Optional remuneration arrangements (480: Appendix 12)
Find out about the rules when a benefit is provided as part of optional remuneration arrangements.
Overview
Schedule 2 Finance Act 2017
From 6 April 2017 where a benefit is given as part of optional remuneration arrangements, the rules for valuing the amount of the benefit treated as earnings from the employee’s employment has changed.
Section 69A
Optional remuneration arrangements are arrangements where the employee gives up the right, or the future right, to salary (known as salary sacrifice) or the right to some other form of salary or cash pay in return for the benefit.
Where a benefit is given under optional remuneration arrangements, the value of the benefit treated as earnings from the employment is the greater of the amount of:
- salary or cash pay given up by the employee in return for the benefit
- the benefit treated as earnings from the employment under the normal rules, ignoring any amount made good, as outlined in this guide
Sections 228A(1)
Except in certain limited circumstances, the normal exemptions from Income Tax do not apply when the benefit is given under optional remuneration arrangements. Where the benefit would otherwise be exempt from tax under one of the exemptions in Part 4 of ITEPA, the value of the benefit to be compared with the amount foregone is deemed to be nil. The amount of the benefit treated as earnings is therefore equal to the amount foregone.
Paragraphs 62(3) to (15) Schedule 2 Finance Act 2017
Where the employee entered into the optional remuneration arrangements before 6 April 2017 transitional rules may apply. Subject to certain limited exceptions, arrangements entered into before 6 April 2017 are still covered by the normal benefit valuation rules until the earlier of:
- variation, renewal or modification of the arrangement
- 6 April 2018
Those exceptions are cars with emissions of more than 75g CO2/km, living accommodation and school fees which are all protected until the earlier of:
- variation, renewal, modification of the arrangements
- 6 April 2021
Special rules also apply for school fees (see paragraph 20).
1 What are optional remuneration arrangements?
Section 69A(2) to (4)
1.1
Optional remuneration arrangements are arrangements where the employee is given a benefit in return for giving up some form of salary, cash pay or allowance. A benefit is given under optional remuneration arrangements if the employee is given that benefit under arrangements where the employee:
- gives up the right, or the future right, to receive an amount of salary (commonly called salary sacrifice)
- agrees to be provided with the benefit rather than an amount of cash pay
1.2
Where a benefit is given under optional remuneration arrangements, the employee continues to be taxed on the benefit they have been provided with. However, the value of the benefit that’s treated as earnings from the employment is the greater of the:
- cash amount foregone
- value of the benefit treated as earnings under the normal benefit valuation rules
This value is called the ‘relevant amount’.
1.3
When making the comparison, ignore any amounts made good. However, once you’ve determined the relevant amount, in most cases the taxable amount is reduced by any amount made good by 6 July following the end of the tax year in which the benefit was given.
Example 1
An employer provides an employee with private medical insurance that costs it £500. The employee gives up her right to salary of £600. The relevant amount treated as earnings from the employment is £600, being the greater of the cost of providing the benefit (£500) and the amount foregone (£600). If the employee then makes good £50, this reduces the relevant amount by £50 to leave an amount treated as earnings from the employment of £550.
Different types of benefit
2 Vouchers and credit tokens
Where an employee is given a voucher under optional remuneration arrangements, the relevant amount treated as earnings from the employment is the greater of the:
- sum of money for which the voucher is capable of being exchanged
- amount of salary or cash pay the employee has foregone in relation to the voucher
Where a non-cash voucher or credit token is provided, the comparison with the amount foregone is with the cost of providing the voucher or credit-token.
Example 2
An employee is provided with a gift card which they can use to buy goods to the value of £500 from a high street retailer in return for giving up salary of £500. The employer receives a discount when it buys the voucher which costs it £450. The cost of providing the non-cash voucher of £450 is compared with the salary foregone of £500. The employee is taxed on a benefit of £500 which is equal to the amount foregone.
3 Living accommodation
Where an employee is given living accommodation under optional remuneration arrangements, the relevant amount treated as earnings from the employment is the greater of the:
- living accommodation benefit calculated under the normal rules
- amount of cash pay foregone by the employee in relation to the provision of the accommodation.
In working out the living accommodation benefit to be compared with the amount foregone, do not take into account any amount made good or rent paid by the employee.
