Salary Sacrifice & VAT Explained: What You Need to Know
Salary sacrifice schemes have grown in popularity across the UK, especially for electric vehicles. These arrangements involve an employee agreeing to reduce their gross salary in exchange for a non-cash benefit. Understanding how VAT works with these schemes can help both employers and employees navigate the system effectively.
Salary sacrifice schemes have grown in popularity across the UK, especially for electric vehicles. These arrangements involve an employee agreeing to reduce their gross salary in exchange for a non-cash benefit. Understanding how VAT works with these schemes can help both employers and employees navigate the system effectively.
Whether you're an employer considering implementing a salary sacrifice scheme or an employee thinking about participating in one, understanding the VAT treatment is crucial to maximising the benefits and ensuring compliance with HMRC regulations.
How VAT Works with Salary Sacrifice
Salary sacrifice is an arrangement where an employee agrees to reduce their gross salary in exchange for a non-cash benefit, such as an electric car. From a VAT perspective, this creates an interesting situation because the transaction essentially involves:
The employer obtains a vehicle from a supplier (with VAT)
The employer provides this vehicle to the employee in exchange for reduced salary
VAT applies at the standard rate (currently 20%) to most goods and services in the UK, including vehicle leases. When an employer enters a leasing agreement for a vehicle used in a salary sacrifice arrangement, the leasing company charges VAT on the lease payments.
VAT Recovery Considerations
For employers, several factors affect VAT recovery:
Business purpose transactions may allow for VAT recovery
Private use expenses generally have limited VAT recovery
Partial exemption may apply to businesses making both taxable and exempt supplies
With business contract hire leases (such as those of EV salary sacrifice schemes), VAT recovery is typically restricted to 50% of the VAT charged on lease payments. This is known as the 'blocking order' and applies regardless of actual private use.
Employees participating in these schemes don't directly deal with VAT. From their perspective, they agree to a reduction in gross salary in exchange for the benefit of a car, with the cost being inclusive of VAT.
HMRC's Perspective
HMRC views salary sacrifice schemes as:
A supply of services (the vehicle) from the employer to the employee
A consideration (the salary sacrifice) from the employee to the employer
This means that, in principle, employers should account for output VAT on the supply of benefits to employees. However, HMRC guidance suggests that with genuine salary sacrifice arrangements, they generally accept that no supply takes place for VAT purposes.
Electric Vehicles and Salary Sacrifice
The popularity of electric vehicle salary sacrifice schemes has increased due to:
Favourable Benefit-in-Kind (BIK) rates for electric vehicles
Environmental considerations and corporate sustainability goals
Lower running costs of electric vehicles compared to petrol or diesel alternatives
Government push towards electric vehicles ahead of the 2030 ban on new petrol and diesel cars
VAT Treatment for Electric Vehicles
This growth has brought increased attention to the VAT implications specific to electric vehicles in salary sacrifice schemes. Although they are generally treated the same way as conventional vehicles, some specifics may differ.
For example, whilst chargers, cables, and electricity are generally subject to VAT - some businesses are increasingly interested in VAT recovery for business use of those items.
Businesses considering implementing an electric car scheme for employees should be aware of VAT recovery rules, and seek their own financial advice when setting up a scheme, to avoid unintended pitfalls around tax reporting.
There is ongoing discussion about potential future changes to VAT treatment of electric vehicles as part of the government's environmental initiatives.
Compliance and Record-Keeping
Proper documentation is essential for VAT compliance in salary sacrifice schemes:
Salary sacrifice agreements: Clearly documenting the reduction in gross salary and the benefit provided
Lease agreements: Full details of vehicles, payment terms, and VAT charged
Benefit valuation: Documentation showing how the benefit value is calculated
Mileage records: If claiming VAT on fuel or electricity, business vs private mileage should be recorded
It is important for businesses to maintain records for the standard VAT record-keeping period (normally 6 years), and to seek appropriate advice when necessary to ensure ongoing compliance.
Consider consulting with a VAT specialist before implementing a salary sacrifice scheme to help your business set up robust systems to track and document all aspects of the arrangement. Regularly reviewing the scheme and promptly answering any salary sacrifice questions in conjunction with current HMRC guidance is crucial to ensure ongoing compliance as guidance may change.
Future Considerations
Spring Budget 2025: Changes to VAT Rules Affecting Salary Sacrifice
While no specific VAT changes have been announced at the time of writing, businesses should stay alert to potential reforms, particularly as the government continues to develop its environmental taxation strategy.
Changes to BIK Rates for Electric Vehicles
BIK rates for electric vehicles are confirmed until 2029, with rates rising gradually:
| undefined | 2024/25 | 2025/26 | 2026/27 | 2027/28 | 2028/29 | 2029/30 |
|---|---|---|---|---|---|---|
| BiK % (EV) | 2% | 3% | 4% | 5% | 7% | 9% |
These increases, while modest, will affect the overall cost of electric vehicle salary sacrifice schemes and the associated VAT calculations. It must be noted that BiK for petrol and diesel cars has a maximum rate of 37% - and depends on the P11D value of the vehicle as well as its emissions.
When compared to petrol and diesel - EV BiK remains much cheaper - especially when considering the fact that it is flat - and does not change based on the value of the EV.
Post-Brexit Implications for VAT Treatment
Following Brexit, the UK has greater freedom to set its own VAT rules. This could potentially lead to:
Specific VAT reliefs for electric vehicles to support environmental goals
Simplification of VAT recovery rules for businesses
Changes to VAT treatment of imported vehicles and parts
Conclusion
VAT in the context of salary sacrifice schemes, particularly for electric vehicles, presents a complex but important area of consideration for both employers and employees. Understanding the principles of VAT recovery, keeping appropriate records, and staying informed about regulatory changes are all crucial aspects of maximising the benefits of these arrangements.
As the UK continues its transition to electric vehicles and workplace benefits evolve, the VAT landscape will likely continue to develop. By working with tax professionals and staying informed of changes, businesses can ensure they remain compliant while offering attractive benefits to employees.
For employers considering implementing an electric vehicle salary sacrifice scheme, the potential VAT implications should be carefully considered alongside the other tax efficiencies and environmental benefits these arrangements can offer.
Are you looking to set up an EV salary sacrifice scheme at your company? Book a call to see how we can assist you.
Please note, The Electric Car Scheme does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors should you require advice.
Last updated: 21.03.25
