Flexible compensation
General considerations
Flexible compensation differs from traditional pay plus employee benefits in that individual employees are able to choose for themselves from a range of benefits selected by the company, possibly following consultation with the employees. This means that the employee also has the option to opt out of benefits and have the value of the opted-out benefits paid out as salary.
Studies point to a growing prevalence of flexible compensation among academics in the private sector. Furthermore, the remuneration system has proved to be extremely popular, particularly amongst employees who have experienced it. This may be because the system offers certain opportunities for tax benefits. Another reason could be that employees feel valued when the company offers a range of optional benefits.
However, flexible compensation is not necessarily entirely problem-free. The schemes raise a number of issues of a collaborative, legal and tax-related nature, which employees should consider before entering into an agreement on flexible compensation. The guidance on this page serves as a tool to help avoid various pitfalls in the system.
What benefits do not work well in a flexible compensation package?
Not everything is suitable as part of a flexible compensation package. Some benefits can have negative consequences for working relationships in the workplace, and sometimes freedom of choice means that a benefit cannot be retained. It is therefore important to consider what it makes sense to agree on collectively, and what can be agreed upon individually.
Before entering into agreements on flexible remuneration packages, employees at the workplace should discuss the specific benefits on offer. The general guideline should be to avoid benefits that lead to colleagues ‘getting in each other’s way’.
As a general rule, flexible compensation packages should not include benefits that have:
- Negative consequences for working relationships in the workplace
- The nature of a collective insurance scheme
- A direct work-related purpose
Benefits with negative consequences for working relationships
Relationships in the workplace may be damaged if flexible pay packages include benefits that give individual employees an advantage over the rules on working hours. This may, for example, involve deviations from the company’s rules on maximum working hours, the scheduling of working hours, notification of overtime and remuneration for overtime.
The distribution of work tasks and the willingness to lend a helping hand can change radically if, for example, some colleagues are paid per hour worked, whilst others do not receive a higher wage for working longer hours.
Benefits similar to joint insurance schemes
A number of labour market-related insurance schemes are not suitable as optional benefits in flexible pay packages, because freedom of choice means that the schemes are selected only by those employees who are likely to need to use them. The employees who choose these schemes would therefore have to bear the entire cost themselves, thereby removing the insurance element.
This applies, for example, to absence due to a child’s illness, care days, pay during parental leave and various senior schemes offering extra days off or reduced working hours without a full reduction in pay and pension. Furthermore, the issue may arise in relation to employer-paid health insurance schemes, including alcohol rehabilitation and similar programmes.
In the case of pension insurance schemes that include cover for death and disability, it is crucial that the scheme is collective and compulsory. If the schemes are individual, only those in the best of health will be able to obtain cover at a reasonable price. A contribution of approximately 8% of the total payroll will typically cover the insurance component. Contributions in excess of the 8% should therefore be regarded as individual savings for old age, which thus have no consequences for others.
Benefits directly related to work
Facilities and equipment that are essential for the performance of work should not be included as benefits in flexible remuneration packages. This applies, for example, to offices and office furnishings, computers, diaries, etc. It is fundamentally unreasonable to ask employees to pay in this way to carry out their work.
The same applies if the remuneration package includes the option to choose communication tools, such as an employer-paid mobile or landline telephone, ADSL connections, etc. Such tools only constitute a genuine benefit if they are not accompanied by a requirement that the employee must be able to work from home or be available for calls in the course of their work.
The agreement must be open to amendment
Agreements on flexible compensation must include the option to alter the composition of benefits included, as well as the option to replace benefits with standard fixed pay. There may be many reasons why, over the course of one’s life, one may need to swap a company car, mobile phone or extra days off for a higher monthly salary.
At the same time, experience shows that when methods for obtaining tax-free remuneration become widespread, there is often a change in tax legislation. In such a situation, it may well prove advantageous to replace the employer-funded computer with a different model.