Example 3
An employer rents a property for £12,000 a year which one of its employees occupies. The employee needs to pay rent of £3,000 per year to the employer and also sacrifices salary of £3,000. The rent of £12,000 paid by the employer is compared with the amount of £3,000 sacrificed by the employee. The relevant amount is the higher amount of £12,000. The employee is taxed on this amount less the rent paid of £3,000.
Where living accommodation is given under optional remuneration arrangements, the living accommodation exemptions do not apply.
Cars available for private use
4 Cars with CO2 emissions of 75 grams or less
The optional remuneration arrangement rules do not apply to cars with CO2 emissions of 75 grams per kilometre (km) or less. Cars with CO2 emissions of 75 grams/km or less continue to be taxed on the cash equivalent of the benefit worked out under the normal rules without having to make a comparison with the salary foregone.
Example 4
An employee is given a low emission car which is available for their private use under an optional remuneration arrangement in which the employee gives up salary of £150 per month, or £1,800 per year. The car has CO2 emissions of 70g per kilometre. The car has a list price of £11,500 and a cash equivalent value of £1,495 (£11,500 x 13%). The relevant amount to be treated as earnings from the employment is £1,495 because its CO2 emissions are no more than 75 grams.
5 Cars with CO2 emissions of more than 75 grams
Cars made available for private use with emissions of more than 75 grams of CO2 per kilometre are covered by the optional remuneration arrangement rules. In order to determine the relevant amount to be treated as earnings from the employment, find the greater of the:
- modified cash equivalent of the benefit
- amount foregone in relation to the provision of the benefit
The modified cash equivalent is the amount which would be the cash equivalent under the normal benefit rules but ignoring any capital contributions made by the employee and any payments the employee is required to make for private use.
If the amount foregone by the employee is greater than the modified cash equivalent, then make a deduction for any capital contribution. For tax years 2017 to 2018 and 2018 to 2019, the deduction is given by multiplying any capital contribution (up to the maximum of £5,000) by the appropriate percentage – see example 5.
From 2019 to 2020 onwards, there is an additional step.
After multiplying the capital contribution (up to a maximum of £5,000) by the appropriate percentage, the result should be multiplied by the ‘availability factor’. This is found by taking the number of days in the tax year, subtracting the number of days in that year that the car was unavailable, and dividing the answer by the number of days in the tax year.
The result is the amount of the capital contribution allowed in the tax year (this step will only be needed where the car is available for less than the full tax year) – see example 5a.
A deduction is then given for any private use contribution. The result is the relevant amount which is treated as earnings from the employment.
Example 5
An employee is given a car in the 2017 to 2018 tax year in return for giving up £300 salary per month or £3,600 per year. The car has a list price of £20,000 and an appropriate percentage of 17%. The employee also makes a capital contribution of £1,500 for a higher specification vehicle. The cash equivalent value of the vehicle would normally be £3,145 (£20,000 less capital contribution £1,500 =£18,500 x 17%). The modified cash equivalent is, however, £3,400 as no account is taken of the capital contribution.
The modified cash equivalent is then compared with the amount foregone of £3,600. The amount foregone of £3,600 is greater, so this amount is used in determining the relevant amount.
The relevant amount to be treated as earnings is £3,600 less £255 (capital contribution of £1,500x 17%) = £3,345.
Example 5a
An employee has a car made available to them in the tax year 2019 to 2020 under the terms of an optional remuneration arrangement under which they give up £300 per month.
The car is first made available on 6 October 2019 and as in example 1 above, the employee also makes a capital contribution of £1,500 for a higher specification vehicle.
The car has a list price of £20,000 and an appropriate percentage of 17%.
The modified cash equivalent of the car will be £1,700 (£20,000 x 17%) = £3,400 less deduction for unavailability.
The availability factor here is 0.5 (366-183/366) £3,400 x 0.5 = £1,700.
The modified cash equivalent is then compared to the amount foregone £1,800 (£300 x 6 months). The amount foregone is greater than the modified cash equivalent (£1,700) and so £1,800 is used to determine the relevant amount.
The relevant amount to treat as earnings is £1,800 minus £128 (capital contribution of £1,500 x 17% x 0.5 availability factor) = £1,672.
5.1 Trading up
Employees may be given a car partly through optional remuneration arrangements and partly through a personal contribution out of net pay. When determining the relevant amount, only the amount foregone under the optional remuneration arrangements should be taken into account.
