When are staff discounts tax efficient?

Win-win

Staff discounts provide a valued perk for the employee and usually cost the employer next to nothing. Whether it’s a modest discount for supermarket employees or a free ticket for airline staff, the underlying tax principles are the same.

How much does it cost?

The taxable value of in-house benefits is calculated using the “residual charge” rules. The cost of providing the benefit is compared to how much the employee pays for it. If the residual charge exceeds the amount paid by the employee, the difference is taxable, but if it’s equal to or less, the benefit is tax free for the employee. You may have gathered that this means if there’s no cost associated with providing the benefit, there’s no additional tax to pay. If there’s a taxable benefit, your business will be liable to pay Class 1A NI on the taxable amount.

Calculating the cost of benefits

For tax purposes the cost of an in-house benefit to an employer is its “marginal cost”. This includes:

• the cost of production or acquisition
• any taxes or duties, e.g. VAT (even if it’s reclaimed) paid by the employer directly relating to the product; and
• a proportion of any overhead expenses which directly relate to production or acquisition.

For example, if duties are payable on certain goods, such as alcohol, then that is a distinct cost of providing the product. General overheads such as rent can be ignored as it won’t change as a consequence of the staff discounts.

This principle was established in Pepper v Hart,  which concerned masters at a public school who were able to educate their sons at the school for a 20% reduction on the normal fees. Using the marginal cost basis, the cost of providing the places for the masters’ sons were the additional costs attributable to each boy, e.g. in respect of food, laundry and stationery, rather than a share of the total running costs of the school.

Staff discounts in practice

Tip. Work out the marginal cost of supplying the goods and/or services you wish to apply a staff discount to. As long as the discounted price exceeds (or matches) the marginal cost no taxable benefit arises (and there’s no employers’ NI to pay either).

Example. A DIY store marks up their goods by 60% of cost. Therefore, a drill which cost £75 normally retails at £120. The retailer sells the drills to staff at a 20% discount, i.e. £24 off. As the discounted price (£96)exceeds the cost (£75) no taxable benefit arises. The retailer must record the sale for £24 in the normal way but there’s no taxable benefit in kind for the employee and no employers’ NI.

By working out the marginal cost of the goods/services you’re supplying you can reverse engineer the level of discount to make sure no taxable benefits arise. Have a policy to exclude, e.g. certain sale items from the staff discount to ensure no unexpected tax/NI charges will result.