Temporary workers, salary sacrifice and travel expenses (First-tier Tribunal)

Practical Law UK Legal Update Case Report 3-517-4673 (Approx. 10 pages)

Temporary workers, salary sacrifice and travel expenses (First-tier Tribunal)

by PLC Tax

Background

Tax relief for travel expenses

If an employee is obliged to undertake a business journey as part of the duties of their employment, the reimbursement of the cost of the journey (and certain associated subsistence costs) by the employer is free of tax and national insurance contributions (NICs). Travel between home and a permanent workplace is not a business journey but is ordinary commuting. Accordingly, the reimbursement of the cost of ordinary commuting is taxable. However, travel between home and a temporary workplace is a business journey. A temporary workplace is one at which the employee works for less than 24 months.

An employee who works under an "overarching employment contract" for an employment agency and who works for a number of different clients each for less than 24 months may, therefore, qualify for tax relief on travel and subsistence expenses.

An overarching employment contract is an employment contract between the employment agency and the employee that links a series of separate engagements into a single ongoing employment. Consequently, the employment agency is able to treat each engagement as a temporary place of work (rather than a permanent place of work) and, under the temporary workplace rules, pay travel expenses to workers free of income tax and NICs in circumstances where this would not normally be possible.

For further details, see Practice note, Taxation of employees, Tax free expenses: Travelling and subsistence expenses.

Dispensations

If the rates of the travel and subsistence payments are agreed with HMRC (or standard scale rates are applied) and certain other conditions are met, HMRC will issue a dispensation. The effect is that the reimbursement of travel and subsistence expenses (assuming the amount does not exceed the agreed rates) can be made free of tax and NICs. In addition, employees are not required to keep detailed expense claims (but are required to keep sufficient records to prove entitlement to a payment) and neither the employer nor employee is required to report the reimbursement of expenses to HMRC.

For a discussion of scale rate payments, see Expense allowances and scale rate payments: a briefing note for employers and for a quick guide to dispensations, see PAYE dispensations: a quick guide.

Salary sacrifice

A salary sacrifice arrangement involves an employee giving up part of their entitlement to salary, which is subject to income tax and NICs, in exchange for a new or enhanced non-cash benefit, which benefits from a full or partial exemption from tax and/or NICs. For a full discussion of salary sacrifice arrangements, see Practice note, Salary sacrifice arrangements.

Although the use of overarching contracts allows employees to obtain income tax relief for travel expenses, it seems that in most cases the travel expenses are not paid on top of the employee’s salary. Instead, travel expenses are paid as part of a salary sacrifice arrangement. Under this arrangement, a portion of the employee’s salary is paid, not as salary, but as travel expenses. This reduces the employee's taxable salary. Most of the benefit of this arrangement therefore falls on the employer, whose NICs liability reduces. For this reason, employers will often share the benefit of the employer's NICs saving with the employee.

Government's response to overarching contracts

For some time the government has been concerned about the exploitation of the temporary workplace rules and in particular the use of overarching employment contracts effectively to change what would have been a series of permanent workplaces (for which no tax relief is due) into temporary workplaces (for which relief is due).

In July 2008, HMRC and HM Treasury launched a joint consultation on reforming the tax rules (see Legal update, Consultation on avoidance involving tax relief claims for travel expenses of temporary and contract workers). However, as part of the 2008 Pre-Budget Report, the government announced that it would leave the current rules unchanged, but would monitor compliance (see further Legal update, Pre-Budget Report 2008: key business tax announcements: Tax relief for travel expenses). Further, on 6 August 2009, HMRC published Brief 50/09, which confirmed that HMRC was conducting a more detailed investigation with a view to considering whether measures should be introduced to counter the issue (see Legal update, HMRC concerns about taxation of temporary workers). On 5 May 2010, HMRC published revisions to its employment status manual, dealing with travel expenses and overarching contracts (see Legal update, New guidance on taxation of temporary workers).

Facts

The appellant (Reed) is an employment business that supplies workers to end-clients.