Example 6
An employee has the option of a cash allowance of £5,000 which she gives up for a car with a modified cash equivalent of £3,000. However, the employee wants a higher specified model with leather seats costing a further £500. They make a payment of £500 to the employer out of her taxed pay. The amount foregone is £5,000 which is compared with the modified cash equivalent of £3,000. The relevant amount is £5,000. A deduction of £85 (£500 x 17%) is then made for the capital contribution of £500.
6 Vans available for private use
Where a van is made available to an employee, the relevant amount to be treated as earnings from the employment is the greater of the:
- modified cash equivalent of the benefit of the van
- amount foregone with respect to the benefit of the van
The modified cash equivalent in relation to the benefit of a van means the amount which would be the cash equivalent under the normal rules, but ignoring any payments made by the employee for the private use of the van.
Once the relevant amount has been determined a deduction is then made for any private use contribution made by the employee that they needed to make as a condition of being able to use the van privately.
Example 7
An employee is given the use of a van that they can use privately under an optional remuneration arrangement. As part of the arrangement the employee has agreed to give up £300 salary each month. The employee makes no further payments for the private use of the van.
The modified cash equivalent of the benefit of the van is calculated under the normal method for the tax year 2017 to 2018 as £3,230.
The relevant amount to be treated as earnings is the higher of the modified cash equivalent of the benefit and the amount foregone, which in this case is £3,600 (£300 x 12).
7 Car and van fuel
Where fuel is made available to an employee who’s chargeable to tax for a car or van, under an optional remuneration agreement, the relevant amount to be treated as earnings from the employment is the greater of the:
- cash equivalent of the benefit of the fuel
- amount foregone with respect to the benefit of the fuel
Example 8
An employee has a car with an appropriate percentage of 20% made available to them for the duration of the tax year 2017 to 18. The employee enters into an optional remuneration arrangement with their employer under which they give up a £400 per month cash allowance in return for car fuel.
The cash equivalent of the benefit of the fuel is £4,520 (the fixed amount of £22,600 multiplied by the appropriate percentage). The cash allowance foregone of £4,800 (£400 x 12) is the relevant amount to be treated as earnings.
No deduction is given from the relevant amount for the fuel benefit for any private use payments.
8 Beneficial loans
Where a taxable cheap loan is made available to an employee under an optional remuneration arrangement and the amount of salary or cash pay foregone is greater than the interest that would have been payable on the loan at the official rate of interest, the relevant amount to treat as earnings from the employment for the tax year is the amount of:
- salary or cash pay foregone, less
- any interest paid on the loan for the tax year
If the amount foregone is less than the interest that would have been payable on the loan at the official rate of interest then apply the normal rules for determining the amount treated as earnings from the employment.
Example 9
An employee has an interest-free loan of £15,000 made available by their employer outstanding for the tax year 2017 to 2018, when the official rate of interest is 2.5%. The interest that would be payable on the loan at the official rate of interest is £375.
The employee agrees under an optional remuneration arrangement to waive his bonus for the tax year of £400 in return for which he does not have to pay interest on the loan. The amount of £400 foregone is greater than the interest of £375 that would be payable at the official rate of interest.
The amount treated as earnings from the employment is £400. This is the amount of £400 foregone less any interest paid (nil) on the loan for the tax year.
9 General employment-related benefits
Where an employment-related benefit, treated as earnings from the employment as a general benefit under Chapter 10 of Part 3 of ITEPA, is given to an employee under an optional remuneration agreement, the relevant amount treated as earnings from the employment for the tax year is the greater of the:
- cost of providing the benefit
- amount foregone with respect to the benefit
When determining the taxable value of the benefit and whether to use the cost of providing the benefit or the amount foregone, any amount made good by the employee is not taken into account. However, if any amount has been made good by 6 July following the end of the tax year in which the benefit was given, this should be deducted from the relevant amount in determining the amount chargeable to tax.
Example 10
An employer provides an employee with medical insurance costing £500. The employee is required to sacrifice salary of £600. The relevant amount is £600, being the greater of the cost of providing the benefit and the amount foregone. If the employee then makes good an amount of £100 within the time permitted, the amount chargeable to tax is reduced to £500.