Agreements on flexible compensation should therefore include the following or equivalent wording:
'The employee may, every six months / every year in (specified months), change their choice of flexible compensation benefits or convert the benefits into standard salary payments. In addition, in exceptional circumstances during a commitment period, the employee may change their choice of benefits if unforeseen events affect the employee’s financial situation, including if a change in tax legislation results in a deterioration of the employee’s financial situation'.
Depreciation must be factored into the value of the benefit
In agreements on flexible compensation, depreciation should be factored in when determining the value of a benefit. Under tax legislation, employee benefits are subject to various rules regarding depreciation. This means that the value of the various benefits decreases in line with depreciation. If the salary reduction is not adjusted accordingly, the employee will end up paying far more for the benefit than it is actually worth, thereby effectively eroding their own salary.
It is important, when entering into agreements on flexible salary packages, to ensure that the salary reduction is adjusted once a year in line with the depreciated value. For some benefits, it may be advantageous instead to agree to replace the benefit at fixed intervals, for example every two or three years. This may be particularly the case for slightly larger benefits, such as cars, computers and the like.
The benefits must be pensionable
Pension contributions should be paid for the agreed benefits in line with the pension percentage of the monthly salary agreed between the parties. The following wording should therefore be included in the agreement on flexible salary packages:
'Standard pension contributions shall be paid in accordance with the employment contract based on an assessment of the benefit’s actual value. The starting point for the benefit’s actual value is, as a minimum, the amount paid for the benefit in the form of a corresponding reduction in salary.'
If no agreement is reached that flexible remuneration benefits are pensionable, a return to standard salary payments may result in the pension fund requiring new health information. When switching from partially remunerated benefits that do not count towards pension to standard salary, there will be an increase in pension contributions. If this increase is significant, the pension fund will require new health information to prevent people who believe they will soon be unable to work from speculating on increasing their pension contributions.
Legal aspects
Agreements on flexible compensation raise a number of legal issues. These primarily concern the calculation of levels of remuneration and compensation, as well as cover during periods without work. This section contains advice on a number of such aspects, which together should ensure that the conclusion of agreements on flexible compensation is, at the very least, cost-neutral for the employee.
Calculation of holiday pay
The employer must calculate holiday pay and holiday allowance on any taxable salary and employee benefits. In the case of flexible compensation, the employee will therefore, as a general rule, be entitled to holiday pay and holiday allowance on the taxable employee benefits.
Insofar as the flexible compensation package also includes benefits that are not subject to tax, the agreement should contain a provision stating that these benefits are also included in the calculation of holiday pay and holiday allowance. Alternatively, the employee will experience a reduction in income, as they have paid for the benefit in the form of a reduction in salary. The agreement should therefore contain the following wording:
'Holiday pay and holiday allowance are calculated on the basis of all flexible compensation benefits that are offset by a reduction in salary'.
Unless otherwise indicated by the circumstances, holiday pay and holiday allowance will be calculated according to the tax value of the benefits. This value rarely exceeds the economic value of the benefit, and it is zero for benefits that are not taxable. Therefore, the agreement on flexible compensation should ensure that holiday pay and holiday allowances are calculated according to the economic value of the benefit.
In connection with the taking of holiday by employees who have not earned the right to paid holiday, the employer is formally entitled to have flexible compensation benefits handed over. However, many benefits, such as an ADSL connection, will be practically difficult to hand over. To avoid such problems, it is recommended that the following wording be included in the agreement:
'The employee retains and may dispose of agreed flexible remuneration benefits whilst on holiday'.
Holiday pay and holiday allowance are not calculated on salary paid during holidays. Consequently, the employee is generally not entitled to have holiday pay and holiday allowance calculated on flexible compensation benefits whilst on holiday.
