Long reads

One year on from salary sacrifice

2 Oct 2018 By Louise Farrand

What has the huge scaling back of tax advantages really meant for employee benefits?

A seismic change to the employee benefits landscape or a storm in a teacup? When it comes to the sweeping alterations the government enacted to the rules on salary sacrifice a year ago, it is tough to find much agreement. But one thing is for sure: no UK organisation has been left untouched.

Employers have now had more than a year to bed in the changes, which were announced in 2016 and came into effect in April 2017 with some exceptions: car-related salary sacrifice and school fees are both subject to a grace period until 2021. 

In many cases, they will have needed it: salary sacrifice is a mainstay of most companies’ employee benefit strategies. In essence, it allows employees to take a salary cut in exchange for receiving another benefit, reducing the amount of income tax and both employee and employer national insurance due. 

Salary sacrifice is most commonly used to pay for pensions (which remain unaffected) and is intrinsically linked to company car schemes, but it also enabled the rapid diversification of benefits schemes in recent years to cover things like gym memberships, cycle-to-work schemes, childcare and more. The potentially unlimited scope of the regime, which could have deprived the exchequer of significant revenue if it went unchecked, was what led the chancellor to curb it.

For some organisations, the changes resulted in significant upheaval. “It has really forced employers to put their thinking caps on,” says Ian Hodson, head of reward at the University of Lincoln. The university had structured its benefits offering around the national insurance savings it was making, generously reinvesting the money into enhancing its benefits programme. When the changes were announced, it had to review its whole benefits offering. 

“It is a backhander when the government withdraws [salary sacrifice schemes] because they realise they are losing money. It is quite sad really,” says Hodson. “We have been encouraged to use these initiatives to promote certain government agendas, but now they are costing too much. We felt a bit cheated; we set these up, we probably wouldn’t have otherwise, and that is a real shame.”

Not everyone was as badly affected as Hodson, but for employers that offer salary sacrifice, the result was at the very least extra paperwork. When employees agreed to sacrifice their salary in exchange for a benefit, that would have been written into their employment contract. When the arrangement changes, they need to sign a new contract. 

“That would have been a lot of work for employers – if they haven’t already done it, it’s important they should change it. And trying to work out the value of something to deduct from the salary can be complicated,” says Debi O’Donovan, director of the Reward & Employee Benefits Association (REBA).

It’s worth noting, of course, that some of the biggest benefits eligible for salary sacrifice remain unchanged. “There were some elements that were ring-fenced – pensions, cycle to work and childcare vouchers were outside the scope of the consultation. The bottom line was that the government wants us to save for pensions, they are happy for employers to support a greener transport system and childcare was being dealt with separately. So when they made all the changes, those three things were kept out of it,” says O’Donovan. 

Pensions are a mainstay of salary sacrifice, and the government decided not to change the rules in this area. As Michael Rose, head of Reward Consulting Limited, puts it: “The changes were mostly at the margins; the big one is pensions salary sacrifice and that remains the same.”

Samantha Gee, director of reward and benefits consultancy Verditer, is another expert who thinks the changes were an anti-climax. “Most of our clients didn’t see their benefits affected. Those clients that did need to make changes quite often say, ‘Well, we don’t compensate employees for loss of favourable tax treatment – this has happened, and we move on.’”

There are other reasons why salary sacrifice changes may not have hugely impacted benefits regimes. First, businesses may have simply absorbed the cost in order to keep employees on board. But more likely, they have negotiated with benefits providers to meet them in the middle, continuing to offer a discount on retail prices that means it remains cheaper to receive a gym membership through work than outside work, for example.

“I haven’t heard of organisations hugely changing their benefits approach,” says Charles Cotton, senior adviser for performance and reward at the CIPD. “Partly because a lot of the salary sacrifice reforms were focused on a few benefits, and partly because providers were saying, ‘We can still get your employees better deals than they would be able to get individually.’ There may have been more impact in the public and voluntary sectors, where salary sacrifice was being used to extend the benefits on offer.”

There will be winners and losers, adds Gee: “The clever employers will be the ones that bring something new to the package for those people that are worse off – they may go off and get a better bulk deal on products and services or do something on wellbeing.”

The government too must strike a delicate balance when it comes to the issue. On the one hand, it wants to encourage positive behaviours, which will ultimately save it money. For instance, a healthy workplace is in its best interest, as a healthy population is less likely to call on the NHS. On the other hand, the government is ultimately subsidising salary sacrifice, which comes at a cost to the Treasury’s purse.

That is why some of the marginal behaviour encouraged by the old regime was a particular target. Technology is a prime example: tax breaks on computers for home use were originally designed to open up internet access across the UK. It wasn’t long, however, before the idea had unintended consequences, says O’Donovan.

“People discovered there was a way to continue the scheme with smartphones and iPads under salary sacrifice,” she says. “It started to extend. As we got smart TV and internet-enabled music systems, that’s where people started to stretch it. It was intended for one thing – to make employees across the land more computer literate – but then people were kitting out their homes with sound systems.

“I started to hear about people buying washing machines on salary sacrifice and having double glazing installed, so it seemed to get broader and everyone was finding a way to stick things through.”

It might have been a useful compromise, she adds, for the government to allow parents on low incomes to continue saving money on laptops for their children. But there isn’t room for much nuance in the salary sacrifice rules. And the government is always on the hunt for further savings, which means even pensions might not be off limits forever.

 “Politicians are always looking at pensions,” says Rose. “I suspect that pensions salary sacrifice has got a chance of remaining, simply because there isn’t that much [tax advantage] left on pensions now and they are constantly salami slicing all the time. But in the medium term, there is a very strong chance with Brexit that, whoever the chancellor is, they are going to be scrabbling around for money.”

More broadly, employers shouldn’t base their benefits on the foundation of tax advantages, adds O’Donovan. “First and foremost, what do you want to achieve as an employer? If there happen to be tax breaks, happy days, but don’t build your benefits strategy around it. You will carry on offering it irrespective of tax, if it’s the right benefit.”

The new salary sacrifice rules also dovetail with a broader shift towards a smaller range of benefits and a recognition among both employers and employees that straightforward monetary savings aren’t always best. Many businesses, for example, have decided to invest in enabling and promoting flexible working, believing it to be a far better engagement and retention tool than what might be seen as flashier perks.

Gee believes businesses are evolving in the way they operate, with benefits becoming more of a philosophy, rather than a package of discounts and tax incentives. “There is a lot of focus on wellbeing, whether that’s mental or physical. It’s a big area that can make a difference to a business.” 

She adds: “We try to find benefits that align with employers’ goals. At the moment, we are working with a medical device company in the fertility space. They have a fantastic maternity offering and they pay shared parental leave that is similar to their maternity leave, which I think is quite unique in the market.”

The changes to salary sacrifice have been a welcome shake-up, she believes. Losing tax advantages on some benefits has caused employers to rethink what they offer, and to redouble their efforts to communicate that to their staff. “It’s an opportunity to tidy up, find new and exciting things to put in, strike better deals, and find things that might differentiate that employer’s deal. That’s much more what it’s about these days than the same old benefits.” 

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