Understanding UK Optional Remuneration Arrangements

Many UK employers are still not aware of the new rules covering flexible benefits/salary sacrifice or cash alternative arrangements that were introduced as long ago as 6 April 2017. These are known as the Optional Remuneration Arrangements rules (OpRA).

Any arrangements that have been offered to employees since April last year are covered by the new legislation and will be taxed on whichever is higher, the ‘Benefit-in-Kind’ or cash alternative rate, unless covered by one of several exemptions. But what about older arrangements?

With many questions still unanswered in the guidance from Her Majesty’s Revenue & Customs (HMRC), filing correct 2017/18 P11Ds will be tricky. For instance, one employer we know is trying to locate contracts from more than 20 years ago in order to work out their implications.

Overview of the rules

The new rules introduce the concept of ‘Type A’ and ‘Type B’ arrangements. The ‘Type A’ arrangement is normally a standard salary sacrifice-type offering. A ‘Type B’ arrangement, meanwhile, is one in which employees are given a choice between taking a benefit or a cash alternative.

The new legislation in S69A of the Income Tax (Earnings and Pensions) Act (ITEPA) 2003, summarises the different arrangements as follows:

• In ‘Type A’ arrangements, employees give up the right (or a future right) to receive an amount of earnings within Chapter 1 of Part 3 in return for a benefit;
• ‘In Type B’ arrangements, employees agree to be provided with a benefit rather than the amount of earnings described in Chapter 1 of Part 3.

The “restriction” applied by an OpRA covers both Type A and Type B arrangements regardless of whether they were entered into before, or after the beginning of, an individual’s employment. As a result, tax and national insurance charges arise on the higher of the amount foregone (the amount of salary sacrificed) and the modified cash equivalent of the benefit.

What is not included in the new rules?

Benefits or facilities provided via an OpRA from 6 April 2017, subject to the transitional arrangements, are only covered by existing exemptions from income tax if the exemption is either a ‘special case exemption’ or an ‘excluded’ one. A benefit or facility means anything that constitutes employment income or that is treated as arising to the employee regardless of how or in what form it was provided.

Special case exemptions ▼

A special case exemption means an exemption that is conferred by any of the following provisions:

• Section 289A ITEPA 2003 – Exemption for paid or reimbursed expenses;
• Section 289D ITEPA 2003 – Exemption for other benefits;
• Section 308B ITEPA 2003 – Exemption for independent advice relating to conversions and transfers of pension schemes;
• Section 312A ITEPA 2003 – Limited exemption for qualifying bonus payments;
• Section 317 ITEPA 2003 – Exemption for subsidised meals;
• Section 320C ITEPA 2003 – Exemption for recommended medical treatment;
• Section 323A ITEPA 2003 – Exemption for trivial benefits provided by employers.

Special case exemptions already have their own specific salary sacrifice rules. You should continue to apply them rather than the new rules when determining the taxable value of any benefit covered by such exemptions.

Excluded exemptions ▼

An excluded exemption means an exemption conferred by any of the following provisions:

• Section 239 ITEPA 2003 – Exemption for payments and benefits connected with taxable cars, vans and heavy goods vehicles;
• Section 244 ITEPA 2003 – Exemption for cycles and cyclist’s safety equipment;
• Section 266(2)( c) – Exemption for non-cash vouchers used in conjunction with the exemption for cycles and cyclist’s safety equipment;
• Section 270A – Limited exemption for qualifying childcare vouchers;
• Section 308 – Exemption for contributions to registered pension schemes;
• Section 308A – Exemption for contributions to overseas pension schemes;
• Section 308C – Exemption for the provision of pensions advice;
• Section 309 – Limited exemption for statutory redundancy payments;
• Section 310 – Exemption for counselling and other outplacement services;
• Section 311 – Exemption for retraining courses;
• Section318 – Exemption for employer-provided childcare;
• Section 318A – Limited exemption for other childcare provisions.

These exemptions are not affected by the new rules.

Taxable value of the benefit

If an employee receives a benefit as part of an OpRA, other than one of the excluded or exempt special benefits, its taxable value will be whichever is greater between the:

• Salary sacrificed for ‘Type A’ arrangements, or the cash allowance for ‘Type B’ arrangements;
• Cash value of the benefit.

In working out the cash value of the benefit, normal calculation rules are broadly amended as follows:

• The cash value of the benefit is deemed to be nil if, without the restriction being in place, the benefit would have been exempt from tax;
• Any amount made good is disregarded when calculating the cash value of the benefit. But the amount made good is deducted from the amount treated as earnings.

What is the situation with arrangements entered into before 6 April 2017?

