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Salary Sacrifice Guide

The tax-efficient way to fund company vehicles for drivers and businesses

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Fast-forward to…

• What is Salary Sacrifice?
• How Salary Sacrifice Works
• Vehicle Insurance & Salary Sacrifice
• Other considerations under Salary Sacrifice
• Does Salary Sacrifice work for all employees?
• Salary Sacrifice summary

Salary Sacrifice Buying Guide

What is salary sacrifice?

Salary sacrifice is an established method of providing tax-efficient benefits to employees, and it can be used effectively in the provision of a car-related benefit. Salary Sacrifice is best used as an employee benefit for non-car-eligible employees, and those employees in receipt of a cash allowance in lieu of a company car. It also provides an option to support a business’s commitment to achieving net zero carbon emissions. In this way, the carbon footprint of these employees’ commute to work can be factored into your company’s carbon footprint calculations.

The scheme can also be used as a replacement for existing company car users, although financial savings by doing this are marginal. In effect, you are moving a driver from a Benefit in Kind (BIK) driven benefit to another BIK driven benefit with no material difference in their financial position.

When viewed in its most basic form, the use of Salary Sacrifice to provide cars to employees is a simple marriage of three established tax principles – PAYE, NIC and BIK.

An employee agrees to have their salary reduced – and will therefore pay less PAYE and NI on the reduced salary. In return for the salary reduction, they receive a traditional company car, on which they pay BIK tax like any company car.

The trick to making salary sacrifice work, therefore, is to ensure the saving in PAYE and associated NI is greater than the BIK tax incurred. Of course, where an employee pays NIC, their employer pays Class 1A NIC, so if the employee saves money, then so does the employer (in saved employer’s NIC).

"The trick to making salary sacrifice work, is to ensure the saving in PAYE and associated NI is greater than the BIK tax incurred"

How it works

In practice, a funder leases a company car to the employer in exactly the same way they would normally do with their corporate clients.

This is a business lease, with the employer as the contracting party, and VAT is charged on the monthly rental. The funder owns the vehicle, and the employer makes it available to their employee. The employee returns the vehicle at the end of the agreement as with any other Contract Hire arrangement.

In a traditional company car arrangement, the employer would not charge their employee anything for this (except for any trade-ups and private mileage contributions), but the employee would pay BIK.

However, where an employer enters into a salary sacrifice arrangement with the employee – it agrees a change to their terms and conditions of employment to reduce gross salary and provide a company car in return. This is a contractual benefit of employment. The amount deducted from the employee’s gross salary is typically equal to the amount the employer pays to the scheme provider for the monthly rental for the car, including maintenance and motor insurance, plus the 50% of VAT that cannot be recovered on the finance element of the rental. This is known as the ‘effective rental’. The employee still pays the same BIK as with any company car.

When it works best

As Benefit in Kind rates are linked to CO2 emissions from a vehicle, lower CO2 means lower BIK, and the greater the saving against the salary sacrificed. Battery Electric Vehicles (BEVs) with emissions of 0g/km CO2 will attract a BIK rate of 2% (fixed until tax year 2025) and so these vehicles will deliver the greatest tax efficiencies under a salary sacrifice arrangement.

Implications of OpRA (Optional Remuneration Arrangements)

On 6 April, 2017, HMRC introduced legislation titled Optional Remuneration Arrangements (OpRA), which covered a number of tax treatments surrounding Salary Sacrifice of various benefits (Pension, Childcare, cycle to work etc). Salary Sacrifice for cars was included in this and the rules changed. Under the ruling, Ultra-Low Emission Vehicles (with emissions of 75g/km or less) are exempt from any tax changes under OpRA and it is these vehicles (BEV or PHEV) that generate significant tax savings under a Salary Sacrifice scheme.

Insurance under Salary Sacrifice

Bearing in mind a contractual arrangement will be between the funder and the employer, it is worth considering what insurances you may need to offer, and how these can be applied in the simplest possible form.

Vehicle Insurance with Salary Sacrifice

Under salary sacrifice, an employer can provide its own fleet cover for drivers, and include it within the amount of salary sacrificed by the employee. However, the amount paid for insurance must be specified and separated within the salary sacrifice arrangement for each driver.

Consideration may need to be given to high-risk drivers who cause an increase in the employer’s premiums. However, this is no different to any other fleet insurance provision. It could also be argued that this is the most cost-effective method of providing insurance for a group of drivers.

More typically, Salary Sacrifice providers offer insurance-inclusive solutions, where the insurance premium forms part of the overall salary sacrifice, and no demand is placed on the employer to source or provide this. Insurance premiums, under this inclusive offer, tend to appear expensive, as they are fixed for the period of the lease, and are designed to be broad in their application, to cover a varied employee base of male/female, old/young and geographically diverse. That said, it should be remembered that this price is passed onto the employee through their gross salary deduction.

