3. Reducing tax through salary sacrifice
Suggested amendment to the progressive scale
3.1 By using the progressive scale, employees who sacrifice salary in return for increased employer superannuation contributions can reduce their overall tax. Some reduction in tax by using salary sacrifice has been possible since 1 April 2000, when a new top personal tax rate of 39% was introduced, but the top rate of SSCWT remained at 33%. However, since 1 April 2004, when the progressive scale was introduced, some employees have been able to achieve significant reductions in their tax by using the progressive scale to calculate SSCWT. This has led to some employees rearranging their affairs in order to minimise their tax rather than using employer superannuation contributions as a mechanism for retirement savings. This creates pressure on the integrity, fairness and efficiency of the tax system.
| Example 1: Extreme salary sacrifice under the progressive scale
John earns $100,000 a year in salary. Income tax on his salary is $30,270. John makes an arrangement with his employer so that his salary is cut to $9,500, and the balance of $90,500 is paid as employer superannuation contributions.
In the first year of this arrangement, John will pay $1,425 income tax on his salary. His SSCWT rate will be 33%, based on his previous year's salary, so he will pay $29,865 SSCWT ($90,500 * .33). His total tax liability will be $31,290.
In the second year, John will again pay $1,425 income tax on his salary. However, his SSCWT rate will drop to 15%, so he will pay $13,575 SSCWT ($90,500 * .15). His total tax liability will be $15,000.
Over the first two years of the arrangement, John's tax liability will be $14,250 less that it would have been if he had received all his remuneration as salary.
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3.2 Although some degree of salary sacrifice can form part of usual employment arrangements, it is sometimes used merely to reduce tax, which can create unfairness between taxpayers. Use of extreme salary sacrifice schemes can result in some employees paying less tax than others who earn the same or less income.
3.3 Some salary sacrifice schemes entail employees reducing their salaries to very low levels, which means they will need another means of support. Therefore reducing tax through salary sacrifice is likely to be available only to employees who have large assets or income from other sources or who are supported by someone else.
3.4 If enough people engage in salary sacrifice, there could be significant erosion of the Crown's tax revenue base, which could lead to upward pressure on other taxes, thereby increasing the tax burden on other taxpayers.
Suggested amendment to the progressive scale
3.5 Extreme salary sacrifice could be minimised by determining SSCWT rates under the progressive scale by the total of salary or wages and employer superannuation contributions, instead of basing rates on salary or wages alone. At the same time, the SSCWT thresholds could be increased by 15% over the corresponding effective income tax thresholds, to minimise the possibility of over taxation. Available data suggest that most employer superannuation contributions are equivalent to 15% or less of salary or wages.
3.6 Under the suggested changes, the new thresholds would be:
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| Threshold: |
SSCWT rate: |
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| Salary or wages plus superannuation contributions up to $10,925: |
15% on all contributions |
| Salary or wages plus superannuation contributions from $10,926 to $43,700: |
21% on all contributions |
| Salary or wages plus employer superannuation contributions over $43,700: |
33% on all contributions |
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| Example 2: SSCWT based on salary or wages and superannuation contributions, and thresholds 15% higher than the corresponding effective income tax thresholds
Kylie earns $36,000 salary, and also receives $3,600 employer superannuation contributions. Under the suggested changes to the SSCWT thresholds and rates, her SSCWT rate will be 21%, and she will pay $756 SSCWT.
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3.7 If the thresholds were not adjusted upwards, some employees could be overtaxed on their employer superannuation contributions if those contributions took them over a SSCWT threshold.
| Example 3: Overtaxation when SSCWT is based on salary or wages and superannuation contributions, and thresholds are the same as the effective income tax thresholds
Hemi earns $36,000 salary, and also receives $3,600 employer superannuation contributions. If SSCWT rates are determined by the total of salary or wages and employer superannuation contributions, and thresholds are equivalent to income tax thresholds, his SSCWT rate would be 33%, and he would pay $1,188 SSCWT. Had he received those superannuation contributions as salary or wages, $2,000 of them would have been taxed at the lower effective rate of 21%. He is overtaxed by $240 on his employer superannuation contributions.
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3.8 Basing SSCWT rates on the total of salary or wages and employer superannuation contributions, and setting the thresholds 15% higher than the corresponding income tax thresholds would resolve the problem of extreme salary sacrifice. At the same time it would ensure that employer superannuation contributions are not overtaxed in comparison to salary or wages.
| Example 4: Extreme salary sacrifice under the amended progressive scale
John, from example 1, earns $100,000 a year in salary. Income tax on his salary is $30,270. John makes an arrangement with his employer, so that his salary is cut to $9,500, and the balance of $90,500 is paid as employer superannuation contributions.
In each year of this arrangement, John will pay $1,425 income tax on his salary. His SSCWT rate will be 33%, based on his combined salary and superannuation contributions of $100,000, so he will pay $29,865 SSCWT ($90,500 * .33). His total tax liability will be $31,290.
Every year, John's tax liability will be $1,020 higher than it would have been had he received all his remuneration as salary.
Instead of using extreme salary sacrifice, John can continue to save for his retirement through making contributions himself from his tax-paid salary. These personal contributions are not subject to any further tax. Any employer superannuation contributions will be taxed at 33%, and provided that they do not exceed a certain proportion of his salary, John's overall tax liability will not exceed the amount of tax he would have paid if all his remuneration was received as salary.
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3.9 Instead of amending the progressive scale, employer superannuation contributions could be taxed as part of wages and salary. However, this approach would have implications for the social assistance received by some taxpayers. Our preferred approach is to ensure that employer superannuation contributions are taxed at more or less the right rate, and employees' entitlements to social assistance are not affected.
3.10 We invite feedback on our suggested changes to the progressive scale. We are particularly interested in whether the proposed uplift of the SSCWT thresholds would be sufficient to ensure that most employees are not overtaxed on their employer superannuation contributions.
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