There has been concern that the conditions for tax efficient salary sacrifice arrangements are incompatible with the new auto-enrolment requirements. In particular, workers enrolled automatically into an employer's pension scheme via salary sacrifice could be penalised financially if they opt out of the scheme. We understand HMRC has agreed to change its salary sacrifice guidance to alleviate this concern. This speedbrief considers the issues.
A salary sacrifice arrangement is one where a person agrees to give up (or "sacrifice") part of his future salary in exchange for the employer agreeing to provide a non-cash benefit, such as the equivalent amount by way of contribution to a pension scheme or childcare vouchers.
The main benefit of entering into a salary sacrifice arrangement is that it can reduce the national insurance contributions payable, as these are calculated by reference to the employee's reduced (post-sacrifice level) salary. Currently, for a salary sacrifice arrangement to be valid for tax purposes, HMRC requires that the individuals must not be able to give up the benefit in return for cash at any time (generally the arrangement must remain in place for a year), except in the case of a lifestyle event such as divorce or the birth of a child.
The new auto-enrolment regime (being phased in from October 2012) will place a duty on all employers to enrol eligible workers into a qualifying pension scheme automatically and to pay minimum contributions. Due to the cost advantages, many employers were hoping to use salary sacrifice as a key part of their auto-enrolment strategy.
Under auto-enrolment rules, workers will have a statutory right to opt out of their pension scheme (within one month of joining) and receive a refund of their contributions.
Those who were enrolled automatically into a pension scheme via salary sacrifice and subsequently opted out would no doubt be unimpressed to find that (due to HMRC salary sacrifice rules) they would not be entitled to a refund of contributions made on their behalf via salary sacrifice, and their salary may have to remain at the reduced (post-sacrifice) level for up to a year. Otherwise, the validity of the whole salary sacrifice arrangement could be called into question by HMRC.
Due to industry lobbying, we understand HMRC has confirmed that those who opt out of an auto-enrolment pension scheme will be entitled to a refund of the salary sacrificed (subject to tax and national insurance) and to return promptly to their pre-sacrifice level salary. We expect HMRC to update its guidance soon.
The prospect of a very significant incompatibility between auto-enrolment and salary sacrifice was worrying. So, whilst full details of the new HMRC guidance are still awaited, this proposed change is a very welcome development.
Some areas of difficulty remain in terms of the interaction between auto-enrolment and salary sacrifice (particularly around joining requirements). However, with careful planning, these should not be insurmountable.