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@tom.
One thing that no one seems to have mentioned with any force is the fact that the company is saving 12.8% National Insurance on the sacrificed amount (which will be net of VAT). If someone goes into it for a £1,000 then you've almost covered the extra admin costs.
Also, the company isn't obliged to pass the VAT saving on, so you could negotiate on that point. There is a big saving to be had, it's just a case of balancing it between employer and employee.
Finally, if they aren't going to pass out payrises but can sweeten staff while saving money, it makes sense.