Calculation of severance pay under the Salaried Employees Act
The Salaried Employees Act provides for two types of severance pay: special severance pay (Section 2a) and compensation for unfair dismissal (Section 2b). The special severance pay is paid as 1, 2 or 3 months’ salary upon termination if an employee is dismissed after continuous employment with the same company for 12, 15 or 18 years respectively. Compensation for unfair dismissal is paid as a lump sum.
The compensation must correspond to the salary at the time of termination, i.e. the last month’s salary including the value of fixed salary components. An amount must therefore be paid that includes the normal salary components paid to the employee. If the salary includes various benefits, the value of these benefits must be paid as part of the severance pay. This means that the employee is entitled to have the value of the various benefits included in the calculation of the special severance pay.
Unless otherwise indicated by the circumstances, the value of the benefits will be calculated according to their tax value. As the tax value rarely exceeds the benefit’s actual value, the employee will consequently experience a reduction in income. Therefore, the agreement on flexible remuneration packages should ensure that severance pay is calculated based on the actual value of the benefit. If this is higher than the tax value, the difference must be added to the severance pay.
Compensation for clauses
Some employees enter into agreements containing non-competition or non-solicitation clauses, which may entitle them to compensation amounting to at least 50% of their salary at the time of leaving the company. In such cases, the value of any employee benefits should be included in the basis for calculation.
Unless otherwise agreed, the value of the benefits will be calculated according to their tax value. As the tax value rarely exceeds the actual value of the benefit, the employee will therefore experience a reduction in income. Therefore, the agreement on flexible compensation should ensure that compensation for agreeing to a non-competition or non-solicitation clause is calculated based on the benefit’s actual value. If this is higher than the tax value, the difference must be added to the compensation.
Retention of benefits during unpaid leave
Unpaid leave means that the employee is not entitled to receive any pay for the entire duration of the leave. If the employee has entered into an agreement on flexible compensation that includes a number of benefits, the employee must return the various benefits to the employer during the period of leave or, alternatively, pay the value of the benefit or benefits.
However, flexible compensation packages may contain many different types of benefits, some of which can easily be returned, whilst others require the cancellation of subscriptions, etc. Furthermore, the employee may have an interest in retaining the right to the benefits, or parts thereof, during the period of leave.
Therefore, when entering into agreements on flexible remuneration packages, the parties should determine which benefits may be retained and under what conditions in the event of unpaid leave. The agreement should therefore include a section with the following introduction:
'The employee retains and may dispose of the following flexible benefits during periods of unpaid leave:'
Retention of benefits during a garden leave
The Danish Salaried Employees Act sets out various rights and obligations for the parties following the giving of notice. The fundamental principle of the Act is that the notice period must be governed by the same guidelines as the rest of the employment relationship. This means that an employee who has entered into an agreement on flexible compensation is entitled to retain their benefits during the notice period.
However, it is not uncommon for an employer to require the return of employee benefits in connection with the notice period. In certain cases, the employer’s requirement is stipulated in the employment contract. If an agreement on flexible compensation has been entered into, however, the employee has paid for the right to use the benefit through a corresponding reduction in salary. It must therefore be reasonable to take the view that, in such situations, the employer is not entitled to have the benefits returned. There are no rulings in this area, but there are in cases involving company car schemes. Here, case law shows that rulings can go either way.
In order to avoid a potential legal dispute, the agreement on flexible compensation should include the following wording:
'In the event of termination, the employee may retain and dispose of the agreed employee benefits and flexible compensation benefits throughout the notice period. It may be agreed that the benefits are returned prior to leaving the company in exchange for compensation corresponding, as a minimum, to the financial value of the benefit'.
Alternatively, a requirement from the employer for the return of benefits upon release from one's duties may be made in return for payment of the benefit’s taxable value. It should be noted here that the taxable value rarely outweighs the inconvenience to the employee of having to do without or invest in a new benefit. If the agreement on flexible compensation does not include provisions stating that the employee may retain the agreed benefits upon termination, provisions should be included to ensure that the employee is compensated for the actual loss incurred upon the return of the benefit.