The new rules apply to OpRAs entered into on, or after, 6 April 2017. But to address concerns about employees who are locked into salary sacrifice arrangements, the legislation does include grandfathering provisions that apply as follows for:

• Salary sacrifice arrangements entered into before 6 April 2017 (even if the arrangements take effect after 6 April 2017). Here the restriction applies from 6 April 2018 unless the arrangement has ended, varied or renewed before then, or the following provision applies;
• Cars, accommodation and school fees until 6 April 2021, unless the arrangement is ended, varied or renewed before then.

An example based on car benefits

The car benefit charge for a vehicle ‘provided’ after 6 April 2017 under OpRA is now whichever is higher between the:

• ‘Normal Benefit Charge’ (list price x appropriate % based on CO² emissions and fuel type);
• Amount of salary foregone in relation to the benefit.

As of 6 April 2017, the new rules applied:

• To any new employees;
• If an arrangement between an employee and employer is varied in relation to the benefit in kind;
• If the arrangement was renewed;
• When the grandfathering provisions lapsed.

All car arrangements entered into before 6 April 2017 are covered by the grandfathering provisions and will move to the new rules as of 6 April 2021, unless they are varied or renewed before then, in which case the new rules will apply from the date of the change.

Variations or renewals

Employers will need to carefully consider the grandfathered OpRA conditions as any ‘variation’ to the terms may lead to grandfathering status being lost from the date of the variation.

Both the legislation and HMRC have made it clear that an arrangement is not regarded as being varied if the variation is only connected with a replacement due to accidental damage or reasons that are beyond the control of all parties.

The variation of an arrangement is also disregarded if it is linked to an employee’s entitlement to statutory sick pay, maternity pay, adoption pay, paternity pay or shared parental pay.

For arrangements relating to school fees, the normal rules on variation and renewal relating to pre-6 April 2017 arrangements are disregarded. The tax treatment of pre-6 April 2017 arrangements is due to continue until 5 April 2021, as long as any post-6 April 2017 arrangement relates to the same employment, school and child.

Example 1

A given employee is entitled to an annual cash allowance of £600 (US$845), which they gave up to benefit from private medical insurance. The arrangement was entered into before 6 April 2017 and the transitional provisions applied.

On being promoted, the employee’s cash allowance entitlement increased to £800 (US$1,114) and so they decided to increase the level of their health cover. An agreement was made with their employer to give up the additional cash allowance and amend their medical insurance to the next higher level of cover. The OpRAs were varied when the promotion took place, and the transitional provisions no longer applied from that date.

Example 2

A second employee was entitled to an annual cash allowance of £600, which they gave up to benefit from private medical insurance. The arrangement was entered into before 6 April 2017 and the transitional provisions applied.

Under the terms of their original OpRA and medical insurance contract, the level of cover was automatically increased to the next highest level of cover when they were promoted. This meant that when the promotion took place, their insurance cover increased too.

The insurance cover was provided under the terms of the original arrangement, which was not varied. This meant that the employee was provided with benefits under the terms of the original arrangement and the transitional rules continued to apply to the higher level of cover.

But in the absence of any other guidance from HMRC as to what constitutes a variation, it is worth noting that all possibilities should be reviewed and considered. These might include:

• A new automatic remuneration package on being promoted to a new grade;
• Pay rises;
• Other reissuing of an individual’s employment contract if it changes the remuneration terms;
• Auto-renewal of arrangements;
• Other instances in which an employee’s condition of employment could change, for example, due to a secondment.

For further guidance, see HMRC’s Optional Remuneration Arrangements.

How straightforward are OpRA calculations?

OpRA calculations can be complex. The amount of earnings that are given up is compared to a modified benefit. If a given employee makes good on this amount, it will be ignored in the first instance.

The taxable benefit that arises is then reduced. This situation will usually affect an individual’s benefits if part of that benefit is provided under OpRA and the employee also contributes towards the benefit cost in other ways.

Example 1

An employer rented a property and paid a monthly rent to the landlord of £2,100 (US$2,924). Their employee entered into a salary sacrifice arrangement on 8 April 2017 and sacrificed £2,000 (US$2,785) per month. They also agreed to make good a further £250 (US$348) per month towards the cost of their accommodation, which was deducted from their net monthly pay.

The benefit in kind arising for 2017/18 was the higher of the earnings foregone of £24,000 (US$33,433) – that is £2,000 x 12 months - and the modified value of the benefit was £25,200 (US$35,104), which is the annual rent paid by the employer. No deduction was made in the comparison calculation for the additional amount made good by the employee in the year, which totalled £3,000 (US$4,179).

