Appendix B: Summary of current legislation and its interpretation
The legislation for determining the tax treatment of payments to or on behalf of employees is set out in the Income Tax Act.[34]
In order for a payment to be taxable as employment income, it must be income within Part C of the Income Tax Act 2007 and, more specifically, employment income within section CE 1. Provided a payment is employment income, section CW 17 then sets out the circumstances in which it is exempt income so that it is not assessable. There are also a number of specific exemptions in sections CW 16 to CW 26.
These arrangements are different from circumstances when the employer incurs the liability directly and provides goods or services to the employee for their private benefit. In those circumstances the fringe benefit rules in subpart CX apply. Fringe benefit tax is then payable by the employer on the cost or value of any private benefit rather than income tax payable by the employee.
The current statutory framework covering circumstances when payments are made directly to the employee or paid on their behalf is summarised in more detail in the following paragraphs. They consider, first of all, the general position before going on to consider certain specific circumstances.
Payments made to or for the benefit of an employee
Any amount derived by an employee in connection with their employment or service will be income to that employee under sections CE 1(1)(a) and (b) if that amount is either an allowance or is expenditure on account of an employee.
Expenditure on account of an employee is defined in section CE 5(1) as meaning a payment made by an employer relating to expenditure incurred by an employee. A payment made by an employer in the section CE 5(1) definition includes both payments by an employer to a third party on an employee’s behalf and payments to an employee.
Section CE 5(3) exclusions
Section CE 5(3) contains exclusions from the definition of “expenditure on account of an employee”. If a payment satisfies the requirements of the definition of expenditure on account of an employee in section CE 5(1) but is excluded from the definition by one of the exclusions in section CE 5(3), the payment will not be employment income of the employee. The two exclusions most likely to apply to payments made to or on behalf of employees for their expenditure are contained in section CE 5(3)(a) and (c).
The section CE 5(3)(a) exclusion covers expenditure on account payments that would be exempted under section CW 17. If section CW 17 applies, the payment is excluded from the definition of “expenditure on account of an employee” and is not income.
As the section CE 5(3)(a) exclusion is aimed at payments intended to be exempted under section CW 17, the two types of expenditure on account payments it applies to are:
- expenditure that is committed to by the employee but paid for by the employer (for example, the employer pays the employee’s phone bill on behalf of the employee); and
- expenditure that is committed to and paid for by the employee and reimbursed by the employer (for example, the employer reimburses the employee for the cost of the employee’s phone bill).
The exclusion in section CE 5(3)(c) applies to expenditure that is committed to by the employer, paid for by the employee, and reimbursed by the employer (for example, the employer orders and is invoiced for stationery, the employee pays for the stationery on the employer’s behalf, and the employer reimburses the employee for the cost of the stationery).
The section CE 5(3)(a) exclusion covers reimbursements for expenditure incurred by employees in deriving their employment income while the section CE 5(3)(c) exclusion applies to reimbursements for expenditure paid for by employee’s on their employer’s behalf. These exclusions are mutually exclusive, so if a payment is for expenditure incurred by an employee in deriving their employment income, it is the subject of the section CE 5(3)(a) exclusion and will not be within the scope of the section CE 5(3)(c) exclusion.
Exempt income under section CW 17
Section CW 17(1) provides an exemption from tax for payments made by an employer to a third party on behalf of an employee for expenditure that the employee has incurred when the employee would be able to deduct the expenditure (or part of it) if the employment limitation in section DA 2(4) did not exist. The expenditure must be in connection with the employee’s employment or service and the employee must have incurred the expenditure in the sense of being legally liable for that expenditure.
Section CW 17(2) provides an exemption from tax for payments made by an employer to an employee in connection with that employee’s employment or service to reimburse the employee for expenditure they would have got a deduction for if the employment limitation did not exist.
Under section CW 17(1) and (2), an apportionment may have to be made between the deductible and non-deductible elements of the expenditure under consideration. This apportionment is a question of fact.
Section CW 17(3) provides that, for a relevant period, the employer may make a reasonable estimate of the amount of expenditure likely to be incurred by an employee or a group of employees for which a reimbursement is payable. In practice, these types of reimbursement will be paid in the form of an allowance.
