Is VAT due on salary sacrifice benefits

Q: What mistakes come up most often?

Relying on the old distinction. Calling the arrangement a reduction in salary rather than a deduction no longer keeps it outside VAT. That distinction ended with the change announced in Revenue and Customs Brief 28/11. Charging VAT on blocked cars. Where the purchase or leasing block applied, output tax is not due on the car benefit. See our guide to the 50% leasing block. Charging VAT on third party childcare. The employer is not the supplier, so there is no output tax, and the admin costs are overheads. Using a value below cost. If the salary given up is less than what the benefit cost the employer, HMRC expects the value to be based on cost. Forgetting the end of the scheme. A sale of the bicycle, computer or other item to the employee is a separate taxable supply. Missing the voucher position. Retail vouchers through salary sacrifice are the case the court decided. Our guide to VAT on vouchers covers the voucher rules more generally. Where an employer has run a scheme without accounting for VAT, the error correction rules apply, and HMRC's compliance checks on employers often look at benefits paperwork alongside payroll. If HMRC opens a check into your return, tax investigation insurance pays your accountant's fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

When an employee gives up part of their salary in return for goods or services the employer provides, HMRC treats the salary forgone as payment for those benefits, so a VAT registered employer must account for output VAT on taxable benefits and can reclaim the related input VAT under the normal rules. There is no charge where the employer makes no supply of its own (childcare bought from a third party), where input tax on a car was blocked, where the benefit is zero rated, or where the benefit is free to all staff.

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Why does salary sacrifice create a VAT charge at all?

VAT is charged on a supply of goods or services made for a consideration. Section 5(2) of the VAT Act 1994 says a supply does not include anything done otherwise than for a consideration, and anything that is not a supply of goods but is done for a consideration is a supply of services. The question with salary sacrifice is whether the pay an employee gives up counts as consideration.

HMRC’s VAT Supply and Consideration manual at VATSC05880 says it does. Where deductions are made from salary for goods or services the employer provides, the remuneration the employee forgoes is consideration for the taxable benefits, output VAT is due from the employer and input VAT is recoverable in line with the normal rules.

This position follows the Court of Justice judgment in Astra Zeneca (Case C-40/09). Astra Zeneca ran a flexible package under which staff could take part of their pay as retail vouchers. The court found a direct link between the vouchers and the cash remuneration given up, so the vouchers were supplied for a consideration expressed in money (VATSC05882).

Before that judgment HMRC drew a line between a deduction from salary, which was taxable, and a reduction in salary under an amended contract, which was not. Revenue and Customs Brief 28/11, issued on 28 July 2011, announced the change, and VAT has been due on salary foregone for taxable benefits from 1 January 2012 under any agreement entered into on or after that date. Agreements in place before the Brief ran on under transitional rules only until they expired, reached an annual benefits review or were renegotiated.

Which benefits carry VAT?

Any benefit that is a taxable supply by the employer is caught when it is provided in exchange for salary. HMRC’s guidance at VATSC05881 deals with the common ones:

Cycle to Work schemes. The employer buys bicycles and safety equipment and lends or hires them to staff. Under salary sacrifice, output tax is due on the salary forgone for the hire.
Face value vouchers. Retail vouchers provided through salary sacrifice give the employer input tax on the purchase and an output tax liability on the salary given up, exactly as in Astra Zeneca.
Meals and catering. Where staff pay for meals by salary sacrifice, the employer accounts for VAT on the value of the supplies unless they are zero rated.
Equipment the employee later buys. VATSC05880 notes that if an employee buys an item at the end of the arrangement, such as a computer or a Cycle to Work bicycle, that sale is taxable in the normal way.

The rate is whatever applies to the benefit. A standard rated benefit is charged at 20%, a zero rated one at 0%, and the employer reclaims the input tax on its purchases subject to the usual rules.

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Which benefits fall outside the charge?

The manual identifies several situations in which no output tax arises even though salary is given up.

