If you provide your employees benefits via a flex scheme that is funded through a salary sacrifice arrangement, you need to know how tax laws are changing from 6 April 2017. We explain what employers need to know about the new rules and the steps to take to ensure tax efficiencies so your employees can make informed choices.

Key points

Salary sacrifce rules are changing from 6 April 2017

Group Income Protection and Excepted Group Life Assurance schemes will be affected.

Income tax and National Insurance Contributions (NICs)

Contributions made to fund those benefits under a salary sacrifice arrangement will now be subject to income tax and NICs.

Transitional provisions apply until 6 April 2018

But any variations to existing arrangements will end that transitional protection.

Employers need to review their existing salary sacrifice and flex benefit arrangements now, to ensure they are operated tax efficiently after 6 April 2017

HR and payroll staff need to understand the changes and employees need to be told how the changes affect their options.

What's happening on 6 April 2017?

  • A change to legislation, announced in March, means the withdrawal of some of the tax and National Insurance Contributions advantages provided to employees who give up rights to salary in return for a benefit. The change is introduced from 6 April 2017 and, except in specific, short-term transitional circumstances, it will have an immediate impact on the salary sacrifice arrangements that employers operate for their employees.
  • The change is being made to help re-dress an unfairness that the Treasury perceives as intrinsic to the use of salary sacrifice as a way of funding employee benefits.  Employees pay less income tax and NICs in comparison to what they would otherwise pay if they were paid directly from their earned income.
  • The draft legislation was revised in March to ensure that benefits from Group Income Protection ("GIP") and Excepted Group Life ("EGL") schemes could no longer be funded via a salary sacrifice arrangement.
  • This change is expected to have important, and immediate, implications for employers who allow their staff to fund their employee benefits via a salary sacrifice arrangement, either directly or through a flex scheme.

Salary sacrifice - what's changing?

We knew last autumn, after the Treasury completed its consultation on the subject, that reforms to "optional remuneration arrangements" ("salary sacrifice", to the rest of us) were coming. But it was only after a recent revision to the Finance (No.2) Bill 2017 that the full extent of those reforms became clear.

Benefits funded by employees via a salary sacrifice arrangement will no longer attract the income tax and NIC advantages that were previously available. These include benefits in kind with a cash allowance option and flexible benefits packages with a cash option.

Caught within the range of the new reforms are GIP and EGL benefits.

Benefits provided via HMRC Registered group life assurance schemes still enjoy the exemption and are unaffected by the reforms.

What is an Optional Remuneration Agreement?

For the purposes of the benefits code, a benefit is provided under an optional remuneration arrangement if it is provided under an arrangement of either type A or type B:

  • Type A arrangements: where the employee gives up the right, or the future right, to receive an amount of earnings (for example, salary) which would be chargeable to tax under existing income tax rules in return for the benefit.
  • Type B arrangements: where the employee agrees to be provided with a benefit rather than an amount of earnings, other than type A arrangements (for example, the option of a cash allowance).

Where a benefit is chosen instead of some form of cash pay, the taxable value of the benefit is the greater of the amount of cash pay given up and the taxable value under the normal benefit in kind rules.

Transitional protection

The changes take effect for any new salary sacrifice arrangement starting on or after 6 April 2017. All existing arrangements are provided with up to one year's grace, meaning that the previous salary sacrifice exemptions are maintained until the earlier of:

  • 6 April 2018; or
  • the date on which the terms of the arrangement are varied

We believe the Bill to mean that, as soon as an employee varies their contract to revise the quantum of their sacrificed amount (for example, as a result of a lifestyle event), OR the underlying salary sacrifice arrangement is altered by the employer, then the transitional protection will be lost and the new tax rules come into effect immediately, in respect of that affected employee.

How are existing salary sacrifice arrangements affected?

Core employer-paid benefits will remain unaffected, but the change in the law means new consequences for employees who increase or decrease their level of cover after 6 April 2017. Where an employee chooses to decrease their level of GIP or EGL benefit under a salary sacrifice arrangement, this will have the effect of making the remainder of their salary-sacrifice funded cover a taxable benefit and bring the transitional period to an end.

Likewise, if an employee 'flexes up', this could also prejudice their ability to benefit from the transitional period. However, this might be prevented by treating the additional sum as paid outside of the existing salary sacrifice arrangement (leaving that arrangement unvaried), by a normal deduction from net pay, or provision as a benefit in kind and reported on the P11d statement.

Our expectation of how the new rules will affect the treatment of GIP and EGL benefits from April 2018 (or the earlier end of the transitional period in each case) is outlined below:

Group Income Protection

Current position until 5 April 2018

Employee has core, employer funded GIP only

Expected position on and from 6 April 2018

Benefit remains non taxable

Current position until 5 April 2018

Employee flexes down their cover in return for cash

Expected position on and from 6 April 2018

Remainder of their salary sacrifice-funded benefit becomes a taxable P11d benefit for that employee

Current position until 5 April 2018

Employee is allowed to flex up their cover at their own cost

Expected position on and from 6 April 2018

Can be outside the salary sacrifice arrangement. Employee's payment cannot benefit from tax relief so must come from net pay or appear on P11d.

Registered Group Life cover

Current position until 5 April 2018

Employee has core, employer funded GLA only

Expected position on and from 6 April 2018

Benefit remains non taxable

Current position until 5 April 2018

Employee flexes down their cover in return for cash

Expected position on and from 6 April 2018

Benefit remains non taxable

Current position until 5 April 2018

Employee is allowed to flex up their cover at their own cost

Expected position on and from 6 April 2018

Benefit remains non taxable

Excepted Group Life cover

Current position until 5 April 2018

Employee has core, employer funded GLA only

Expected position on and from 6 April 2018

Benefit remains non taxable

Current position until 5 April 2018

Employee flexes down their cover in return for cash

Expected position on and from 6 April 2018

Remainder of their salary sacrifice-funded benefit becomes a taxable P11d benefit for that employee

Current position until 5 April 2018

Employee is allowed to flex up their cover at their own cost

Expected position on and from 6 April 2018

Can be outside the salary sacrifice arrangement. Employee's payment cannot benefit from tax relief so must come from net pay or appear on P11d

What do you need to do now?

If you are operating a salary sacrifice arrangement for your employees with a flex option that includes GIP or EGL benefits, we recommend that you carry out an urgent review of that arrangement, alongside your legal and benefits advisers, to ensure that:

  • the effect of the new changes are understood, and implemented, by your HR and payroll staff;
  • your benefit structure, and your use of salary sacrifice and flex benefits, remains as tax efficient as possible;
  • the new tax position is understood by all employees who participate in your salary sacrifice and flex benefits arrangements; and
  • your contracts of employment reflect any changes that need to be made to your salary sacrifice arrangement in light of the new tax treatment and employees' options to alter their participation in it.