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What should be a taxable benefit?
Valuing benefits
2.1 In theory, anything that employers provide to employees that could be considered to be a substitute for salary and wages should be treated as a fringe benefit. Fringe benefits that reduce employees' needs to meet private outgoings from their own resources clearly increase their capacity to spend or save in just the same way as does the payment of additional salary and wages in cash. Given that salary and wages are taxable, it follows that, to ensure neutrality of treatment, fringe benefits should be taxable on an equivalent basis, provided that the economic benefits of doing so are not outweighed by the economic costs.
2.2 Applying neutral treatment ensures that economic behaviour is not influenced by the tax outcome and improves economic efficiency. The efficiency gains from FBT result from a reduction in the tax incentive to provide fringe benefit remuneration and the associated reduction in attractiveness of activities that lend themselves to high fringe benefit remuneration.
2.3 Neutrality also means greater equality as employees enjoying equivalent remuneration packages pay equivalent tax, regardless of the package's composition.
What should be a taxable benefit?
2.4 Because what constitutes a benefit can be very wide, further tests are necessary to identify more specifically the extent of any taxable benefit. Should FBT apply to all benefits that make an employee better off, even if they are not readily substitutable for cash, or should it apply only to those benefits that are easily substitutable for cash or are the non-cash equivalent of a taxable allowance?
Taxing cash substitutes only
2.5 The argument for a more limited approach is that it would be more consistent with the position that benefits arise with the use of goods and services that employees would otherwise purchase privately. Anything that an employee could not substitute for cash remuneration would not be a fringe benefit.
2.6 Take, for example, the case of employer-provided, non-exchangeable tickets to a weekend sports event. The value of attending will vary greatly depending on whether the employee enjoys the particular sport or the team playing. It is unlikely that an employee not keen on sport could negotiate a cash substitute for such a low-value benefit, particularly if the tickets are part of a sponsorship package. That employee may be able to sell the tickets but there can be costs associated with doing so. On the other hand, if an employee is a sports fan it is likely that the employer-provided tickets alleviate the cost the employee would otherwise have met from cash remuneration. The cash substitution approach would, to some extent, remove this uncertainty about whether the employee is likely to receive a benefit.
2.7 Applying the cash substitution approach would mean a comparatively narrower range of benefits would be covered. As such, the approach could have a greater impact on economic decision-making and equity across employees, depending on the extent to which those benefits that were not covered were considered by employees to have value. Furthermore, it could be difficult in many instances to determine whether a fringe benefit is, in fact, substitutable for cash. One approach would list a range of benefits that were considered to be substitutable for cash. Any such list would, however, involve a degree of arbitrariness.
Taxing all non-cash remuneration
2.8 Taxing all non-cash remuneration will have a lesser impact on decision-making as it seeks to treat all benefits that flow from the employer to the employee equally for tax purposes. Although this may appear to be too wide to be practicable, the ability to value a benefit will act as a practical limitation and the ultimate test as to whether something has potential value to the employee.
2.9 Further practical adjustments can be applied. Some benefits are very difficult to value as there is no readily associated market price. When it is evident in such cases that the cost involved in paying FBT on the benefit clearly outweighs the value of the benefit, exempting the benefit can operate as a useful moderating tool to prevent the FBT rules from applying unreasonably.
2.10 When benefits can be more easily measured, instances of when the cost involved in paying FBT outweighs the value of the benefit can be handled by the setting of minimum taxable values, or de minimis thresholds.
Valuing benefits
2.11 Two key tests are helpful in valuing benefits:
- if the benefit involves the provision of an asset, whether the asset is available for private use by the employee; and
- the value of the benefit to the employee.
2.12 Consider, for instance, the situation of an employer providing an employee with a motor vehicle. Without the employer-provided car, the employee would have had to purchase a car and incur fixed costs (depreciation, interest, licensing, insurance and warrant of fitness). If the employee uses the vehicle, he or she enjoys further savings in terms of avoiding running costs (maintenance, tyres and possibly oil and petrol if the employer also covers this).
2.13 If recognition of the benefit was confined to actual private use - say, on the basis of either kilometres travelled or time, the benefit would be materially undervalued because the fixed costs occur irrespective of whether the vehicle is used. The employee enjoys the economic benefit of avoiding these costs, hence the concept of availability being a fringe benefit.
2.14 The other important concept is that the value of the benefit should be the value to the employee rather than, say, the cost to the employer of providing the benefit. In many cases the two values will differ, with the employer having an incentive to provide benefits that have a low marginal cost to them but that are more highly valued by the employee. An example that highlights this disparity is air tickets, which an employer who is in the business of providing air travel may be quite happy to offer to employees at a very low price because the marginal cost of an empty seat at the time of departure is close to zero. In contrast, the benefit of the ticket to the employee is in most instances the price of a normal (standby) fare. The reason the focus needs to be on the value to the employee is because it should measure what the employee is willing to give up in terms of (after tax) salary and wages.
Trade-off between accuracy and compliance costs
2.15 Trying to measure all benefits accurately is unrealistic as it would give rise to significant compliance costs for taxpayers and enforcement costs for Inland Revenue. Also, the behavioural effects and revenue implications are minimal from low-value benefits. This means, just as when deciding which benefits should be taxable, that a realistic approach should be taken, with the main emphasis being on the "big ticket" and more frequently occurring benefits. Even in those cases, however, we acknowledge that there is room for flexibility and the need to make trade-offs between accuracy and compliance costs.
2.16 Getting the right trade-off is important. The broader the application of tax to fringe benefits, the greater the incentive to switch from fringe benefits to cash remuneration, which then becomes taxable under the personal tax system. At the same time, a reduction in the occurrence of fringe benefit remuneration eases the administration of the tax. However, a relatively onerous tax also increases the incentive for avoidance and evasion and leads to pressure for the granting of concessions or exemptions. A concessionary tax tends to have the opposite results, including making the administration of the tax more difficult through reducing the incentive to switch to cash remuneration.
Categorisation of benefits
2.17 Fringe benefits can be categorised into three groups for valuation purposes:
- benefits that are easily quantified and can be assessed by individual valuation - for example, an employer paying for an employee's holiday;
- benefits, such as motor vehicles, that would require a more complicated calculation if assessed on an individual basis and should, therefore, be treated as a class to which a standard set of rules applies; and
- benefits, such as a staff cafeteria in which food is provided at subsidised prices, that are difficult to allocate to individuals largely because, although the benefit might be frequently used, each benefit is small.
2.18 The earlier discussion suggests that the FBT rules should focus primarily on the first two categories and that the third is unlikely to be worth taxing and can be addressed by setting minimum values that apply before a benefit is recognised.
2.19 When, as in the first category, an employer provides a taxable benefit by paying for a good or service that is supplied by another independent party, the value of the benefit to the employee can be taken for practical reasons as the cost to the employer. In such cases the benefit has a clear market price and the value to the employee should equate to the cost to the employer.
2.20 The next chapter discusses how the current rules compare with this framework.