9.1 Payments where employee absent because of sickness or disability
Payments by an employer to give an employee with the right to get sickness or disability payments are normally excluded from being taxed. Where such benefits are provided under optional remuneration arrangements, the exclusion does not apply. The value of the benefit is the greater of the:
- cost of providing the benefit
- amount of salary or cash pay foregone by the employee
Example 11
An employer arranges sickness pay cover for its employees through an insurance policy to pay out an amount to them as sick pay.
The employer arranges a basic level of cover for its employees without requiring its employees to contribute. However, the employer arranges a higher level of sick pay that costs it £40 for employees who salary sacrifice £50 to cover the additional premium.
The basic level of cover is an excluded benefit and is not treated as earnings from the employment. However, the employee will pay tax on £50 for the higher level of cover. Since that part of the benefit is provided under optional remuneration arrangements it’s not covered by the exclusion.
9.2 Transfer of assets
The optional remuneration rules apply in the same way as for other employment-related benefits where an asset is made available for an employee’s use or is transferred to an employee after having been provided for the employee’s use as an employment-related benefit.
Chapter 6 paragraph 6.9 of this guide explains how to work out the value of the benefit where an asset is transferred to an employee. Where the calculation requires any sums already taken into account in taxing benefits derived from the use of that asset in an earlier year then use the amounts for those years as if the optional remuneration arrangement rules had not applied in those years.
Example 12
An employer provides its employee with the use of a computer for 3 years. The employee sacrifices £300 each year. The market value of the computer when first provided for the employee’s private use was £1,200. The cost of the benefit is £240. The employee makes a payment of £300 under salary sacrifice and is given the computer at the start of year 4.
In years 1, 2 and 3, the amount foregone in each of those years (£300) is compared with the cost of the benefit (£240). The relevant amount is the greater of the 2: £300. The amount of £300 is treated as earnings from the employment for each of those years.
In year 4, when the asset has a market value of £300, the employee is given the asset in return for foregoing £300. To work out the benefit for year 4 take the higher of the market value at the date of transfer (£300) and compare with the market value when first applied as an employment-related benefit (£1,200) less the cost of the benefit in each of the tax years when provided as an employment-related benefit (3 x £240 = £720).
This gives the cost of the benefit as £480 (£1,200 -£720). This is higher than the amount foregone of £300 so the relevant amount treated as earnings from the employment in year 4 is £480.
10 Definition of benefit
The definition of benefit is widely drawn to include any benefit or facility within the benefits code, regardless of its form or the manner in which it is provided.
However, this does not include arrangements under which an employee reduces their working hours or becomes entitled to additional unpaid holidays. The employee is simply reducing their working hours and having their pay adjusted to take account of this.
Similarly, where an employee’s pay is reduced because of changes to their working pattern they’re not being provided with a benefit. For example, where an employee gives up their shift allowance because they no longer work shifts.
11 Exemptions
Benefits provided under optional remuneration arrangements are not covered by the existing exemptions within Part 4 of ITEPA 2003 except in certain limited circumstances. Where a benefit would otherwise be covered by one of the exemptions the value of the benefit to be compared with the amount foregone in determining the relevant amount is nil. The relevant amount, therefore, is the amount foregone.
Example 13
An employee is provided with the use of a workplace gym in return for sacrificing £300 per year. The benefit would otherwise be exempt from tax under section 261. The exemption does not apply because the benefit of the workplace gym is provided under optional remuneration arrangements. The cost of the benefit is treated as nil. The relevant amount is the salary foregone of £300. The employee is taxed on a benefit of £300.
11.1 Approved Mileage Allowance Payments (AMAPs)
Employees are sometimes provided with mileage allowance payments under optional remuneration arrangements. The exemption for mileage allowance payments does not apply when they’re paid under such arrangements. The taxable amount is the amount foregone by the employee.
Example 14
An employer pays 20p per mile to its employees when they use their own cars for business journeys. The employees then sacrifice 25p per mile and the employer tops up the mileage allowance payment to make a total payment of 45p per mile. The amount of 25p paid to the employee under salary sacrifice is taxable.