Childcare from a third party. Where employees forgo salary that is applied to pay for childcare provided by someone else, the employer is not making a supply of childcare. Its payroll and administration costs are general overheads.
Company cars where input tax was blocked. Most businesses cannot recover all the VAT on buying or leasing a car: the block is 100% on purchase and 50% on leasing. Because of that block, employers do not account for output tax when the car is made available to staff. If the employer suffered no input tax restriction, output tax is due. Where the employee receives a single supply of a car and maintenance, the block covers the whole cost and again no output tax is due.
Benefits free to everyone. If no charge is made, no VAT is due. HMRC’s example is a workplace gym open to all employees at no cost, with the VAT on providing it recoverable as an overhead.
Zero rated benefits. These remain within the scope of VAT, but the rate is 0%, so there is nothing to pay.

The car point links to the wider rules in VAT Notice 700/64. That notice explains that where a car has been subject to the 50% leasing block, no further charge for private use applies, because the block is itself a proxy for private use. If an employee pays a charge for private use of a car on which VAT was fully recovered, VAT is due on those charges.

How is the value worked out?

VATSC05880 says that in most cases the value of the benefit for VAT is the salary deducted or forgone. Where that figure does not reflect the true value, for example where benefits are supplied for less than they cost the employer to acquire, the value is based on the cost to the employer.

Section 19(2) of the VAT Act 1994 provides that where a supply is for a consideration in money, its value is the amount which, with the VAT added, equals the consideration. Salary forgone is therefore treated as VAT inclusive: at the 20% standard rate, the output tax is one sixth of the salary given up.

When a Cycle to Work bicycle is sold at the end of the hire, VAT is due on a value normally based on the price of an identical or similar item, taking account of age and condition. To reduce the burden, HMRC accepts use of the table published for direct tax purposes in its Employment Income manual. Antique or specialist bicycles outside the table must be valued under the normal rules, and lower values may be challenged.

What does this look like in numbers?

Illustration only. An employer registered for VAT runs a Cycle to Work scheme. It buys a bicycle for £1,200 plus £240 VAT and hires it to an employee who gives up £100 of salary a month for 12 months.

The employer reclaims the £240 input tax on the purchase.
Each month, the £100 salary forgone is VAT inclusive. Output tax is £100 ÷ 6, or £16.67, so £200 over the year.
If the employee then buys the bicycle for an agreed sum, VAT is due on that sale, with the value tested against the HMRC table or the normal valuation rules.

Had the same employer offered childcare through salary sacrifice, with the childcare provided by a nursery under its own contract with the parent, there would be no output tax at all, because the employer supplies nothing.

How does this sit alongside the income tax rules?

VAT and employment taxes look at salary sacrifice from different directions. The income tax and National Insurance treatment depends on the optional remuneration rules, which decide whether the employee is taxed on the salary given up or on the cash equivalent of the benefit. The VAT treatment depends only on whether the employer makes a supply for consideration. A benefit can therefore be tax efficient for the employee while still carrying output VAT for the employer, or the reverse.

For the employment tax side, see our guides to optional remuneration rules, electric car salary sacrifice and technology schemes, along with our overview of salary sacrifice schemes.

What mistakes come up most often?

Relying on the old distinction. Calling the arrangement a reduction in salary rather than a deduction no longer keeps it outside VAT. That distinction ended with the change announced in Revenue and Customs Brief 28/11.
Charging VAT on blocked cars. Where the purchase or leasing block applied, output tax is not due on the car benefit. See our guide to the 50% leasing block.
Charging VAT on third party childcare. The employer is not the supplier, so there is no output tax, and the admin costs are overheads.
Using a value below cost. If the salary given up is less than what the benefit cost the employer, HMRC expects the value to be based on cost.
Forgetting the end of the scheme. A sale of the bicycle, computer or other item to the employee is a separate taxable supply.
Missing the voucher position. Retail vouchers through salary sacrifice are the case the court decided. Our guide to VAT on vouchers covers the voucher rules more generally.

Where an employer has run a scheme without accounting for VAT, the error correction rules apply, and HMRC’s compliance checks on employers often look at benefits paperwork alongside payroll.

If HMRC opens a check into your return, tax investigation insurance pays your accountant’s fees. Solar Protect cover pays up to £100,000 with no excess; it never pays tax, interest or penalties. Read how our cover works or get a quote.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.