Deductions – general rules
The deduction rules are set out in Part D with the general deduction rules in subpart DA. Section DA 1(1)(a) permits a deduction for an amount of expenditure to the extent that it is incurred in deriving assessable income. However, to qualify for a deduction, the expenditure in question must bear a sufficient relationship, or nexus, with the income.[35]
The general deductibility permission in section DA 1(1)(a) requires there to be a sufficient relationship between the expenditure and the income-earning process of the individual claiming the deduction. The expenditure under consideration must be incurred in the course of the employee deriving their employment income. It is not sufficient that the expenditure puts the employee in a position to earn income.
Section DA 2 denies a deduction “to the extent to which” the expenditure falls within a number of general limitations The words “to the extent to which” provide that there may be an apportionment when part of the expenditure falls within one of the general limitations. The general limitations relevant to section CW 17 include:
- The “capital limitation” in section DA 2(1). The capital limitation denies a deduction for any expenditure to the extent that the expenditure is capital in nature. However, the capital limitation will not apply to an amount of depreciation loss (see section DA 4).
- The “private limitation” section DA 2(2). The private limitation denies a deduction for expenditure to the extent that the expenditure is of a private or domestic nature.
- The “employment limitation” in section DA 2(4). The employment limitation denies a deduction for an amount of expenditure to the extent that expenditure is incurred in deriving income from employment.
An outgoing is of a private nature if it is exclusively referable to living as an individual member of society, and domestic expenses are those relating to the household or family unit.[36] Examples of expenditure that are often of a private nature include food, clothing and accommodation. Examples of expenditure that are often domestic in nature include a home telephone, an internet connection and furniture.
When a benefit of a private or domestic nature accrues to the recipient, but this benefit is incidental to the income-earning or business activity of the payer, the deduction is not prohibited. When the private or domestic benefit accrues from a purpose of the taxpayer distinct from the employment purpose, apportionment is necessary.
Accommodation allowances
Section CE 1(1B) provides that the market value of accommodation, or an accommodation allowance, provided to a person in relation to their job is treated as his or her employment income.
When the employer provides their employee with actual accommodation, rather than an allowance or reimbursement, this differs from most other circumstances when an employer provides their employee with a non-cash benefit. The value of the accommodation is not a fringe benefit.
When the property is owned by the employer, market value is the market rent that the property would otherwise fetch on the open market. If the property is rented by the employer, the market value is the rent paid by the employer. In both circumstances, the taxable value is adjusted for anything made good by the employee.
Section CE 1(2) defines accommodation as meaning board or lodging, or the use of a house or living premises, or the use of part of a house or living premises. Accommodation benefits are taxed under PAYE.
There are also two specific circumstances when the provision of accommodation or an accommodation payment is exempt from tax:
- Section CW 25 provides an exemption for the value of personal board and lodging for members of religious orders or societies in certain narrowly defined circumstances. There is no general legislative provision, though, for a concessionary treatment for valuing accommodation benefits provided to a minister of religion.
- Section CW 17B provides that relocation payments are tax-free provided certain criteria are met. When the employee is entitled to the relocation exemption, the provision of accommodation benefits is not taxed for up to three months after moving to the new location.[37]
Other allowances
Section CW 17C provides an exemption for payments for overtime meals and sustenance allowances. The exemptions set out certain criteria that have to be satisfied before payments can be treated as exempt income.
Section CW 18 provides an exemption for payments by an employer to meet above normal transport costs that an employee has incurred in travelling between their home and place of work. A payment is exempt to the extent that the employee incurs the additional transport costs in connection with their employment for the employer’s benefit and convenience.
The effect of sections CW 31 and CX 12 is that the payment of allowances to members of Parliament under the Civil List Act 1979 is taxed by way of fringe benefit tax, rather than under income tax.
34 All statutory references are to the Income Tax Act 2007.
35 The leading New Zealand cases on the deductibility of expenditure are CIR v Banks [1978] 2 NZLR 472 and Buckley & Young Ltd v CIR [1978] 2 NZLR 485. These cases are authority for the proposition that there must be a sufficient nexus between the expenditure and the income earning process for the expenditure to be deductible.
36 CIR v Haenga [1985] 7 NZTC 5198, in which Richardson J commented on the meanings of “private” and “domestic” (at p5, 207): “An outgoing is of a private nature if it is exclusively referable to living as an individual member of society and domestic expenses are those relating to the household or family unit…”.