Two recent cases underscore some key points to remember to operate a "safe" salary sacrifice arrangement.
Case 1 ( Reed Employment Plc v The Commissioners for HM Revenue and Customs - available to download here . )
You should use the case to review your current salary sacrifice arrangements, making sure they are robust, but also consider additional areas where salary sacrifice could now be introduced with confidence.
The recent decision in the First-tier Tribunal (FTT) case of Reed Employment plc (and other Reed Group companies) v The Commissioners for HM Revenue and Customs has now been issued. The case considered the employment tax treatment of a travel and subsistence arrangement that was purported to be a salary sacrifice arrangement. Reed may well appeal against the ruling.
Reed made daily payments to cover lunch and commuting to around 500,000 temporary workers between 1998 and 2006, which they maintained was part of a salary sacrifice arrangement.
The FTT found that the schemes operated did not constitute an effective salary sacrifice arrangement, as in reality no part of the salary was sacrificed. The tribunal judges said “The salary was paid in full, even if there was a later manipulation”.
In addition, it was ruled that the employed temps were engaged under a series of job-by-job contracts rather than under a continuing contract of employment. Each assignment should therefore be treated as a separate engagement, and as a result the travel was therefore to a permanent workplace and the expenses were deemed to be ordinary commuting and non-deductible.
This decision turned on:
- the contractual arrangements in place,
- the clarity of the arrangement in place and
- the fact that a salary sacrifice was found not to exist.
The tax and NIC, along with interest, has been calculated at £158m.
The contractual arrangements were much discussed and show the need to carefully draft a contract of employment and to ensure the terms of the contract are fully understood by all. In the present case there was much made of the fact the employees could not understand their pay calculation.
Comment The starting point for any successful arrangements is a correctly worded, understandable contract of employment which in this kind of an arrangement, to be acceptable to HMRC, should be an overarching contract of employment guaranteeing at least 336 hours.
The position put to the tribunal that a salary sacrifice existed was ultimately rejected partly on the basis of the confusing contractual arrangements in place but comment was also made on the small savings enjoyed by the workers as the arrangement was designed to deliver the bulk of the savings to the employer.
The tribunal took the view that the employee could not understand what was happening to their pay from the payslip and that, in the tribunal view, a sacrifice by an employee should deliver a benefit to the employee.
The tribunal went further to say that this purported sacrifice delivered no or little benefit to the worker and was an arithmetical exercise to deliver the maximum savings to Reed.
Comment In this case the tribunal reasoning that a salary sacrifice must deliver a benefit is potentially challengeable but the arrangement has to be transparent and to be understood and accepted by the employee if it is to be a valid sacrifice. To avoid the view that ‘little or no’ benefit is made by the employee, an equitable sharing of the savings would also be advisable.
In this case the tribunal found that HMRC were entitled to issue a dispensation where they had a belief that no tax was payable (even if they were wrong). However, as they found the expenses paid were a part of the employee’s wages, and there was no salary sacrifice in place, the expenses should have been subject to PAYE and NIC. In addition, they considered the effect if a valid salary sacrifice was found to be in place but took a view that the assignments were all fixed term employments and as such the expense allowance would be taxable; that is, the employee did not travel to temporary workplaces which would attract relief from tax.
Comment When entering into these arrangements it is important not only to consider the contractual arrangements to be put in place but also important to ensure that the arrangement is communicated in a transparent way which demonstrates the worker was in agreement or had all the information to understand the arrangements affecting him/her.
The tribunal did not decide on the “Reed’s legitimate expectation” point as that will be left for any further proceedings at the Upper Tribunal. However, the question they stated to be answered was “Can HMRC be required to apply a dispensation that Reed had a legitimate expectation was in place and covered the allowances paid, even where HMRC had no power to grant a dispensation”. The tribunal commented that as the disclosures made did not provide the full facts to HMRC this helps support HMRC’s contention that Reed had no “legitimate expectation” as it did not fully disclose all relevant matters.
Comment In this kind of arrangement all the facts should be on the table and HMRC and other parties should fully understand the arrangements in place with this being supported by clear employee communications. If this had been the case here it would have aided the case that a legitimate view was held that the dispensation made the payment of expenses exempt from PAYE and NIC even if that dispensation was later found to be wrong.
What should you do next? This case will have possibly have far reaching implications for all employers entering into salary sacrifice arrangements (salary sacrifice arrangements can cover pensions, cars, bicycles, child care vouchers, flexible benefit schemes and many others). We suggest that all these arrangements are reviewed to ensure they are compliant and importantly that the workers fully understand the arrangement they have entered into. The Reed case highlights the pitfalls of getting it wrong. The employment contractual arrangements are also as important as the tax considerations.
I have experience of successfully implementing these arrangements with the agreement of HMRC on a fully disclosed basis. Therefore do not be put off by this case if you are considering implementing a salary sacrifice as they can be implemented successfully. These arrangements can realise considerable savings for both the employer and worker.
