VAT on salary-sacrifice benefits

On 1 January 2012 new rules on the VAT treatment of certain benefits provided under salary-sacrifice schemes came into force.

The changes follow a ruling in the European Court of Justice (ECJ) that an employer operating a salary-sacrifice scheme must pay output tax on the pay given up by employees, with no distinction between deductions from salary and salary sacrifice.  Output VAT will be due from, and input VAT recoverable by, employers operating salary-sacrifice schemes.

Employers must account for VAT that is chargeable on benefits in kind supplied under a salary sacrifice scheme.  The value of the benefit for VAT purposes will usually be the same value as the amount of salary deducted.  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.

The change applies from 1 January 2012.  However, salary-sacrifice agreements 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.

Benefits that are not subject to VAT will not be directly affected by the change, for example 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.

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.

The ECJ decision does not affect the income tax treatment of benefits provided to employees under salary-sacrifice arrangements and HNRC will not be amending the existing published guidance.