We are all feeling the squeeze brought about by the Government’s attempt to deal with Britain’s budget deficit and one response is to ensure that we are tax efficient.           

When considering employees, the concept of salary sacrifice is a well-used method by which employees give up part of their salary to fund a number of tax-efficient benefits including enhancement of pension contributions, reducing the cost of childcare provision and funding the acquisition of a bicycle under the ‘Cycle to Work’ scheme.

Another valuable but under-utilised tool is the staff suggestion scheme under which cash rewards can be paid free of tax. Research suggests such schemes have a positive impact on staff creativity at all levels and clients like to use such an arrangement not only to attract new recruits but to reward existing employees for their ideas.

Details of the suggestion scheme must be well planned in advance if it is to succeed and engagement with staff is a key feature. Formal scheme rules are essential along with proper communication of the reason for the scheme and what it is that management are seeking to achieve.

An ‘encouragement award’ of up to £25 per suggestion can be made free of tax for a suggestion ‘with intrinsic merit’ or showing ‘special effort’ on the part of the employee. Higher tax-free payments can only be made for a ‘financial benefit award’. Such awards must be based on anticipated improvements in efficiency or effectiveness arising from the adoption of the suggestion by the employer, who must ‘reasonably expect’ the adoption to result in a financial benefit.

Such an award must not exceed half of the expected financial benefit to the employer during the first year of implementation or (if higher) ten per cent of the expected financial benefit over a five-year period. In any case, the tax-free award must not exceed £5,000 as an overriding maximum per suggestion, however large the savings for the employer.

An employer may want to make a further award for the same suggestion, in circumstances where perhaps the financial benefits prove to be greater than initially recognised. This is acceptable, within the same overall limits and is best explained by way of an example:

The chef at a hotel makes a suggestion that leads to a reduction in food costs. The hotel implements the suggestion and calculates that there will be a saving of around £3,000 per year. The hotel can make an award of £1,500 tax-free and does so.

In the event, the reduction in food costs is much larger than anticipated. The annual saving proves to be in the region of £12,000. As such, two years after the first award was made to the chef, he is paid a further £4,500.

The annual saving of £12,000 means that the financial benefit share is £6,000. However, the maximum tax-free award is capped at £5,000. As such, the chef can receive a further £3,500 tax-free but the last £1,000 is taxable.

To avoid a tax charge, various conditions need to be met including formal rules, the scheme being open on the same terms either to all employees or to a particular description of them and the suggestion being made by an employee who could not reasonably have been expected to make such a suggestion in the course of the normal duties of his or her employment.

With the right guidance, establishing an employee suggestion has potential benefits for all parties with no discernible downsides – a rare, but welcome win/win situation. 

For further information:

Andrew Squires, Tax Partner, Francis Clark LLP.
Telephone:  01823 275925 

Francis Clark has offices in Exeter, Plymouth, Salisbury, Taunton, Tavistock, Torquay and Truro. Francis Clark is the winner of the ‘Auditor of the Year - Mid Tier’ in the National Financial Directors’ Excellence Awards 2011, and LexisNexis Best General Tax Practice Award 2009. More information is available by logging on at our Online Information Centre