At the end of July (2015) the Court of Appeal heard, and rejected, an appeal by Reed Employment plc (“Reed”), against a nine-figure assessment of arrears of PAYE/NIC by HMRC.
For anyone unfamiliar with this potential landmark case, Reed had paid its temporary employees partly in salary and partly in tax free travel expenses, ostensibly implementing a ‘variable’ salary sacrifice so that PAYE/NIC would apply only to the lower salary element. HMRC took the view that no genuine alteration to contractual salary had ever been made, hence PAYE/NIC applied to the full original contractual sum. This view was supported by both the First Tier and Upper Tribunals.
In also agreeing, the Court of Appeal highlighted the absence of any clear unequivocal statement, by the employer to the employee, that the employment contract had been changed (i.e. in any way that the employee could be said to have understood, much less agreed to, the change). For example an employer statement that there will be a ‘small reduction’ to the employee’s gross pay was seen as at best ambiguous, and could not override the ‘clarity’ of the main contract’s terms.
The Court of Appeal also accepted the earlier Tribunals’ decisions that dispensations previously issued by HMRC were not relevant in this matter. In short, Reed had previously agreed with HMRC as to what circumstances a payment of tax free expenses could be made; however it was felt to have not also explicitly agreed the salary sacrifice methodology with HMRC.
Whilst the suggestion that Reed had not made ‘full disclosure’ in discussions with HMRC seems harsh, in our view the courts were correct in regarding the ‘salary sacrifice’ and the payment of expenses as two completely separate steps (i.e. if the two operate in conjunction, then the salary sacrifice must always come first). If the salary sacrifice does not work in the first place, any subsequent payment of ‘expenses’ would be considered as mere window dressing on the payslip and would be ineffective for tax/NIC purposes. The 1960s tax case of Heaton v Bell established the premise that there must be more than a mere payslip deduction, to effect a true contractual change.
Are statutory changes to salary sacrifice rules likely?
There has been speculation (following some rather vague government announcements recently) that there will be a general attempt to ‘outlaw’ salary sacrifice in future. ET4B certainly does not see this as a simple matter and therefore happening in the short to medium term. There are a vast number of different scenarios to consider, such as the employer which automatically applies a supposedly ‘invisible’ tax free benefit in addition to salary (e.g. as in the case of most Civil Service pension contributions), employers which provide and quantify tax-favoured benefits but don’t permit them to be altered by the employee, employers which automatically ‘opt-in’ employees to receive specific benefits (e.g. stakeholder or other occupational pension contributions) unless the employee ‘opts-out’ directly, employers which operate a full flexible benefits package, and employers which allow individual employees to opt for salary sacrifice in conjunction with tax-favoured benefits (e.g. employer sponsored childcare) merely on an ad hoc basis. Arguably there is no fundamental difference between each of these schemes; merely that larger employers tend to be slightly more sophisticated in the way in which they are able to demonstrate and agree revised terms with staff.
What we will very probably see is that specific arrangements, which HMRC is known to ‘disapprove of’, will continue to be challenged actively. For example it is expected that employee travel expenses, if paid in direct conjunction with a salary sacrifice agreement, will be excluded from the proposed statutory exemption for allowable expenses (planned to be introduced in April 2016, to replace existing employer dispensations for allowable expenses).
What steps should be taken now?
The Reed case provides another timely reminder that basic principles should always be followed when implementing or reviewing salary sacrifice or flex schemes, i.e.:
- Is the contractual change legally effective? As Reed has found, this question is particularly important if an employee is included ‘automatically’, so that the employee cannot be said to have signed up to the scheme directly. Annual employee ‘total reward’ statements can often help, but in some cases can indeed hinder, this process.
ET4B has noted that many salary sacrifice schemes (worryingly, including many of those drafted by the Big-4) do not appear to address this basic principle fully. Rather than explaining to employees exactly how a salary sacrifice will operate, we have seen extremely vague wording which is no more than saying ‘we [the employer] will decide how much your salary sacrifice will be each month’. The Reed case reminds us that a mutual and clear ongoing agreement is needed with the employee, before an employment contract may be regarded as altered.
- Payroll calculations and operation of ‘notional pay’ e.g. as regards overtime, bonuses, increments etc., must also be thought through, and payslips must be able to cope if there are multiple sacrifices.
- Treatment of leavers, staff on long term sick, and maternity leave etc. should be considered. There may well be employee rights at those times, as well as ongoing employer costs to consider.
- Exclusion of certain employees should be considered e.g. those close to or below Minimum Wage or NIC Lower Earnings Limits.
- Finally, is any tax clearance from HMRC comprehensive and effective i.e. is it specific to your own organisation and has it been achieved by putting all your cards face up on the table on a full disclosure basis?
In this complex area, choosing the right specialist adviser to review or implement your scheme may mean the difference between having confidence in a robust and watertight arrangement, and nervously awaiting the next knock on the door from HMRC.