On 1 January 2012, new rules on the VAT treatment of certain benefits provided under salary-sacrifice schemes will come into force.
The changes follow a ruling in the European Court of Justice (ECJ) that, where an employer operates a salary-sacrifice scheme, output tax should be due on the pay given up by employees.
With weeks to go until the new VAT rules come into force, employers will need to get to grips with how the changes will affect their benefits.
1. What is changing under the new VAT rules?
Employers that provide benefits in kind under a salary-sacrifice scheme will have to account for output tax, which is the VAT charged when the benefit is supplied to the employee, where the benefit is subject to VAT.
The value of the benefit for VAT purposes will usually be the same value as the amount of salary deducted or foregone under a salary-sacrifice arrangement. However, where this is less than the true value, for example if the employer supplies the benefit for less than the cost to buying it in, the value should be based on the cost to the employer.
This will apply from 1 January 2012. However, salary-sacrifice agreements that were agreed on or before 27 July 2011 can continue to be provided free of VAT until the earliest of the following:
- The date that a fixed-term agreement expires or the fixed number of salary-sacrifice payments specified within the agreement are completed.
- The date of an employee's annual salary or benefits review.
- The date of any other review or renegotiation that leads to a change in the provisions of benefits under a salary-sacrifice agreement or to a change in an employment contract.
Read more about the VAT changes.
2. Why is it changing?
In the case of Astra Zeneca UK Ltd v HMRC, employees at Astra Zeneca were able to purchase vouchers through salary sacrifice for less than their face value and the employer claimed back the input tax.
The ECJ held that output VAT was due when the vouchers were supplied to staff as input VAT had been reclaimed. HM Revenue and Customs (HMRC) stated that it considered the rationale in this ruling to go further than deductions from salary and stated that there was no longer a distinction between deductions from salary and salary sacrifice.
Therefore, from January 2012, output tax will be due from, and input tax recoverable by, employers operating salary-sacrifice schemes.
View more information on how the ECJ ruling affects VAT in relation to vouchers and other services provided to employees under salary-sacrifice arrangements.
3. Will it affect all benefits under salary-sacrifice arrangements?
Benefits that are not subject to VAT will not be directly affected by the change. However, businesses providing benefits under salary-sacrifice schemes that are subject to VAT must account for the output tax on these supplies.
The provision of childcare vouchers will not be directly affected by the ruling as they are not subject to VAT. However, there will be changes to the VAT procedure for administration fees from the employer's voucher provider.
Employers that provide childcare vouchers were previously allowed to recover VAT on these fees as a general business overhead. However, they may no longer be able to do so as the fees are directly attributable to the exempt supply of vouchers.
Read more about how the VAT changes will affect employers offering childcare vouchers.
For company cars, most organisations are prevented from recovering VAT in full on the purchase and leasing of cars. Where this restriction applies, employers will not have to account for output tax when the vehicles are made available to employees. However, where an employer has no input tax restriction, output tax will remain due.
Additionally, employers that provide bicycles and safety equipment to employees under a salary-sacrifice arrangement will have to account for output tax. Employers can, however, continue to recover VAT on the purchase of bicycles and related equipment.
4. Does this affect the income tax treatment of benefits?
According to HMRC, the ECJ decision does not affect the income tax treatment of benefits provided to employees under salary-sacrifice arrangements and it has confirmed that it will not be amending the existing published guidance relating to employment income issues in light of the ECJ ruling.
View more information about income tax and the salary-sacrifice changes.
If you are looking into buying or amending benefits, including childcare vouchers, incentive vouchers or cycle-to-work schemes, read our buyers' guides on employee benefits.