Historically, Reed engaged workers on a self-employed basis. However, in 1995 and subject to certain exceptions, Reed engaged workers as employees so that employees could participate in Reed's profit related pay scheme, a tax-efficient scheme that was repealed in 1998.

In 1998, coinciding with the repeal of the profit related pay scheme, legislation was introduced that gave tax relief to employees for expenses incurred for travelling to a temporary workplace. Reed sought to take advantage of this new tax relief. It sought and obtained from HMRC a dispensation that permitted Reed to reimburse travel and subsistence expenses free of tax and NICs to employees that had no permanent place of work and who were required to perform their services at various locations for a limited duration (of less than 24 months). However, rather than reimburse travel and subsistence expenses as an addition to salary, Reed devised a scheme, the effect of which was to pass most of the benefit to Reed.

The Reed Travel Allowance scheme

The calculation made under the Reed Travel Allowance scheme (RTA) operated as follows:

The employee's gross (usually weekly) salary was calculated by multiplying the employee's hourly rate by the number of hours worked.
An amount reflecting the travel allowance was deducted. (This amount, which Reed claimed was the amount sacrificed, was calculated by reference to the scale rates agreed with HMRC at the relevant time, the entries in the employee's timesheets and the employee's tax and NICs position.)
Tax and NICs were calculated on the net amount giving a net pay figure.
The travel allowance was then added back giving a total pay figure.
A further deduction was made, which removed the benefit of the tax saving, giving a total pay after adjustment figure. (The deduction was equal to the difference between the sum of the tax and NICs that was paid under the scheme and the sum of the tax and NICs that would have been paid had the scheme not applied.)

The result was that the entire tax saving fell to Reed because Reed paid less employer's NICs as the employee's taxable income reduced.

So that the employee derived some benefit from the scheme, the employer paid a travel and subsistence allowance, initially set at £1 per day but which increased by 2001 to £1.50 per day (if the employee worked more than five hours a day). The travel and subsistence allowance was subject to tax and NICs. Accordingly the benefit to the employee of the scheme was daily travel and subsistence allowances (after tax and NICs).

The scale rates agreed with HMRC in the first dispensation were: £5.00 per day for employees using public transport in central London and £1.75 per day elsewhere, plus a daily subsistence allowance of £3.15 in London and £2.45 elsewhere.

Example

	£
Gross pay	100.00
Travel allowance	(47.25)
Taxable amount	52.75
Tax (22%)	11.61
NICs (10%)	5.28
Net pay	35.86
Add travel allowance	47.25
Total pay	83.11
Less adjustment	(15.11)
Net pay	68.00
Employer NICs (12.2%)	6.43

The RTA scheme was explained to the employees through the Reed staff handbook and orally by Reed branch managers. The staff handbook did not expressly refer to a salary sacrifice. The RTA scheme was an "opt out" scheme, which required no action on the part of the employee unless the employee wished to opt out. It was possible to opt out at any time. Employees were required to complete daily timesheets to record their daily mileage or to indicate that public transport to work was used.

As a result of the decrease in the employee's gross earnings, the employee paid less tax and NICs. This meant the employee's entitlement to contributory benefits decreased as did the employee's entitled to a tax rebate. Although a copy of a "draft guide" made some mention of loss of entitlement, it was not clear that the draft guide was ever made available to employees.

Employees were not aware of the tax free rates that HMRC had agreed with Reed.

The Reed Travel Benefit scheme

This RTA scheme was replaced by the Reed Travel Benefit (RTB) scheme in 2002. The RTB scheme was less complicated and the employee obtained a slightly greater benefit (although Reed continued to retain the entire benefit of the employer NICs saving). However, the amount the employee "sacrificed" continued to be greater than the tax free benefit added back to the employee's net pay. Employees were not told of the tax free rates that HMRC had agreed with Reed.

The change from the RTA scheme to the RTB scheme was communicated to employees by a list of questions and answers and by amendments to the employee staff handbook. The staff handbook expressly stated that the employee would need to make a "salary sacrifice" to be within the RTB scheme. The amount sacrificed was not a fixed daily or weekly amount.

