Pension Reform Salary Sacrifice clarification

Published on 18th June 2012 in:
Business Case, HR Software and Outsourcing, Payroll Services, Pension Auto-Enrolment

Can Salary Sacrifice work with Pension Reform Auto-Enrolment?

As auto-enrolment nears for large organsiations, there has been much public and private debate about the legality of operating Salary Sacrifice with auto-enrolment duties.

For many employers, auto-enrolment will mean that the cost of employing people will rise. In addition to increased contributions, the work involved with administering, monitoring and implementing auto-enrolment opt-ins and opt-outs will also increase costs. Salary Sacrifice could be a way of mitigating part of this additional cost.

In this article our resident expert Simon Parsons helps explain the validity of Salary Sacrifice with auto-enrolment.

Salary Sacrifice is about varying the employee’s terms and conditions of employment, a matter of agreement between the employer and employee where HMRC is only concerned on the collection of the resulting correct amount of Tax and NICs.

An employer can contract with their employees by either notifying or applying a change of contractual terms, or obtaining employee individual agreements to do so. Therefore the options are: the employee is in unless they say no; or, the employee is out unless they want to be in – both methods of contractual change are effective.

If an employer’s auto-enrolment scheme information notifies employees that the default method of application and contribution is via Salary Sacrifice, then that is acceptable as long as the individual has an alternate choice.

The next phase of salary sacrifice confusion – the Heaton v Bell principle – is when the terms and conditions provide the right to revert to cash within the period of time they are set to cover (usually a minimum of 12 months). The House of Lords ruled that such a flipping of cash or benefit made the arrangement chargeable to income tax as earnings, opposed to any other code, such as benefits in kind or total exemption. Although the principle applies for many Salary Sacrifice benefits cases, it does not apply (by special legislation) to employer provided childcare, workplace parking, and employer provided cycle and cycle safety equipment.

Auto-enrolment brings with it an employee right to opt-out within one month of being notified of joining. If Salary Sacrifice has been applied and an employee opt-outs, what should happen in light of the Heaton v Bell principle?

This has raised a hotbed of discussion and disagreement. With Salary Sacrifice there is no employee contribution, the pension contribution is entirely the employer’s. So, what happens with a refund?

Well it’s simple really. The Pension provider refunds it to the employer – in full as required by Pension Reform law, and the employer can give the sacrifice amount back to the employee if they so choose.

The challenge here, is the breaking of the Heaton v Bell principle and the mass fear is that such an action will undermine an entire pension scheme Salary Sacrifice arrangement. The impact is in fact that the refund of Salary Sacrifice money is subject to Tax and NICs – a status quo. It has absolutely no effect on a scheme or another individual contractual agreement, as long as they are individually valid. In effect, the employee never had a benefit as they have opted-out and they have paid the right amount of tax and NICs.

The Pension Regulator had already stated that Salary Sacrifice…

…is not necessarily incompatible with automatic enrolment, so long as active membership of the pension scheme can be achieved without the jobholder having to consent to the salary sacrifice arrangement before they are made an active member.The Pension Regulator

Prior notification of the scheme operation would satisfy this. What an employer cannot do, is be in a position of delaying to wait for permission.

So for an employer to fulfill its pension reform obligations and where it wants to generally operate salary sacrifice, this is OK, however, they must also offer an alternate option for those employees who do not want this fulfilled by a salary sacrifice arrangement.

Recent reports indicate that HMRC will revise some of its guidance to make clear that they will not adversely impact any scheme where the right to opt-out has been exercised in relation to Salary Sacrifice, and that as long as any repayment to the employee is appropriately assessed for tax and NICs, then no additional adverse effect takes place.

So, can Salary Sacrifice work with Pension Reform Auto-Enrolment – the answer is yes. The minimum contributions required for a defined contribution scheme is based on total contributions paid, and all of these can be indicated as employer contributions with no employee contributions. Employers, however, need to make sure the wording of any communication is correct.

If you would like to see how our Payroll and Pension Auto-Enrolment solutions can help you, or see if Salary Sacrifice is viable for your organisation, contact us online or call 0800 0482 737.

Comments

P Simon Parsons

26th June 2012

Since the writing of this article HMRC have published their clarification on salary sacrifice and pensions.

HMRC Confirms Salary Sacrifice position for “employer made contributions under a registered pension scheme”
HMRC have now confirmed in guidance their position in relation to Salary Sacrifice and employer pension contributions:

If the terms and conditions provide the right to revert to cash within the period of time they are set to cover, any tax exemption may be lost. In the case of Heaton v Bell, the House of Lords decided that the benefit of a company car provided through a salary sacrifice arrangement was chargeable to income tax as earnings instead of by reason of the benefits code. The key feature of the arrangement was the ease with which the employee could give up the car and revert to the higher cash salary.

Special legislation has been enacted to prevent this happening for the following exempt benefits:
-Employer provided childcare
-Workplace parking
-Employer provided cycles and cycle safety equipment
-Employer made contributions under a registered pension scheme

In consequence, these benefits are exempt from income tax altogether. It is not necessary to stipulate a period for which the arrangement must be entered into or to set out ‘lifestyle changes’.

This does not purely relate to Pension Reform and AE, but any salary sacrifice arrangement related to a registered pension scheme.