But the living accommodation benefit arising during 2017/18 was £22,200 (US$30,925) – that is, £25,200 less the £3,000 made good by the employee.

Example 2

An employee sacrificed £6,000 (US$8,358) in exchange for the use of a car and connected benefits. Some £5,200 (US$7,243) related to the use of the car and £800 to servicing, vehicle tax, insurance and breakdown recovery.

The modified cash equivalent of the benefit of the car was £5,000 (US$6,965). Comparing the amount foregone with the modified cash equivalent, the relevant amount of the car as a benefit was £5,200. The connected benefits were exempt and the taxable value of those benefits remained nil.

It is worth remembering that once the connected benefits and their underlying costs have been separately identified on a commercial basis, HMRC will be prepared to accept them.

Conclusion

All employers should consider the impact of this new legislation in light of any arrangements that they offer their employees. This is not least because the requirement to report a benefit type has the potential to be different for each employee, depending on whether all or part of that benefit was provided under an OpRA, when it commenced, was modified, varied or renewed.

It is also worth seeking specialist advice, where necessary, to ensure the tax reporting of the benefits being offered, are compliant with these new rules.

HMRC has made small changes to the 2017/18 P11D form to reflect these shifts, but it is easy to miss them. In particular, as P11D reporting approaches, it makes sense to focus on:

• Tracking arrangements, for example, at the start of employment or annual renewal;
• Ensuring employers know which arrangements are covered by the transitional rules and to note any changes;
• Calculating the reportable amount;
• Systems and processes that are capable of supporting the required calculations;
• Making certain that the correct amount has been taxed on payroll benefits;
• Ensuring that communications are effective in helping employees understand their P11D;
• Asking benefits/flex providers if they are able to provide suitable information;
• Knowing that yourP11D software will cope with OpRA;
• Checking on any potential problem areas with HMRC via non-statutory clearance applications, or your professional advisor.

Remember that getting things wrong can lead to unexpected liabilities and HMRC penalties. So given the complexities and ambiguities involved, employing reasonable care to ensure you comply with the rules is key.

Susan Ball is partner at Crowe Clark Whitehill LLP and heads up its Employers Advisory Group. She has more than 30 years’ experience focusing on UK and overseas employment tax, social security, investigations and rewards.  Susan also sits on the Council of the Chartered Institute of Taxation (CIOT) as well as on its Employment Taxes sub-committee.

Many UK employers are still not aware of the new rules covering flexible benefits/salary sacrifice or cash alternative arrangements that were introduced as long ago as 6 April 2017. These are known as the Optional Remuneration Arrangements rules (OpRA).

Any arrangements that have been offered to employees since April last year are covered by the new legislation and will be taxed on whichever is higher, the ‘Benefit-in-Kind’ or cash alternative rate, unless covered by one of several exemptions. But what about older arrangements?

With many questions still unanswered in the guidance from Her Majesty’s Revenue & Customs (HMRC), filing correct 2017/18 P11Ds will be tricky. For instance, one employer we know is trying to locate contracts from more than 20 years ago in order to work out their implications.

Overview of the rules

The new rules introduce the concept of ‘Type A’ and ‘Type B’ arrangements. The ‘Type A’ arrangement is normally a standard salary sacrifice-type offering. A ‘Type B’ arrangement, meanwhile, is one in which employees are given a choice between taking a benefit or a cash alternative.

The new legislation in S69A of the Income Tax (Earnings and Pensions) Act (ITEPA) 2003, summarises the different arrangements as follows:

• In ‘Type A’ arrangements, employees give up the right (or a future right) to receive an amount of earnings within Chapter 1 of Part 3 in return for a benefit;
• ‘In Type B’ arrangements, employees agree to be provided with a benefit rather than the amount of earnings described in Chapter 1 of Part 3.

The “restriction” applied by an OpRA covers both Type A and Type B arrangements regardless of whether they were entered into before, or after the beginning of, an individual’s employment. As a result, tax and national insurance charges arise on the higher of the amount foregone (the amount of salary sacrificed) and the modified cash equivalent of the benefit.

What is not included in the new rules?

Benefits or facilities provided via an OpRA from 6 April 2017, subject to the transitional arrangements, are only covered by existing exemptions from income tax if the exemption is either a ‘special case exemption’ or an ‘excluded’ one. A benefit or facility means anything that constitutes employment income or that is treated as arising to the employee regardless of how or in what form it was provided.