The employment terms

A number of versions of the terms and conditions of employment existed throughout the relevant period. The conditions in use before April 1999 included the following clauses:

“1. The Temporary Employee’s employment and continuous employment begins on the date of the commencement of the current assignment. 2. Reed will endeavour to find the Temporary Employee the opportunity to work in the capacity specified on the Temporary Employee’s copy of the time sheet where there is a suitable assignment with a Client for the supply of such work. Reed reserves the right to offer any assignment to such temporary employees as it may elect where that assignment is. suitable for several workers. 3. The duration of the Temporary Employee’s employment will be for so long as Reed offers work to the Temporary Employee. It is anticipated that this will be for the duration of the assignment with the Client provided that the Temporary Employee satisfies the Client’s requirements. Reed may instruct the Temporary Employee to end the assignment at any time without specifying reasons.”

The conditions also provided that Reed was obliged to endeavour to find work for the employee but it could elect to which employee is offered assignments. The employee was under no obligation to accept any particular assignment.

Reed's advisors confirmed during correspondence to Reed in 2001, that the contracts "only applied when the [employees] are carrying out assignments on behalf of Reed" and Reed also considered that the contracts applied "from assignment to assignment" and that there is no "umbrella contract".

Significant changes were made to the terms and conditions of employment in April 2004. The conditions in use after April 2004 included the following clauses:

“3. The Temporary Employee’s employment and continuous employment begins on the date of the commencement of the current assignment or secondment.

4. Reed will endeavour to find the Temporary Employee the opportunity to work in the capacity as agreed at registration and specified on the Temporary Employee’s copy of the time sheet where suitable work with a Client is available. Where the Temporary Employee is offered work with a Client, his/her copy of the time sheet will indicate whether this will be on an ASSIGNMENT or a SECONDMENT basis.

7. The duration of the Temporary Employee’s employment will be for the duration or likely duration of the assignment or secondment with the Client as notified prior to the commencement of the assignment or secondment provided that the Temporary Employee satisfies the Client’s requirements. Reed may instruct the Temporary Employee to end the assignment or secondment at any time without specifying reasons.…”

By mid-2004, it became apparent to Reed that HMRC was concerned about the nature of the employment contracts and considered that Reed's employees were engaged under separate contracts that last for the duration of an assignment rather than an overarching contract that extended over multiple assignments. The significance, if HMRC's view prevailed, was that the employees were not entitled to tax relief for travel to temporary workplaces, as each assignment would be considered a permanent workplace. Reed therefore amended the employee terms and conditions to remove the statement "for the duration or likely duration of the assignment or secondment".

Dispensations

HMRC granted Reed five dispensations covering the period 6 April 1998 to 5 April 2006.

The first dispensation was granted in November 1998 but back dated to 6 April 1998. It was granted on the basis of assurances provided by Reed that:

“We confirm that the dispensation will apply only to employees of Reed Staffing Services Limited who have no permanent workplace, and who are required to attend various locations for a limited period only.”

“We confirm that the temporary workplace of the employee will vary from one assignment to the other.… The only time similar journeys will be an issue is when the assignment is not for a limited duration or temporary purpose, in which case the employee will not be entitled to any expense allowance for travel and subsistence.”

HMRC did not, however, seek copies of the employees' contracts until 2004.

HMRC revoked the dispensation to the extent it applied to travel and subsistence allowances with effect from 6 April 2006. It did not revoke the dispensation retrospectively on the ground that it didn't need to as the payment Reed made did not come within the dispensation.

HMRC's determinations

HMRC issued determinations against Reed in accordance with regulation 80 of the Income Tax (PAYE) Regulations 2003 (SI 2003/2682) and notices of decision in accordance with regulation 67 of the Social Security Contributions Regulations 2001 (SI 2001/1004) covering the period 6 January 2001 to 5 April 2006. Together they assess both the employer’s NICs for which HMRC say Reed should have accounted, and the sums which HMRC say Reed should have deducted (as tax or NICs) from employees' salaries. The overall amount in dispute, including interest, is in the order of £158 million. Reed appealed to the First-tier Tribunal (tribunal). Reed also brought judicial review proceedings on the basis that HMRC's actions (in failing to apply the dispensations) breached their legitimate expectations. The judicial review proceedings have been stayed until after the determination of the tax appeals.