Additional employer costs linked to salary sacrifice

Early termination charges

As with any Business Contract Hire arrangement, ending the contract early is likely to incur an early termination charge to the employer from the funder. This can be handled in a number of ways, depending on the circumstances surrounding the ET (resignation/redundancy/long-term sick/death in service, etc) It is worth noting that the best way to avoid early-termination charges is to not return the car at all, but to reallocate it to another employee, if at all feasible.

All providers offer various levels of protection to minimise any financial risk. This can be expensive, but as it is included within the monthly payment, this is effectively passed on to the employee as part of their gross salary deduction – leaving no exposure to the employer.

As with any insurance, the option to ‘self-insure’ should be considered. How would this work in practice?

The employer could apportion an element of the employer’s NIC savings they will generate from the salary sacrifice arrangement as provision for any ETs they may need to fund in any given period. The provider can establish how many they think will occur, and what the average cost may be and help the employer to make this provision. Alternatively, the employer could pass this cost on to the employees by simply making a small addition to each employee’s monthly salary sacrifice to build up this provision – For example, 50 vehicles under salary sacrifice at £300/month, with a notional sum of £30.00pvpm, added to the salary deduction would generate a provision of £18,000pa – which the employer could use as a fund to cover any ETs incurred in that 12-month period. The impact to the employee would be a small reduction in the significant tax savings they would enjoy from the scheme.

End of Contract Damage

Commercially, the employer may choose to recharge drivers any costs incurred – via salary deduction, with the Ts&Cs included in any salary sacrifice agreement. If their policy is to absorb these costs and not recharge, this can also remain in place, although a self-insurance provision as described above could mitigate the risk.

Excess Mileage

Again, this can be passed on to drivers (provided this is included in the agreement between employee and employer) – especially as any business mileage element of this excess mileage would have resulted in additional employee income through mileage claims.

It’s important to ensure there’s an opportunity for employees to ‘reset’ their agreement if they are driving over or under their stated mileage. This should offer them the opportunity to pay any increased amount through the tax efficiency of the Salary Sacrifice arrangement while it is still in place, rather than out of net salary when the arrangement ends. Conversely, if the driver is travelling fewer miles than stated, they are unlikely to receive any benefit for this at the end of the contract, whereas a reschedule would reduce their monthly deductions.

It can be seen from the above, that the same cost areas and risks will be incurred by the employee under Salary Sacrifice that they would incur if they offered company cars – and these costs/risks can be passed on to employees if required, through a fully-insured solution, a self-insurance provision and/or robust policy that recharges drivers for costs they have incurred. Alternatively, the employer could build a provision for these from employer’s NIC savings.

Other considerations under Salary Sacrifice

How will it affect an employee’s pension?

A salary sacrifice arrangement reduces gross salary, as an employee has agreed to exchange some of their salary for a benefit instead. It is therefore natural to think this lower salary figure will be used to calculate salary-dependent benefits like pension.

Whether Salary Sacrifice impacts an employee’s pension will depend on the pension scheme operated by the employer, and its rules. Therefore, any potential impact on pension should be referred to the employer’s pension provider who will be qualified to advise.

Some employers choose to create what is called a ‘notional’ or ’reference’ salary which is used for such calculations.

This notional salary is the pay rate before any salary sacrifice arrangements. So, if an employee’s salary was £40,000, before car salary sacrifice (or any other salary sacrifice) this is the figure the employer may refer to when calculating other benefits, like pension contributions and pay rises.

Confirmation of this approach comes from HMRC which states: “Often, employers will use a notional level of pay to calculate employer and employee pension contributions, so that employees who participate in salary sacrifice arrangements are not put at a disadvantage”.

However, other pension schemes, particularly Defined Benefit pensions – like career average schemes – will be impacted, because employers look at an individual’s average salary over the course of their career and calculate the pension on that basis. A reduction in pay via salary sacrifice will reduce average earnings across a career and therefore the pension.

If an employee is in a final salary pension scheme, salary sacrifice will only impact pension if an employee sacrifices (reduces) their salary in the years before retirement or leaving the organisation. This may impact final salary on which a pension calculation is based.

Points to bear in mind here are:

1. Does the benefit an employee gets from a salary sacrifice arrangement outweigh any loss in pension?
2. If an employee is approaching retirement or thinking of leaving, should they stop any salary sacrifice arrangement prior to this to ensure final salary is at its highest?

Note: All employees should have a detailed understanding of their pension arrangements before entering into such an arrangement, and the employer should be aware of any potential implications and how to manage these.

Will a salary sacrifice arrangement restrict an employee’s ability to obtain a mortgage?

