Salary sacrifice schemes, notably the Cycle to Work scheme, are about to get more expensive. Up until now purchases made under such schemes had been largely VAT-free. From 1st January 2012, that will change.
How it used to work
For the uninitiated, salary sacrifice schemes work by giving up a portion of your pre-tax pay for a benefit, e.g. a bicycle, voucher, or pension contributions. As such, you reduce your income tax and national insurance liabilities, with the latter benefitting both you and your employer. The business has also been able to claim input VAT on the item being purchased in lieu of wages, so making these purchases effectively VAT-free.
How it will work
However, a recent judgment by the European Court of Justice has decreed that input VAT for purchases through salary sacrifice schemes does not relate to taxable supplies made by businesses. This means that businesses will no longer be able to claim input VAT on these purchases, a cost likely to be borne by employees. This affects supplies under salary sacrifice schemes that are subject to VAT, such as the Cycle to Work scheme, vouchers (excluding childcare) and standard-rated food and catering. Pension contributions and private-use cars, however, will be largely unaffected.