The European Court of Justice's ruling on the VAT status of retail vouchers could have wide implications for salary sacrifice, says Jennifer Paterson

Last month, the European Court of Justice (ECJ) ruled that employees must pay value-added tax (VAT) on retail vouchers bought through salary sacrifice arrangements. In the case of AstraZeneca, the ECJ ruled that the employer must account for the VAT on vouchers bought through salary sacrifice, but that AstraZeneca can reclaim the VAT incurred on purchasing the vouchers.

The ECJ's decision has led to speculation about how the UK government will review VAT under this type of scheme and what this will mean for employers that offer them.

HM Revenue and Custom (HMRC) said AstraZeneca was either not entitled to reclaim this input VAT, or, if it was entitled, it must thereafter account for output VAT on the value of vouchers provided to staff, on a sum equal to the salary sacrificed by the employee. David Hewison, associate director in employment tax and incentives at Smith and Williamson, said: "The ECJ decided that if employers are using salary sacrifice to provide retail vouchers, they are making a supply for value and must account for VAT on the way out."

UK government to decide

The ruling has now been passed to the UK government to decide whether to review VAT under salary sacrifice. Giles Salmond, director of the tax dispute resolution group at Deloitte, said: "What it will mean will depend on how the UK government and, ultimately, HMRC, react to it. We are hoping it will be neutral for employers."

The implications of the ruling on other salary sacrifice arrangements are also generating some debate. Hewison added: "It is much more about VAT than it is about employee benefits, but it could have an effect for salary sacrifice arrangements where the benefits that salary is being sacrificed to take have a VAT charge attached to them."

But it is still unclear whether the ruling will apply to other salary sacrifice arrangements. Graham Muir, partner and head of employment tax at law firm Nabarro, said: "It will be quite easy for HMRC to restrict this case to the particular circumstances of a retail voucher scheme, provided as a deduction from salary, in which case it may not have much of an impact on employers."

But few employers offer retail vouchers paid for via salary sacrifice, said Andrew Johnson, director general of the UK Gift Card and Voucher Association. "Salary sacrifice in relation to retail vouchers accounts for less than 3% of the UK's £4 billion voucher industry," he pointed out.

Salary sacrifice arrangements

While the UK government considers the case, employers should be deciding whether salary sacrifice arrangements, and particularly retail voucher schemes funded in this way, are viable. Steve Hodgetts, VAT partner at Baker Tilly, said: "They should consider whether they have an exposure to a retrospective VAT charge, and take steps to mitigate those costs in the future."

Employers should also consider the VAT increase to 20% in January 2011. Alastair Kendrick, director of employment tax services at Mazars, said: "It may well be we see the voucher idea removed from benefits plans. We are going to see that, in many cases, this is no longer a feasible way of dealing with remuneration."

Employers should also review their scheme documentation and operation, said Marc Welby, VAT partner at BDO.

"They need to be sure that, if HMRC comes and says it now wants to collect VAT on the salary sacrificed, employers can pass that VAT on [to staff].

"It is wider than retail vouchers, but it will not necessarily result in VAT on every salary sacrifice arrangement, because some are VAT-exempt. Employers have to look at what the employee is getting and whether the benefit would be liable to VAT in the open market."

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