Special case exemptions ▼

A special case exemption means an exemption that is conferred by any of the following provisions:

• Section 289A ITEPA 2003 – Exemption for paid or reimbursed expenses;
• Section 289D ITEPA 2003 – Exemption for other benefits;
• Section 308B ITEPA 2003 – Exemption for independent advice relating to conversions and transfers of pension schemes;
• Section 312A ITEPA 2003 – Limited exemption for qualifying bonus payments;
• Section 317 ITEPA 2003 – Exemption for subsidised meals;
• Section 320C ITEPA 2003 – Exemption for recommended medical treatment;
• Section 323A ITEPA 2003 – Exemption for trivial benefits provided by employers.

Special case exemptions already have their own specific salary sacrifice rules. You should continue to apply them rather than the new rules when determining the taxable value of any benefit covered by such exemptions.

Excluded exemptions ▼

An excluded exemption means an exemption conferred by any of the following provisions:

• Section 239 ITEPA 2003 – Exemption for payments and benefits connected with taxable cars, vans and heavy goods vehicles;
• Section 244 ITEPA 2003 – Exemption for cycles and cyclist’s safety equipment;
• Section 266(2)( c) – Exemption for non-cash vouchers used in conjunction with the exemption for cycles and cyclist’s safety equipment;
• Section 270A – Limited exemption for qualifying childcare vouchers;
• Section 308 – Exemption for contributions to registered pension schemes;
• Section 308A – Exemption for contributions to overseas pension schemes;
• Section 308C – Exemption for the provision of pensions advice;
• Section 309 – Limited exemption for statutory redundancy payments;
• Section 310 – Exemption for counselling and other outplacement services;
• Section 311 – Exemption for retraining courses;
• Section318 – Exemption for employer-provided childcare;
• Section 318A – Limited exemption for other childcare provisions.

These exemptions are not affected by the new rules.

Taxable value of the benefit

If an employee receives a benefit as part of an OpRA, other than one of the excluded or exempt special benefits, its taxable value will be whichever is greater between the:

• Salary sacrificed for ‘Type A’ arrangements, or the cash allowance for ‘Type B’ arrangements;
• Cash value of the benefit.

In working out the cash value of the benefit, normal calculation rules are broadly amended as follows:

• The cash value of the benefit is deemed to be nil if, without the restriction being in place, the benefit would have been exempt from tax;
• Any amount made good is disregarded when calculating the cash value of the benefit. But the amount made good is deducted from the amount treated as earnings.

What is the situation with arrangements entered into before 6 April 2017?

The new rules apply to OpRAs entered into on, or after, 6 April 2017. But to address concerns about employees who are locked into salary sacrifice arrangements, the legislation does include grandfathering provisions that apply as follows for:

• Salary sacrifice arrangements entered into before 6 April 2017 (even if the arrangements take effect after 6 April 2017). Here the restriction applies from 6 April 2018 unless the arrangement has ended, varied or renewed before then, or the following provision applies;
• Cars, accommodation and school fees until 6 April 2021, unless the arrangement is ended, varied or renewed before then.

An example based on car benefits

The car benefit charge for a vehicle ‘provided’ after 6 April 2017 under OpRA is now whichever is higher between the:

• ‘Normal Benefit Charge’ (list price x appropriate % based on CO² emissions and fuel type);
• Amount of salary foregone in relation to the benefit.

As of 6 April 2017, the new rules applied:

• To any new employees;
• If an arrangement between an employee and employer is varied in relation to the benefit in kind;
• If the arrangement was renewed;
• When the grandfathering provisions lapsed.

All car arrangements entered into before 6 April 2017 are covered by the grandfathering provisions and will move to the new rules as of 6 April 2021, unless they are varied or renewed before then, in which case the new rules will apply from the date of the change.

Variations or renewals

Employers will need to carefully consider the grandfathered OpRA conditions as any ‘variation’ to the terms may lead to grandfathering status being lost from the date of the variation.

Both the legislation and HMRC have made it clear that an arrangement is not regarded as being varied if the variation is only connected with a replacement due to accidental damage or reasons that are beyond the control of all parties.

The variation of an arrangement is also disregarded if it is linked to an employee’s entitlement to statutory sick pay, maternity pay, adoption pay, paternity pay or shared parental pay.

For arrangements relating to school fees, the normal rules on variation and renewal relating to pre-6 April 2017 arrangements are disregarded. The tax treatment of pre-6 April 2017 arrangements is due to continue until 5 April 2021, as long as any post-6 April 2017 arrangement relates to the same employment, school and child.

Example 1

A given employee is entitled to an annual cash allowance of £600 (US$845), which they gave up to benefit from private medical insurance. The arrangement was entered into before 6 April 2017 and the transitional provisions applied.

