generally the most popular method of operating employee pension contributions in the UK) – this involves the employee making a contribution from net pay and HMRC issuing a direct tax refund through RTI at 20% of the contribution made directly to the pension scheme. No relief is available for NIC. Employees paying tax at higher marginal rates are then required to reclaim additional relief separately via self-assessment.

Introducing a pension salary sacrifice arrangement therefore carries two key benefits over a ‘relief at source’ scheme:

1. The employer will make a considerable NIC saving on the contributions made of 15%, whilst there will also be NIC relief available for the employee at a rate of either 8% or 2% depending on their level of income.
2. Employees who are higher or additional tax rate taxpayers will not be required to claim additional tax relief through self-assessment. This will instead be administered directly through payroll, thus reducing the administrative burden on the employee and providing larger cost savings upfront.

Are there any other benefits of salary sacrifice other than tax and NIC savings?

The OpRA exemptions are partially designed to incentivise employers to pursue initiatives in line with government policy. For example, introducing a ULEV or cycle to work scheme directly feeds into reducing CO2 emissions and aligning with the company’s ESG strategy, where reporting is now mandated by the government.

From the employee’s perspective, salary sacrifice schemes can help deliver benefits at a lower cost than would otherwise be the case if they were not provided by the employer. For example, the tax and NIC savings available on an electric company car mean the net cost of having this provided through salary sacrifice can be significantly lower than if the same car was purchased or leased directly by the employee.

Are there any risks associated with salary sacrifice arrangements?

Where employees are participating in a salary sacrifice arrangement, employers need to ensure that they consider other areas including the following:

• NMW compliance - the employee cannot sacrifice pay to the extent that they receive less than the National Minimum Wage (currently £12.21 per hour for those 21 or over). Working practices and payroll deductions should also be considered to ensure post-sacrifice pay remains compliant with a workers NMW entitlement.
• Employees receiving any form of statutory pay (e.g. Statutory Sick Pay, Statutory Maternity Pay) cannot have a sacrifice taken from any statutory pay elements they receive.
• How it interacts with other benefits like Life Assurance policies etc.
• Ensuring pension automatic enrolment regulations continue to be adhered to.

The employer’s payroll software will need to be configured to account for the above issues and ensure that reductions are being made and displayed correctly. This includes ensuring that salary sacrifice reductions are captured by an appropriate wage code and presented correctly as a reduction from gross pay on the employee’s payslip (i.e. a negative pay type).

How can our tax specialists help?

Our employment tax team has helped many employers to successfully implement salary sacrifice schemes. We can advise and assist on a range of matters, including:

• Cost modelling to assess the likely tax and NIC savings available.
• Assessing pay rates and evaluating eligibility criteria to enhance participation while ensuring compliance with National Minimum Wage (NMW) regulations.
• Advising on the appropriate scheme rules to deliver the best value to employees and maximise participation.
• Preparing key documentation such as key decisions and governance, employee communications and FAQs
• Payroll set up, including testing outputs.

If you are interested in finding out more, please contact a member of our tax team who can explore the options available to your business where salary sacrifice is concerned.

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