When it comes to compensating employees, businesses have the option of providing benefits in addition to their regular pay.
Alternatively, employees can choose to participate in a practice known as salary sacrifice, where they agree to receive lower take-home pay in exchange for receiving specific benefits.
To understand the motivation behind salary sacrifice, let’s first examine the tax structure. In the UK, employees typically pay income tax and national insurance contributions (NICs) on their earnings. Basic-rate taxpayers face a 20% income tax and an additional 12% in NICs. On the employer’s side, there is a 14.25% employer’s NICs.
Providing employee benefits offers advantages for both parties involved.
The UK tax authority, HM Revenue and Customs (HMRC), established the P11D tax rules to prevent the abuse of offering non-monetary items instead of regular pay to circumvent taxes. According to these rules, if the value of the benefit exceeds a specific threshold, it is treated as an extension of the employee’s pay and is subject to taxation.
However, one key benefit of employee benefits is that while employees pay income tax on these benefits, they are exempt from national insurance contributions. This means that by providing employees with benefits rather than the equivalent cash, their overall tax liability can be reduced. Employers still have to pay the Class 1A Employer’s National Insurance, which is the same value as the usual Class 1 contribution. So, the tax burden for employers remains unchanged.
This tax advantage encourages both employers and employees to consider salary sacrifice.
Employees can choose to sacrifice a portion of their salary, resulting in lower take-home pay. In return, the employer uses the saved salary amount to provide specific benefits to the employee. By opting for salary sacrifice, employees can save 12% in national insurance contributions on the value of the benefits received.
Employee benefits and salary sacrifice offer a tax-saving opportunity for both employers and employees. By providing benefits instead of additional pay, employees can reduce their national insurance contributions while still paying income tax on the benefits received. Employers can enjoy the advantages of offering benefits without incurring additional national insurance costs. The decision to implement employee benefits or salary sacrifice ultimately depends on the unique circumstances and preferences of both parties involved.