Case 2 Astra Zeneca UK Limited (AZUL) v HMRC (the opinion of the Advocate General can be found here )
It seems to me the decision in this case was correct within the meaning of both EC and UK VAT legislation, but it could have a significant cost implication for those employers who have provided discounted retail vouchers to their employees without accounting for output tax over the years.
The decision was important because it confirmed the principle that where an employee gives up part of his cash remuneration in return for a supply of goods or services which in themselves are liable to VAT, this represents a supply by the employer to the employee for a consideration. It means that the employer can recover as input tax the VAT paid on the purchase of the goods or services concerned, but must account for output tax on the cash value of the salary “sacrifice”.
VAT and employee benefits VAT and employee benefits have always been a bone of contention between HMRC and businesses. Over the years, we’ve had potential issues arising from staff discounts and company cars. More recently, things have been more interesting as most large private sector employers have introduced different types of “flexible benefit” remuneration packages that enable employees to choose from a wide range of goods and, mostly, services.
The concept is simple – each employee has a remuneration “pot” which can be taken in form of a basic cash salary and minimum holiday entitlement, or varied to include a smaller cash salary and a range of other benefits, which are usually provided at a discounted “price”. These include various types of insurance, such as medical or dental insurance, childcare vouchers, goods such as bicycles, personal computers and various types of retail vouchers.
The AZUL judgement was very important in that it established, beyond any doubt, how VAT should be applied on transactions between employer and employee.
The facts AZUL provided such retail vouchers as part of their staff remuneration scheme. In the particular case, employees could opt to receive vouchers with a face value of £10, although the cost to the employer was between £9.25 and £9.55, representing a discount of between 4.5% and 7.5% to the employee.
Under normal VAT rules, businesses who buy and sell retail vouchers, can claim the VAT paid on their purchase but must account for output tax when the vouchers are “sold”. The sale of the vouchers is regarded as a supply of services as it entitles the purchaser, in this case the employee, the right to purchase goods for the face value of the voucher from the retailer concerned.
HMRC believed that AZUL could recover as input tax the VAT paid on the purchase of the voucher, but should have accounted for output tax on the supply to its employees. This would basically mean that the correct VAT accounting would be neutral for the company, ie the input tax and output tax would be equal.
What actually happened was that AZUL didn’t do either, but submitted a claim for input tax on the purchase of the vouchers, but didn’t account for output tax, arguing that giving the vouchers to staff weren’t liable to VAT as transactions between employers and employees don’t represent supplies for VAT purposes. Their position was that the provision of the vouchers to the employees meant that the vouchers were used for a business purpose so there was no liability to output tax.. In essence, that giving the vouchers to the staff in return for a salary sacrifice meant that the vouchers were “consumed” by the business and there was no supply to the employee.
The relationship between employer and employee and whether there is a supply for VAT purposes The key issue was that AZUL argued that the provision of employee benefits represented use by the business and therefore there was no liability to output tax. The ECJ judgement – which at just 6 pages is one of the shortest and most readable – dealt with the issue by answering the first in a list of questions which were referred by the Tribunal:
In the circumstances of this case, where an employee is entitled under the terms of his or her contract of employment to op to take part of his or her remuneration as a face value voucher, is Article 2 of the [Sixth Directive} ... to be interpreted such that the provision of that voucher by the employer to the employee constitutes a supply of services for consideration?
Article 2 deals with one of the most fundamental of VAT issues, ie it defines the term “supply” for VAT purposes, while Article 4 of the Directive defines the term “taxable person”.
Based on these fundamental principles, the ECJ had no hesitation in supporting HMRC’s view that the provision of the vouchers in return for a salary sacrifice represented a supply for a consideration which was liable to VAT. The vouchers were not used in the business, but represented a supply of services from AZUL to its employees for their personal use.
What it means for supplies by an employer to an employee AZUL confirms that when it comes to the provision of goods or services for personal use, the employer and employee are treated as separate legal entities.
It doesn't affect the employer/employee relationship in so far as the employee is contracted to provide services, ie whenever an employee enters into a contract of employment, the employee and the employer enter into a relationship whereby in return for a salary, the employee is paid by the employer for providing his time and presence working in the employer’s business. Paid employment is not a business activity, so the salary does not represent consideration for a supply by the employee to the employer.
However, the provision of goods and/or services by the employer to the employee for non-business, i.e. personal, use in return for a proportion of the salary does represent a supply for VAT purposes. Such transactions between the employer and employee are liable to VAT in the same way as transactions between any two separate entities.
The judgement of the ECJ simply confirms HMRC’s longheld viewpoint that wherever a business puts taxable goods or services to non-business use, any consideration that is charged for such use is liable to VAT.
The ruling doesn’t affect the position of those benefits which are either available to all employees for no “charge”, or the VAT treatment of benefits which are “purchased” but are exempt from VAT or zero-rated, such as health insurance or nursery vouchers. But employers are advised to review their employee remuneration packages to see if they have any liability on positive rated supplies made to employees that should be disclosed to HMRC.
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