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Current rules
Policy rationale
Proposal
"Publicly available" interest rates
Comparable to valuation of discounted or free goods and services
Proposal
| Proposed changes
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Current rules
11.1 FBT applies when an employer provides a loan to an employee. An employee loan would also be subject to FBT if the employer has entered into an arrangement for the loan to be provided by a third party.
11.2 The value of a fringe benefit arising from an employee loan is the amount by which interest calculated according to the FBT prescribed rate of interest exceeds actual interest paid. The prescribed rate generally differs from the lowest publicly available market rate.
The prescribed rate of interest
11.3 The FBT prescribed rate of interest is set by Order in Council and is reviewed before the start of each quarter. In order to allow for the various reporting requirements and the actual making of the regulations, the new rate must be determined two months before the start of the new quarter. The rate can, therefore, be out of date before the new quarter begins, as well as during the quarter itself.
11.4 The prescribed rate is based on the weighted average of first home mortgage interest rates for eight major providers of housing finance, using each institution's total lending outstanding for housing purposes. For the quarter beginning on 1 October 2003, the prescribed rate is 7.08%.
11.5 This method of setting the prescribed rate generally results in the rate being higher or lower than the lowest market rate by the time the rate is applied. This difference may fluctuate during the quarter, given that market rates can move while the prescribed rate is fixed. The prescribed rate may also be less than the actual market rate if the security for the loan is not a house. Credit card loans, for example, are unsecured and carry a commensurately higher interest rate.
Policy rationale
11.6 The value of the benefit of an employer-provided loan to an employee is the difference between the interest rate of that loan and the lowest market interest rate that would otherwise be available to the employee.
11.7 If the prescribed rate of interest is higher than the market rate of interest the FBT rules overtax the benefit of the loan, but if the prescribed rate is lower than the market rate, the fringe benefit is undervalued. The prescribed rate will be higher than the lowest available market rate when interest rates are declining, as they have been over the past few years. The fringe benefit from employee loans will be undervalued when market interest rates start increasing.
11.8 In this context, the prescribed rate of interest method for valuing employee loans is a compromise between accuracy and compliance costs. It was designed to approximate market rates while saving employers the cost of having to track market rates. These costs could be significant for many employers. Accordingly, employers should be able to continue to use the prescribed rate to value employee loans if they wish.
11.9 On the other hand, employers who have sufficient information to make a more accurate calculation of the benefit of the loan according to market interest rates should be able to do so.
11.10 To reflect the benefit to the employee accurately, the value of the fringe benefit would need to be calculated with reference to a market rate that would be available for the type and length of loan that the employee had received from the employer.
| Example
An employer lends employee A $10,000, unsecured, at 5% over five years to buy a vehicle. The lowest publicly available unsecured personal loan rate is 10%. An employer lends employee B $10,000 for a house deposit. The loan is secured against the house and set at 5% over five years. The lowest publicly available fixed five-year interest rate is 6.5%. The prescribed rate of interest at the time is 7.5%. The benefit of the employer-provided loan to employee A is much larger than the benefit to employee B in this example as employee A would have had to pay a higher interest rate than employee B if the employer had not provided the loans. Accordingly, if the employer had elected to value the loans according to the difference between the market rates and the actual rates applied, the FBT on employee A's loan would be much higher than the FBT on employee B's loan. However, the difference between the prescribed rate and the actual interest rate applied to both the employee loans is 2.5%. The employer would be able to use this rate when calculating FBT on the loans. The prescribed rate would undervalue the loan to employee A and overvalue employee B's loan. |
Proposal
11.11 The government proposes that employers be able to elect to value employee loans for FBT purposes according to the difference between the rate charged on the loan and either the prescribed rate of interest or a relevant publicly available market rate.
11.12 Providing for two methods allows employers to strike the balance between accuracy and compliance cost in the way that best suits their particular business. However, there would need to be legislative guidelines on making an election, to prevent employers changing the valuation method each quarter according to which method resulted in the lowest FBT. The election should apply for five years and cover all loans to employees.
"Publicly available" interest rates
11.13 Generally, the publicly available rate would be a carded rate offered by a member of the New Zealand Banker's Association. This restriction would limit the potential for interest rates that are used to defeat the FBT rules.
11.14 Sometimes, however, special reduced rates are offered to particular groups. If an employee would qualify for a special reduced interest rate for reasons other than his or her employment, no private benefit would arise from an employer-provided loan at that rate.
11.15 On the other hand, when the reduced rate applies to a class to which the employee does not belong, FBT would apply if the employer provided a loan to the employee at that rate. Clearly, in this situation the employee receives a benefit that he or she would not have received if the employer had not provided the loan.
| Example
An employer is a financial institution that is promoting a special interest rate for members of the local tennis club. Employee A is a member of the local tennis club but employee B is not. No FBT would arise if the employer offered a loan to employee A at the special interest rate because employee A qualifies for the discount by being a tennis club member. If the employer provided employee B with a loan at the special interest rate, FBT would be triggered because the special interest rate is a private benefit arising out of the employment situation. |
Comparable to valuation of discounted or free goods and services
11.16 This proposed approach is consistent with the general valuation rules applicable to discounted goods and services that are also provided by the employer to the public.
11.17 Goods that are manufactured, produced or processed by the employer are valued at the price charged for identical goods to arm's length purchasers. Services provided by the employer's business must be valued at the price charged to the general public.
Proposal
11.18 The government proposes that "publicly available market rates" be defined to include reduced interest rates that would be available to employees other than by reason of their employment.