Compensation if the company goes bankrupt
In the event of the company’s liquidation, the Employees’ Guarantee Fund covers salaries and other remuneration for personal work carried out in the service of the bankrupt company. Salary and other remuneration refers to the fixed salary plus any cash allowances, as well as remuneration based on work performance, such as commission, bonuses, piecework surpluses, etc. If the employee is entitled to a company car, a company phone, company accommodation or other benefits that can be converted into monetary claims, these will, as a general rule, also be covered by the Employees’ Guarantee Fund.
An employee who enters into an agreement on flexible compensation will therefore, as a general rule, have their benefits covered, provided that the coverage corresponds to the tax value of the benefit. As the tax value rarely exceeds the actual value of the benefit, the employee will consequently experience a reduction in income. In addition, there may well be benefits that the Employees’ Guarantee Fund does not cover.
Flexible compensation and taxation
In the two preceding sections, the term ‘tax value’ has been mentioned repeatedly. But what does it actually mean?
As a general rule, there are three forms of tax value: full taxation, partial taxation or tax exemption. The rules determining whether an employee benefit falls into one category or another are scattered widely and thoroughly throughout Danish tax legislation.
Similarly, there is no tax law that provides a definition of employee benefits. However, it is stipulated that “saved private consumption and the value of the wholly or partly free use of another person’s assets constitute taxable income when the benefit is received as part of an employment relationship”.
This means that employee benefits in the form of a company car, ADSL connection, increased pension contributions, employer-paid cleaning services and the like will be subject to some form of taxation. Taxation can be a significant factor when choosing a benefit, and a change in tax law may therefore mean that the reasons for choosing that benefit no longer apply.
Firstly, it should be emphasised that this material is not intended to be, nor can it be used as, a reference work regarding the tax implications of flexible compensation packages. The sole purpose of this section is to draw attention to the fact that there are various forms of taxation which may affect the employee’s benefits when entering into an agreement on flexible compensation. For detailed advice on tax matters, please consult an accountancy firm or your local tax office.
Full tax liability
Unless otherwise explicitly stated in tax legislation, a benefit will be taxed as A-income, i.e. with full tax liability on the market value of the benefit, including AM and SP contributions. However, benefits taxed as A-income are not particularly widespread, probably because ‘it is not worth it’ to convert salary into a benefit that is taxed as salary anyway.
The only financial benefit that may be associated with fully taxable salary benefits would be if the employer, due to volume discounts, can obtain a better price for the benefits than the individual employee can secure. If such financial benefits do not exist, serious consideration should be given to whether these benefits should be selected or included in a flexible salary package, particularly as one is committing to them for a certain period.
Partial taxation
In several places within Danish tax legislation, there are provisions regarding specific employee benefits that are taxed based on a valuation, regardless of how high (or low) the market value is. This applies, for example, to a work phone, a company car and a company-provided residence.
Tax exemption
Provided that the chosen benefits relate to the specific work and the total value of the benefits does not exceed DKK 5,500 (2010), the benefits fall below the de minimis threshold and are therefore tax-free. To avoid tax, it is a requirement that the benefits are only available at the workplace and that they can be characterised as standard staff welfare, or that they are directly related to the performance of the work.
Such benefits include, for example, free newspapers (for work purposes and delivered at the workplace) and free access to food and drink in connection with overtime or the vaccination of senior staff.
If the value of the benefits exceeds the de minimis limit, the employee must declare and pay tax on the total value of the benefits themselves.
If there is an option to choose benefits that can be provided below the de minimis limit, it is therefore important that they do not conflict with existing benefits below the de minimis limit.
If the de minimis limit is exceeded, the total amount will be taxed as A-income.
Tax-exempt benefits
Certain benefits are exempt from taxation. However, this requires that certain conditions are met. Typical tax-exempt benefits include:
- Health insurance
- Parking space (provided by the employer for work-related purposes)
- Education (which is not of a private nature)