VAT and Employee Benefits

VAT on Employee Benefits

Background

HMRC has confirmed that from January 2012, there will be a major change in the way that VAT applies to certain taxable employee benefits.

In the past, HMRC accepted that the provision of employee benefits given under salary sacrifice schemes were not liable to VAT. However this practice has recently changed following a decision by the European Court of Justice (“ECJ”).

The case concerned Astra Zeneca UK Limited (“AZUL”). AZUL had been giving certain employees discounted retail voucher under a salary sacrifice scheme. It had recovered input tax on the purchase of the vouchers, but did not account for output tax as it took the view that the provision of such benefits to employees did not constitute a supply for VAT purposes.

The ECJ disagreed with AZUL and as a result HMRC is implementing this ruling with effect from 1 January 2012.

The change was announced in HMRC’s Revenue & Customs Brief 28/11 which was issued on 28 July 2011 http://www.hmrc.gov.uk/briefs/vat/brief2811.htm

So what does this mean in practice and who will be affected?

For those businesses who are affected, this will not only mean an increase in output tax liability, it could also affect their input tax recovery and certain businesses could actually become partly exempt for the first time.

And of course, those businesses need to start reviewing their accounting systems to ensure that they can cope with this new VAT treatment from the beginning of next year.

And here’s the VATspeak: Supply for a consideration

I always, wherever I can, try to avoid VATspeak. But this time the concept “supply for a consideration” is central to the issue because the fundamental principle of VAT is that VAT is due when taxable supplies are made for a consideration.

From January 2012 the value of the salary sacrificed is regarded as consideration for the supply of the goods and services concerned.

Prior to the ECJ decision in AZUL, HMRC accepted that a salary sacrifice didn’t constitute consideration for a supply of the goods and/or services involved because employment arrangements are not within the scope of VAT. Instead they took the view that the provision of the goods and services was part of the remuneration package and therefore not liable to VAT. The salary sacrifice was simply a way of valuing the goods and services concerned for the purposes of working out how much of the remuneration should be paid to the employee in cash.

Input tax

At present, the cost of the goods and services and related expenditure concerned are normally regarded as an overhead cost for the business as they aren’t directly attributable to taxable or exempt supplies. The VAT is therefore “residual input tax” and recovered according to the business’s partial exemption position.

From 1 January, not only must employers account for output tax on the value of the salary sacrifice, but there could also be an impact on their input tax recovery. Employers can no longer treat the costs of the goods and/or services concerned as residual input tax, but must directly attribute the VAT on their costs as being directly attributable to the taxable or exempt supplies of the benefits. For example, VAT on the purchase of taxable assets, eg computers or bicycles, is recoverable, while VAT on the costs of administering exempt insurance benefits is exempt input tax and may not be recoverable if the business is partly exempt. This could include not only third party administration costs, but even the costs of the employer’s own human resources departments.

It’s also worth pointing out that the treatment of exempt benefits as supplies for VAT purposes could mean that some fully taxable businesses – for example accountants or solicitors – could become partly exempt as a result of having to treat the benefits as supplies for VAT purposes.

Cash deduction or salary sacrifice? What does this mean?

VAT is already due on the supply of benefits where the employee pays by a cash deduction from salary. How does this differ to salary sacrifice?

• A “deduction from salary” is where the employer allows an employee the use of a PC for personal use in return for a £10 deduction from salary each month,. The employer would have to account for VAT on the £10. If the salary were £500 per month, the payslip would typically show a cash deduction so that the amount of salary due was £490.

• “Salary Sacrifice”. This is an arrangement where an employee is presented with a range of different benefits which can be selected to compile their remuneration package and is defined as such in the employee’s contract of employment. So in the case of our employee who has the use of the PC, the payslip wouldn’t mention any form of cash deduction but would simply show the salary as £490.

We’re probably all familiar with the type of “salary sacrifice” arrangements involved. Most major employers have similar schemes nowadays where employees can effectively make up their own remuneration packages based on a cash value, including cash, holiday allowances and a range of other benefits. They go by a range of names but are the same in principle.

So this change will mean an additional VAT cost for employers. In the past, the employer giving the employee the use of the PC would typically have recovered the VAT on the purchase as input tax, but wouldn’t have accounted for output tax on the value of the salary sacrifice.

What is a “taxable” benefit?

I should also confirm the meaning of the term “taxable” benefit in this context. When we’re talking about VAT, the term “taxable” means a supply that is liable to VAT at the standard rate, zero rate or reduced rate. This would include charges for the use of certain business assets such as personal computers or bicycles, or for using a gym.

Therefore VAT isn’t due on the provision of goods or services that are exempt from VAT, the most obvious ones being any sort of insurance policy, such as life insurance or private health cover or dental cover.

I wouldn’t normally make a point of explaining this, but I thought it was important to mention the point while we’re talking about employee benefits as the term “taxable” can also apply to employee benefits for PAYE purposes. HMRC have confirmed that the VAT treatment doesn’t affect the direct tax treatment of benefits.

Some of the most common benefits are listed below:

• Taxable Benefits:
Use of company goods or services
Certain retail vouchers
Insurance products that aren’t “insurance” i.e.certain guarantees or warranty cover

• Exempt Benefits
Health insurance
Dental insurance
Nursery care vouchers

Valuation

The value of the supply will be the amount of salary sacrificed by the employee, unless this is below the cost to the employer. If it is below cost, then the value must be based on normal valuation provisions which generally means that open market value must be applied. For further information on valuation, see VAT Notice 700 section 7 http://tinyurl.com/d4vrtvp

The main exception concerns the value for the provision of bikes to employees where HMRC have confirmed that the tables used for direct tax may be used to reduce administration.

How does it affect employees?

The additional VAT liability lies, of course, with the employers and in principle the change shouldn’t have any effect on the employees at all. Employers will doubtless take account of their increased VAT costs when considering pay rises, so it’s likely that there will be some effect on remuneration packages – for those people lucky enough to be getting pay rises nowadays!

Transitional arrangements

The change was originally announced on 28 July and as you’d expect, HMRC have issued transitional rules to prevent businesses from putting in place any “avoidance” arrangements to prevent or delay the effect of the change. Their Revenue & Business Brief 36/11 issued on 3 October sets out the provisions here http://www.hmrc.gov.uk/briefs/vat/brief3611.htm

Getting Ready

If you, or any clients, are affected by this change, then this is the time to review accounting procedures to ensure that they are ready to cope with the accounting changes and account for output tax on the supply of taxable benefits. If any of the benefits are exempt from VAT, then you need to review the business’ partial exemption position to see if its VAT recovery will be affected.

Either way, have a good look at the information provided by HMRC in the Briefs and let me know if you have any queries concerning specific situations.

Copyright 2011 Marie Stein