A ‘notional’ salary, as described above, may be used to calculate compensation or benefits. An employer is also likely to use it to provide confirmation of an employee’s earnings if they are applying for a mortgage.

A mortgage provider will check outgoings to ensure affordability, and any car payments will form part of this review.

It is worth noting that, as a result of a tax efficient salary-sacrifice scheme, an employee’s outgoings would reduce, creating spare income – demonstrating, potentially, greater affordability.

As with the impact on pensions, the employer should take appropriate counsel from a mortgage advisor, or their own finance team to obtain the required level of comfort on this.

Parental Leave

Employees taking parental leave (maternity/paternity/adoption) can also cause complications. Such employees are contractually entitled to retain their benefits of employment throughout a period of parental leave – and they have adjusted their Ts&Cs of employment to sacrifice some of their salary in return for a company car. Where an employer provides more than the statutory minimum leave, payments can often carry on as before, but if this is not the case, the employer will be unable to make salary deductions, yet is obliged to continue offering the same level of benefit during the period of leave.

HMRC says: “When an employee enters into a salary-sacrifice arrangement, they are renegotiating the contract of employment, and the car becomes a contractual benefit”.

Insurance can also be an option here, but this is not always taken out because it can prove unpopular among staff who are unlikely to be affected. As with the self-insurance options detailed above, the employer could retain an amount, say, £15pvpm, from employer NIC savings to cover such eventualities, or could increase salary sacrifice amounts for all employees to pass on the cost.

Some Salary Sacrifice providers include a form of protection in their pricing to mitigate employer risk on this, but care should be taken in comparing one provider with another to ensure their approach to financial protection and the apportioning of employer’s NIC are consistent.

Long-term sick leave

This will depend on the employer’s sickness policy. If an employee’s salary drops to the level where payments can no longer be deducted from the scheme, any shortfall may need to be covered by the employer. Insurance or self-insurance can be incorporated, as with other eventualities mentioned in this paper to cover exposure to this. A provision for Early Settlements could be used here, to protect the employer from having to cover a worst-case scenario of paying up to 36 monthly payments without being able to deduct from the employee’s salary.

Different to parental leave, however, the employer could withdraw the benefit from the employee and return the car early, or reallocate it to another employee. Again, some Salary Sacrifice providers include a form of protection in their pricing to mitigate employer risk on this, but it can appear expensive.

Will Salary Sacrifice work for all employees?

No. One cast-iron restriction with Salary Sacrifice is that an employee cannot sacrifice their salary below National Minimum Wage. If a business has any employees potentially affected by this, those individuals cannot participate in the scheme.

Many lower-priced EVs are available in the UK, so there should be good options for the majority of employees, regardless of their salary, but greater restrictions would apply to the lower-paid workforce.

This paper clearly identifies that Salary Sacrifice is extremely tax efficient for ULEVs, but OpRA limits its effectiveness for vehicles above 75g/km of CO2. Consideration should therefore be made for circumstances where ULEVs are not appropriate. These could include where…

• an employee’s daily and monthly mileage patterns are not conducive to driving an EV due to range restrictions (or where there’s a need to tow a heavy caravan or trailer).
• a driver is unable to charge an EV at home. This doesn’t preclude them from the scheme, but consideration should be given as to whether they should adopt an EV when they can only charge publicly.
• the choice of EVs may be too limited for an employee who needs, for example, a family estate, people carrier or convertible.
• an employee does not like EVs.
• an employee may already have a car and not currently need a new vehicle.

Clearly there will be instances where ULEVs don’t work for every employee – and employee engagement on these schemes tends to be between 5% and 10% (for non-car-eligible employees).

A Salary Sacrifice scheme will provide an additional ‘strand’ to the employer’s commitment to net zero carbon emissions – impacting the wider employer population and specifically their commute to work (included within ‘scope 3’ emissions).

The essential questions you need to ask when choosing a Salary Sacrifice product.

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Salary sacrifice summary

• Salary Sacrifice delivers significant tax efficiencies for EV and PHEV users, and the potential variable costs (ET, Damage, excess mileage etc) can be covered either by insurance, self-insurance or passing the cost on to employees.
• Consideration should be given to how external factors such as pensions and mortgages are affected, but these should not preclude the employer from introducing a Salary Sacrifice scheme.
• EVs may not suit the needs of all drivers.
• Employees cannot sacrifice their salary to such an extent that it takes them below the National Minimum Wage.
• If the employer experiences high levels of staff turnover, then greater consideration should be given to protection (insurance) against leavers. This will impact the levels of Early Termination protection they may wish to build into the scheme.
• Salary Sacrifice schemes generate administration (as you are creating a fleet), so any potential provider should seek to minimise this burden and do most of the ‘heavy lifting’ for the employer.

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