FocusOn - Introduction to salary packaging

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Salary packaging is an arrangement whereby an employee sacrifices part of their future salary in return for receiving remuneration in a different form, such as fringe benefits or superannuation contributions. Common fringe benefits include the provision of a car and having an employer pay or reimburse expenses on behalf of an employee.

The advantages of salary packaging

Salary packaging is widely used in many organisations due to the advantages it can provide to both employers and employees including:

Is any tax payable as a result of salary packaging?

If an employee receives a fringe benefit as a result of salary packaging this may attract tax known as fringe benefits tax ("FBT").

FBT is ordinarily payable by an employer on the "grossed-up" taxable value of a benefit provided to an employee. The grossed-up amount is determined by multiplying the GST-inclusive taxable value of the fringe benefit by the relevant gross-up factor.

FBT is normally included as part of an employee's salary package so that the employer is no worse-off as a result of an employee electing to take their remuneration in a different form. Where the employer is a tax paying entity, both the cost of the benefit and the FBT are tax deductible.

Does an employee have to pay tax on the value of a fringe benefit?

An employee is not assessable on the value of a fringe benefit. However, once the value of fringe benefits received during the FBT year ended 31 March have been ascertained, the taxable value grossed-up (using the type 2 rate) must be shown on the employee's payment summary for the next income year ended 30 June.

This requirement will apply to virtually all fringe benefits where the total taxable value of benefits provided to an employee exceeds $2,000, before being grossed-up. Taxable fringe benefits that do not need to be disclosed include those that are difficult to value and apportion, such as car parking benefits and meal entertainment.

The amount shown on the employee's payment summary must be disclosed in their income tax return.

The grossed-up taxable value is used to ascertain their liability for certain surcharges such as Medicare Levy Surcharge, HELP Compulsory Repayment and eligibility to certain tax deductions/concessions such as personal superannuation contributions. The non-grossed-up value is used in determining their entitlement to Senior Australian, Pensioners and Dependant Tax Offsets, and government benefits, such as family tax benefits and youth allowances.

Types of fringe benefits

The range of fringe benefits eligible to be provided can be categorised as exempt fringe benefits, concessionally valued fringe benefits and ordinary fringe benefits.

Exempt fringe benefits

Exempt benefits are those that have no taxable value, regardless of the status of the employer. They are not required to be disclosed on a recipient's payment summary and are not subject to payroll on-costs, such as Workcover and payroll tax.

Examples of exempt fringe benefits include minor benefits provided infrequently valued less than $300, portable electronic devices such as laptop, PDAs, and mobile phones (limited to a maximum of one per employee per year) provided primarily for use in an employee's employment and relocation expenses incurred when an employee changes their job location.

Concessionally valued fringe benefits

A concessionally valued benefit is where the deemed taxable value of the item is less than its actual cost. Examples of concessionally valued benefits are "in-house" benefits, car parking and an employer-provided car.

Car fringe benefits

The taxable value of an employer-provided car can be ascertained by using the "statutory method". Under this method the car's "base value" is multiplied by a statutory percentage, determined by the kilometres travelled.

As the resulting notional value is usually less than the actual costs of the car, the benefit can be valued on a concessional basis.

An alternative to the statutory method is the "operating cost" method. Under this method an employee maintains a log book for a twelve-week representative period to establish the business usage. All costs associated with the motor vehicle are summarised at the end of the FBT year, and multiplied by the non-business usage to ascertain the taxable value of the fringe benefit.

The operating cost method can generally achieve a lower taxable value where the car travels less than 15,000 kilometres per annum, where there is significant business usage or where the car is expensive.

Ordinary fringe benefits

An ordinary or fully taxable benefit is where the taxable value of an item is the same as it cost, less any work-related or "otherwise deductible" use. An example of this is payment of a personal expense, such as a health insurance costs.

What fringe benefits should be packaged?

When undertaking salary packaging analysis it is generally advantageous to concentrate on fringe benefits which have a taxable value that can be reduced or eliminated in some way. This will be the case with exempt or concessionally valued fringe benefits.

It is generally recommended not to package an ordinary fringe benefit. This is particularly relevant for ordinary employers where the taxable value of the benefit attracts FBT at the full rate of 46.5%. In such circumstances there is no tax advantage if the employee's marginal tax rate is at least 46.5%. However, a tax disadvantage will result if the employee's marginal tax rate is less than 46.5% due to the fringe benefit being subject to a higher rate of tax than the salary that would otherwise be earned.

How can FBT be reduced?

As stated above, the provision of a fringe benefit usually attracts FBT which is effectively calculated at the top marginal rate of 46.5%. As this marginal rate of tax only applies to higher levels of income, the imposition of FBT can result in this form of remuneration being subject to a higher rate of tax than if it had been taken as salary.

To avoid this undesirable outcome, many employees believe that they should simply avoid salary packaging altogether. However, in many instances it is not the provision of the benefit that is not tax-effective but the imposition of FBT.

To avoid FBT it is possible for an employee to make a contribution to their employer for the cost of the benefit. This essentially reduces the taxable value of the benefit to zero, thus avoiding the need for the benefit to be grossed-up and for FBT to be calculated.

How do employee contributions work?

Employee contributions can be facilitated in either of two ways:

The reimbursement arrangement is commonly used and can be implemented by the employee having a regular amount deducted from their after-tax salary. For example, if an employer-provided car had a taxable value of $3,960, the employee would reimburse $330 each month from their after-tax salary. Although the employee would have to pay tax at their marginal rate on the salary required to make this reimbursement, the tax rate might be lower than the FBT rate that would otherwise apply.

A non-salary arrangement can be used where the employer and employee are related parties. For example, many small business proprietors are employees of their own companies or trusts and have funds or "loan accounts" owing to them due to undrawn profit or income distributions. Instead of adjusting their after-tax salary for the estimated taxable value of a fringe benefit, they can simply elect to have their loan account reduced by this value.

If the employee contribution is implemented by way of a salary reimbursement or loan account adjustment, GST will apply to the reimbursed taxable value where the employer is entitled to claim the GST associated with the benefit as an input tax credit. For example, the GST associated with the above employee reimbursement would be $30 (ie. 1/11th of $330).

What now?

Although salary packaging can appear to be a complex subject, many legitimate and tax-effective opportunities still exist. You should not hesitate to contact us if you would like to discuss how salary packaging can be implemented in your employment situation.

Published : August 2010