United Kingdom: Case Looks at Salary Sacrifice Arrangement
The decision from the United Kingdom’s First-tier Tribunal (FTT) in the case of Reed Employment plc (and other Reed Group companies) v The Commissioners for HM Revenue and Customs has now been issued1. The decision has resulted in a £158 million liability for tax, social security, and interest for the company that was a party to the case. The important points from the case are discussed below. It is thought that the company is likely to appeal the ruling.
The case concerned the daily payments Reed Employment plc (“the Company”) made to cover lunch and commuting to around 500,000 temporary workers between 1998 and 2006, which they maintained was part of a “salary sacrifice” arrangement. The FTT found that the schemes operated did not constitute an effective salary sacrifice arrangement, as in reality no part of the salary was sacrificed. The FTT judges said “The salary was paid in full, even if there was a later manipulation.” In addition, it was ruled that the employed temps were engaged under a series of job-by-job contracts rather than under a continuing contract of employment. Each assignment should therefore be treated as a separate engagement, and, as a result, the travel was to a permanent work-place and the expenses were deemed to be ordinary commuting and non-deductible.
The Contractual Arrangements
The contractual arrangements were much discussed and show the need to carefully draft a contract of employment and to foster a clear understanding by all of the contract. In the present case, there was much made of the fact the employees could not understand their pay calculation.
The starting point for any successful arrangements is a correctly worded and understandable contract of employment which, in this kind of an arrangement, to be acceptable to Her Majesty’s Revenue & Customs (HMRC), should be an over-arching contract of employment guaranteeing at least 336 hours.
Salary Sacrifice and Benefit to the Employee
The position put forward to the FTT that a salary sacrifice existed was ultimately rejected partly on the basis of the confusing contractual arrangements in place, but comment was also made on the small savings enjoyed by the workers as the arrangement was designed to deliver the bulk of the savings to the employer. The FTT took the view that the employees could not understand what was happening to their pay from the payslips
and that, in the Tribunal’s view, a sacrifice by an employee should deliver a benefit to the employee. The FTT went further to say that this purported sacrifice delivered no or little benefit to the worker and was an arithmetical exercise to deliver the maximum savings to the employer.
In this case, the FTT’s reasoning that a salary sacrifice must deliver a benefit is potentially challengeable; but the arrangement has to be transparent and be understood and accepted by the employee to be a valid sacrifice. To avoid the view that ‘little or no’ benefit is made by the employee, an equitable sharing of the savings would also be advisable.
Issuing of a Dispensation
In the U.K., the default position is that the reimbursement of expenses is taxable. The employee may claim tax deductible expenses on his/her tax return. The tax system does, however, recognize that certain expenses are deductible and that requiring the employer to report the expenses paid and then have the employee claim deductions for the expenses on his or her tax return is unnecessarily administratively burdensome. Employers can therefore apply for a dispensation that removes this unnecessary extra administration.
The FTT found that the U.K. tax authority, HMRC, was entitled to issue a dispensation where it had a belief that no tax was payable (even if HMRC was wrong). However, as the Tribunal also found that the expenses paid were a part of the employee’s wages, and there was no salary sacrifice in place, the expenses should have been subject to U.K. tax and social security withholding. In addition, they considered the effect if a valid salary sacrifice was found to be in place, but took a view that the assignments were all fixed-term employments and, as such, the expense allowance would be taxable; that is, the employee did not travel to temporary work-places which would attract relief from tax. The allowances were paid for travel to a permanent work-place and taxable in the same manner as normal commuting expenses.
When entering into these arrangements it is important not only to consider the contractual arrangements to be put in place, but also important to communicate the arrangement in a transparent way which demonstrates the employee was in agreement and had all the information to understand the arrangements affecting him/her.
The following question was not decided: “Can HMRC be required to apply a dispensation that the Company had a legitimate expectation that was in place and covered the allowances paid, even where HMRC had no power to grant a dispensation?” This “legitimate expectation” point will be left for any further proceedings at the Upper Tribunal. The Tribunal commented that as the disclosures made did not provide the full facts to HMRC, this helps support HMRC’s contention that the Company had no legitimate expectation, as it did not fully disclose all relevant matters.
In this kind of arrangement, all the facts should be on the table and HMRC and other parties should fully understand the arrangements in place, with this being supported by clear employee communications. If this had happened here, it would have aided the case in that a legitimate view was held that the dispensation made the payment of expenses exempt from U.K. tax and social security withholding, even if the dispensation was later found to be incorrect.
What Could You Do Next?
This case will possibly have far-reaching implications for all employers entering into salary sacrifice arrangements (salary sacrifice arrangements can cover pensions, cars, bicycles, child-care vouchers, flexible benefit schemes, and many others). KPMG LLP (U.K.) suggests that all these arrangements be reviewed to establish that they are compliant and, importantly, that the workers fully understand the arrangement they have entered into.
The Reed Employment plc case highlights the pitfalls of not thoroughly implementing ‘salary sacrifice’. The employment contractual arrangements are as important as the tax considerations.
KPMG LLP (U.K.) has experience of successfully implementing such arrangements and with the agreement of HMRC on a fully-disclosed basis. We have also assisted clients having existing non-KPMG arrangements to help establish that they are compliant and to obtain HMRC agreement. Implementing a salary sacrifice can be done successfully and these arrangements can realize considerable savings for both the employer and the employee.