HMRC will allow limited 'grandfathering' on VAT arrangements for existing salary sacrifice schemes

In a briefing note, HM Revenue and Customs (HMRC) said that it would allow previously agreed salary sacrifice agreements to remain free of VAT until those agreements expire or until the date of the employee's annual salary review, whichever is earliest.

In its July briefing note HMRC confirmed that employers would have to account for VAT where appropriate on certain benefits granted as part of a salary sacrifice scheme from 1 January 2012.

Agreements entered into on or after 28 July 2011 are unaffected. Employers will have to account for VAT due under any such agreements from 1 January 2012, HMRC said.

"This concession will be good news for those employers who already had schemes in place before the July HMRC announcement as it will give them more time – possibly several months – to review and possibly unwind or amend arrangements before VAT becomes due," said Jon Robinson, a tax law expert with Pinsent Masons, the law firm behind Out-Law.com.

Salary sacrifice schemes operate by allowing employees to receive vouchers or benefits instead of part of their salary. The schemes offer tax benefits as they allow employees to pay for goods or services with their income before tax is taken out. They are commonly used to pay for childcare or by some employees to buy bicycles and cycling equipment.

In 2010, the European Court of Justice (ECJ) said that drugs giant Astra Zeneca had to pay VAT on retail vouchers given to staff that formed part of a salary sacrifice scheme. The company had claimed it was permitted to claim back the VAT it had paid on the purchase of the vouchers but not account for VAT when giving the vouchers to employees.

The ECJ said that giving the retail vouchers to employees counted as a "supply of services", and was therefore subject to VAT.

HMRC said it would regard any salary sacrifice arrangements put in place after an employee's annual salary or benefits review as a new agreement for VAT purposes, even if the employee continues to receive the same taxable benefits as before the review.

Any other review or renegotiation that leads to a change in the provision of benefits under the salary sacrifice arrangement or a change in the employee's contract would be treated the same way, it said.

Once a previously agreed fixed term agreement expires or the fixed number of salary sacrifice payments specified are made VAT will be due on any subsequent arrangement, HMRC said.

Benefits provided to employees under salary sacrifice schemes which are not subject to VAT, for example childcare vouchers, will be unaffected by the change.