12 Excluded exemptions
The exception to this is where an exemption is an ‘excluded exemption’. Excluded exemptions apply as normal where the benefit is provided under optional remuneration arrangements. They cover payments by employers into registered pension schemes, childcare vouchers, (closed to new applicants from 4 October 2018) workplace nurseries, and directly contracted employer provided childcare (closed to new applicants from 4 October 2018), bicycles and cyclist safety equipment (including Cycle to Work).
More specifically, the following are excluded exemptions:
| Section 239 | payments and benefits connected with taxable cars, vans and heavy goods vehicles |
| Section 244 | cycles and cyclist’s safety equipment |
| Section 266(2)(c) | 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 307 | only as far as the exemption applies to the provision of retirement benefits |
| Section 308 | contributions to registered pension schemes |
| Section 308A | contributions to overseas pension schemes |
| Section 308C | provision of pensions advice |
| Section 309 | statutory redundancy payments |
| Section 310 | counselling and other outplacement services |
| Section 311 | retraining courses |
| Section 318 | childcare: exemption for employer-provided care |
| Section 318A | childcare: limited exemption for other care |
The exemption under section 307 is only treated as an excluded exemption to the extent that the benefits provided are for retirement benefits.
Where the employee is provided with death benefits (for example, the employer takes out a life assurance policy to provide death in service benefits) then the exemption does not apply when provided under optional remuneration arrangements.
Apart from these excluded exemptions, the optional remuneration arrangement rules also do not apply where the benefit is a car with CO2 emissions of no more than 75g kilometre.
13 Transitional provisions
Subject to certain specific exceptions, optional remuneration arrangements entered into before 6 April 2017 are not affected by the optional remuneration arrangement rules until the earlier of:
- variation, renewal or modification of the arrangements
- 6 April 2018
Those exceptions are where the benefit given is a car with emissions of more than 75g CO2/km, living accommodation and school fees which are protected until the earlier of:
- a variation, renewal, modification of the arrangements
- 6 April 2021
Special rules also apply for school fees (see paragraph 20).
13.1
An arrangement is not regarded as being varied if the variation of the arrangement is for reasons beyond the control of the employer and employee. For example, because the employee is involved in an accident and their car has to be replaced as a result. Variation of an arrangement is also ignored if the variation is in connection with the employee’s entitlement to statutory maternity pay, statutory adoption pay, statutory paternity pay, statutory shared parental pay or statutory parental bereavement pay.
Additionally, where a variation arises under a specific term of the arrangement then this is not treated as a variation of the arrangement.
Example 15
An employee enters into an optional remuneration arrangement for the provision of a car where the amount of salary sacrificed is linked to the mileage driven by the employee. The employee exceeds a particular mileage threshold during the 2017 to 2018 tax year. As a result of this the amount the employee has to pay increases and an additional amount is deducted from his salary. Although the amount sacrificed has increased, this is not a variation of the arrangement and the transitional rules can continue to apply.
13.2
Where an employee changes or renews their arrangement on or after 6 April 2017, the date of change or renewal is taken as the date the optional remuneration arrangement rules comes into effect with respect to the benefit being provided.
13.3
For cars with CO2 emissions of more than 75g per kilometre, accommodation and school fees, where transitional arrangements apply, the new rules come into effect on the earlier of:
- change, renewal, or modification of the arrangement
- 6 April 2021
Where the benefit is reduced school fees or a free school place in a fee paying school, provided the original arrangements were entered into before 6 April 2017, even where a new contract is entered into, the transitional provisions continue to apply until 5 April 2021 provided the new contract relates to the same:
- employment with the same employer
- school
- child
The overall identity of the school is important in determining whether the child is at the same school during the transitional period. For example, if the child moves from the junior to senior school, or senior school to sixth form within the same school, this is treated as being with the same school.
13.4
Arrangements entered into before 6 April 2017 may be covered by the transitional provisions even where those arrangements did not come into effect until on or after 6 April 2017.
Example 16
An employer and employee entered into a salary sacrifice agreement on 1 January 2017 under which the employee sacrifices part of their salary in return for being given a car. The car is not delivered until 1 July 2017 at which point the employee’s salary is reduced.
The salary sacrifice arrangement was put into place before 6 April 2017 and may be covered by the transitional rules even though the arrangement was not put into effect until July 2017.
Updates to this page
Published 30 December 2019Last updated 1 April 2020 + show all updates
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Includes Statutory Parental Bereavement Pay in the list of employee's entitlements.
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First published.