On being promoted, the employee’s cash allowance entitlement increased to £800 (US$1,114) and so they decided to increase the level of their health cover. An agreement was made with their employer to give up the additional cash allowance and amend their medical insurance to the next higher level of cover. The OpRAs were varied when the promotion took place, and the transitional provisions no longer applied from that date.

Example 2

A second employee was entitled to an annual cash allowance of £600, which they gave up to benefit from private medical insurance. The arrangement was entered into before 6 April 2017 and the transitional provisions applied.

Under the terms of their original OpRA and medical insurance contract, the level of cover was automatically increased to the next highest level of cover when they were promoted. This meant that when the promotion took place, their insurance cover increased too.

The insurance cover was provided under the terms of the original arrangement, which was not varied. This meant that the employee was provided with benefits under the terms of the original arrangement and the transitional rules continued to apply to the higher level of cover.

But in the absence of any other guidance from HMRC as to what constitutes a variation, it is worth noting that all possibilities should be reviewed and considered. These might include:

• A new automatic remuneration package on being promoted to a new grade;
• Pay rises;
• Other reissuing of an individual’s employment contract if it changes the remuneration terms;
• Auto-renewal of arrangements;
• Other instances in which an employee’s condition of employment could change, for example, due to a secondment.

For further guidance, see HMRC’s Optional Remuneration Arrangements.

How straightforward are OpRA calculations?

OpRA calculations can be complex. The amount of earnings that are given up is compared to a modified benefit. If a given employee makes good on this amount, it will be ignored in the first instance.

The taxable benefit that arises is then reduced. This situation will usually affect an individual’s benefits if part of that benefit is provided under OpRA and the employee also contributes towards the benefit cost in other ways.

Example 1

An employer rented a property and paid a monthly rent to the landlord of £2,100 (US$2,924). Their employee entered into a salary sacrifice arrangement on 8 April 2017 and sacrificed £2,000 (US$2,785) per month. They also agreed to make good a further £250 (US$348) per month towards the cost of their accommodation, which was deducted from their net monthly pay.

The benefit in kind arising for 2017/18 was the higher of the earnings foregone of £24,000 (US$33,433) – that is £2,000 x 12 months - and the modified value of the benefit was £25,200 (US$35,104), which is the annual rent paid by the employer. No deduction was made in the comparison calculation for the additional amount made good by the employee in the year, which totalled £3,000 (US$4,179).

But the living accommodation benefit arising during 2017/18 was £22,200 (US$30,925) – that is, £25,200 less the £3,000 made good by the employee.

Example 2

An employee sacrificed £6,000 (US$8,358) in exchange for the use of a car and connected benefits. Some £5,200 (US$7,243) related to the use of the car and £800 to servicing, vehicle tax, insurance and breakdown recovery.

The modified cash equivalent of the benefit of the car was £5,000 (US$6,965). Comparing the amount foregone with the modified cash equivalent, the relevant amount of the car as a benefit was £5,200. The connected benefits were exempt and the taxable value of those benefits remained nil.

It is worth remembering that once the connected benefits and their underlying costs have been separately identified on a commercial basis, HMRC will be prepared to accept them.

Conclusion

All employers should consider the impact of this new legislation in light of any arrangements that they offer their employees. This is not least because the requirement to report a benefit type has the potential to be different for each employee, depending on whether all or part of that benefit was provided under an OpRA, when it commenced, was modified, varied or renewed.

It is also worth seeking specialist advice, where necessary, to ensure the tax reporting of the benefits being offered, are compliant with these new rules.

HMRC has made small changes to the 2017/18 P11D form to reflect these shifts, but it is easy to miss them. In particular, as P11D reporting approaches, it makes sense to focus on:

• Tracking arrangements, for example, at the start of employment or annual renewal;
• Ensuring employers know which arrangements are covered by the transitional rules and to note any changes;
• Calculating the reportable amount;
• Systems and processes that are capable of supporting the required calculations;
• Making certain that the correct amount has been taxed on payroll benefits;
• Ensuring that communications are effective in helping employees understand their P11D;
• Asking benefits/flex providers if they are able to provide suitable information;
• Knowing that yourP11D software will cope with OpRA;
• Checking on any potential problem areas with HMRC via non-statutory clearance applications, or your professional advisor.

Remember that getting things wrong can lead to unexpected liabilities and HMRC penalties. So given the complexities and ambiguities involved, employing reasonable care to ensure you comply with the rules is key.

Susan Ball is partner at Crowe Clark Whitehill LLP and heads up its Employers Advisory Group. She has more than 30 years’ experience focusing on UK and overseas employment tax, social security, investigations and rewards.  Susan also sits on the Council of the Chartered Institute of Taxation (CIOT) as well as on its Employment Taxes sub-committee.