Decision

The tribunal (Bishopp and Avery Jones JJ) dismissed Reed's appeal.

Was the purported salary sacrifice incorporated?

The tribunal rejected HMRC's argument that the purported salary sacrifice was ineffective because it was not incorporated in the employees' contracts with Reed. The tribunal noted that the employees' terms and conditions expressly stated that they incorporated "the entire contract". However, it considered that the combination of the information given to the employees both orally and by the staff handbook, and the employee's acceptance of the change in payment method through acquiescence (by not opting out and completing their timesheets) was enough to incorporate the salary sacrifice (if that is what it was) in the employees' contracts.

Was there a salary sacrifice?

The tribunal determined that there was no effective salary sacrifice for either scheme for various reasons. In particular, there was no salary sacrifice because of the existence of an opt in opt out facility.

The tribunal nevertheless considered whether, leaving that facility to one side, there was an effective salary sacrifice.

The tribunal noted that the employees who participated in the RTA and RTB schemes derived very little benefit from them. It considered that the taxpayer concealed both the detail of the dispensation from the employees and the manner in which it operated the scheme. Accordingly, it was not possible for the employees to understand the underlying structure of the scheme. For those reasons, the tribunal found it difficult to imagine that the employees' made an informed decision to participate in the schemes. Further, so far as the RTA scheme was concerned, there was no reference to a salary sacrifice either expressly or implicitly in any of the scheme documentation. The tribunal considered that as "a bare minimum" an effective salary sacrifice required that the employee knew that he was giving up x in order to receive y. A salary sacrifice cannot occur in complete ignorance. Additionally, the amount that the employee "gave up" under the RTA scheme was matched by a corresponding "add back". Accordingly, the tribunal determined that so far as the RTA scheme was concerned, nothing was actually sacrificed.

So far as the RTB scheme was concerned, the documentation did expressly refer to a salary sacrifice. However, the tribunal considered that there was no reciprocity, which is fundamental for a salary sacrifice to exist. While the employee gave up a portion of earnings, Reed did not provide any benefit in return. It applied the dispensation so that it could attribute part of pay to reimbursement of expenses so that the tax and NICs burden could be reduced. It did not provide a benefit to the employee but appropriated most of the saving to itself.

The tribunal was not concerned that the amount "sacrificed" varied.

Were the travel allowances earnings or expenses?

Whether payments made by employers to employees constitute taxable earnings or taxable expenses (with the potential for a tax deduction) depends on whether they are paid to reimburse ordinary commuting expenses (in which case they are earnings) or travel expenses incurred in the course of the employee's employment (in which case they are expenses). The first payment defrays a personal expense (getting to work) while the latter defrays an employment expense (doing the work). Where payments are made to employees who are required to attend temporary workplaces and they represent reimbursement of expenses already incurred, then the tribunal concluded that the payments were expenses and not earnings. Conversely, if payments are made to employees attending a permanent workplace, they are earnings.

Were the employees engaged under "overarching" contracts?

This determined whether the employees had temporary workplaces and, therefore, were entitled to tax relief on travel expenses to those workplaces.

The tribunal considered the issue by asking and answering two questions: does a contract exist during the time the employee is not on an assignment and if yes, is it a contract of employment. The tribunal was not minded to explore HMRC's argument that Reed had, in employment tribunal proceedings, argued that no contract existed in between assignments.

The tribunal considered that there were two terms that applied during periods when the employee was not on assignment. These were that the employee had to give notice to take paid holiday (holiday pay was a statutory rather than contractual entitlement) and that both parties had to give statutory notice (this was largely ignored in practice). While conceding that these terms were weak, the tribunal considered they were just enough to mean that a contract existed. However, the tribunal determined that the contract was not a contract of employment because there was no requirement on the employer to provide work or wages and for the employee to undertake that work; the employer did not exercise any control over the employee and the terms of the contract were not consistent with a contract of employment.

It followed that there was no overarching contract and, accordingly, no temporary workplaces. Therefore, the travel allowances paid to employees were earnings.

The effect of the dispensation

The parties agreed that if the tribunal determined that the travel expenses were earnings, the dispensations could not apply. However, the tribunal considered whether, assuming the travel expenses were expenses (and therefore fell within one of the provisions listed in section 65 of ITEPA 2003) but were not tax deductible, the grant of the dispensation effectively removed the tax and NICs charge.

The tribunal determined that a dispensation is effective only if one of the provisions listed in section 65 of ITEPA 2003 applies. Accordingly, if an amount is taxable under a provision not listed in section 65, a dispensation cannot prevent HMRC seeking tax under that provision even if HMRC grants the dispensation in the mistaken belief that the amount is taxable under a listed provisions.

However, if an amount is taxable under one of the provisions listed in section 65, and HMRC grants a dispensation in the mistaken belief that the amount is tax deductible, the dispensation is effective to remove the tax charge (and related administrative obligations), altogether.

Comment

The tribunal's decision is not surprising but it nevertheless highlights, and provides useful confirmation of, a number important issues.

A salary sacrifice arrangement will be ineffective if:

Employees are permitted to opt in or out of the schemes at will.
It is unlikely that employers permit employees to opt in or out of salary sacrifice arrangements today. HMRC's published guidance has long been that employees should not be able to opt back to original salary within 12 months (see HMRC: Salary sacrifice: conditions for successful sacrifice: right to revert to original salary).
Earnings are not actually given up or, if they are, they are not given up for an identified benefit provided by the employer.
This will be an issue if, as in the present case, most of the benefit of the arrangement passes to the employer.
The decision serves as a useful reminder that employees must make an informed decision when engaging in salary sacrifice arrangements. Open and clear communication between employer and employee is vital. In particular, employees should know what they are giving up and what they are receiving in return. They should also be told the possible downsides of a salary sacrifice, including that their entitlement to contributory benefits might be adversely affected.
It is essential to ensure that the salary sacrifice is incorporated into the employees' terms and conditions of employment. While the tribunal's decision is helpful in confirming that communication of the scheme together with the employee's acceptance by conduct is sufficient to incorporate the change in terms, notwithstanding an "entire agreement" provision, it is preferable for the arrangement to be incorporated expressly by way of the employee's written consent to the change.

The government has long been concerned about the use of overarching contracts (see Background: Government's response to overarching contracts . These are now generally drafted so that the employer guarantees a minimum number of hours' work (or pay in lieu), which, in HMRC's view, must be at least 336 hours in a 12-month period. However, the effectiveness of these contracts has yet to be tested in the tax tribunals. It is notable that HMRC confirmed that, in its view, the new purported overarching contract that Reed put in place in 2006, which includes a 336 hour guarantee of work, was not effective.

The outcome of Reed's legitimate expectation claim is far in the future. However, the tribunal's findings of fact, particularly that Reed did not volunteer to HMRC all of the details of the (innovative) schemes and that, while Reed did not deliberately conceal how the schemes were applied, Reed was less than forthcoming, means that Reed is unlikely to succeed. The need for taxpayers to "put all their cards face upwards on the table" by giving HMRC full details of the arrangements is a fundamental pre-condition for legitimate expectation. (For a discussion of the doctrine of legitimate expectation in the context of tax, see Practice note, Taxation and protection for legitimate expectations .

It is highly likely that both parties will appeal parts of the tribunal's decision.

Case

Reed Employment Plc & Ors v HMRC [2012] UKFTT 28 (TC), Bishopp and Avery Jones JJ (06 January 2012).

If you don’t yet subscribe to PLC, you can request a free trial by completing this form or contacting the PLC Helpline.

Temporary workers, salary sacrifice and travel expenses (First-tier Tribunal) | Practical Law