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Inland Revenue

Tax Policy

Chapter 6 - Current legislation, interpretation and delivery options

  • Alternative approaches to the current general legislation around the tax treatment of employee expenditure payments are considered, ranging from a fundamental change in approach to leaving the general rules unchanged but introducing a power to exempt particular payments by Commissioner determination-making power for the treatment of payments not addressed by specific rules.
  • Changes may be needed to the legislation concerning “expenditure on account of an employee” to remove ambiguities around the application of the general exclusions.

6.1 This chapter considers how well the existing legislation works for employee expenditure payments in general, beyond the most common payments considered in the previous chapters. The intended scope of the current legislation as well as its advantages and disadvantages are therefore examined and options discussed.

6.2 We also consider whether the mechanism within which any outcomes are delivered needs to be legislated so that employers, employees, their advisers and Inland Revenue can then apply them in practice.

The current legislation

6.3 Section CE 1(1) treats any amounts derived by employees from their employment as employment income. This can take a variety of forms beyond salary or wages, and the definition of employment income is drawn widely. It includes amounts paid by way of an allowance, expenditure on account of the employee, and any other benefit in money.


6.4 The term “allowance” is not defined in the Income Tax Act 2007 but case law[28] suggests that to be an allowance, an amount paid must have the following characteristics:

  • the amount must be paid in money to the employee;
  • the amount must be paid periodically or on the occurrence of certain events; and
  • the amount must be an entitlement, rather than a discretionary payment.

6.5 Case law has suggested that allowances only include payments for expenditure yet to be incurred by the employee and do not include payments relating to expenditure already incurred. In the case of M76,[29] Judge Bathgate stated that:

“As a verb, the word [allowance] is said to mean “the action of allowing: a thing allowed”. By paying an allowance an employer pays to the credit of the employee, on account of the employee’s expenses to be incurred, a payment for such expenses. An allowance is not apt to cover the situation of an employer paying a debt owed to the employee, rather it is a payment for or to meet expenditure of the employee, yet to be incurred by the employee, for or on behalf of the employer.”

6.6 Adopting this interpretation, an allowance is not a payment for expenditure already incurred by the employee on behalf of the employer. The amount of the allowance can also be based on a reasonable estimate of the expected expenditure, rather than be an exact reimbursement of expenditure.

6.7 For example, in accordance with company policy to pay an allowance when it sends an employee on a business trip, an employer pays an amount of $300 to an employee before their departure to meet the employee’s estimated travel expenses on an overnight trip to Auckland.

Expenditure on account of an employee

6.8 The second type of employee expenditure payment that is treated as employment income is “expenditure on account of an employee”. This is defined in legislation[30] in very broad terms as a payment made by an employer relating to expenditure incurred by an employee. If a payment satisfies these requirements it is expenditure on account of an employee and treated as employment income for tax purposes, unless it is covered by one of the statutory exclusions.[31] If one of the statutory exclusions applies, the payment is not expenditure on account of an employee and the employee expenditure payment is unlikely to be employment income of the employee.

6.9 Within the statutory exclusions to expenditure on account of an employee, there are two general exclusions.[32] These cover:

  • expenditure for the benefit of the employee, or a payment made to reimburse an employee for expenditure to the extent that the employee would be entitled to a deduction if they incurred the expenditure and the “employment limitation” did not exist (this exclusion applies section CW 17 to the expenditure); and
  • expenditure 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. It is important to note that, in these circumstances, nothing is really provided to the employee. The employee is acting as agent of the employer. From a policy perspective, such payments should be excluded from being expenditure on account of an employee.

Is the amount exempt income under section CW 17?

6.10 Section CW 17 provides an exemption from tax for certain employee expenditure payments in whole or in part. The expenditure in question must be in connection with the employee’s employment and the provision exempts the income from tax to the extent to which the employee would be entitled to a deduction if the “employment limitation” did not exist. The employment limitation in section DA 2(4) denies employees a deduction for expenditure to the extent that it is incurred in earning income from their employment.

6.11 In determining the exempt portion of the income in question, an apportionment may have to be made between the deductible and non-deductible elements of the expenditure under consideration. The apportionment methodology is not defined, but depends on the employee’s circumstances and the particular requirements of the employee’s job.

6.12 The general deductibility provision in section DA 1(1)(a) requires there to be a sufficient relationship or nexus between the expenditure and the income-earning process of the individual claiming the deduction.

6.13 To be exempt using the guidance of the general deductibility provision, the expenditure under consideration must be incurred in the course of the employee earning their employment income. It is not sufficient that the expenditure puts the employee in a position to earn income. So, an employee expenditure payment to reimburse an employee’s travel costs between home and work is taxable since the linked expenditure is to put the employee in a position to earn their employment income rather than in the course of doing so.

6.14 When the expense is private, the general deductibility rule will not be satisfied.

6.15 An employee is also denied a deduction for the expenditure that the employee expenditure payment relates to if the expenditure is capital in nature. Section CW 17, however, ensures that this does not prohibit a payment including a depreciation element from being treated as non-taxable.

6.16 A more detailed summary of the relevant legislation is set out in Appendix B.

Alternative approaches to current legislation

Applying the “nexus” test to employee expenditure payments in general

6.17 The previous chapters considered options for making it easier to identify the taxable amount when employee expenditure payments are made to meet the more common types of work expenditure. However, they do not cover every circumstance and a general rule is still needed.

6.18 The treatment of the specific payments would be legislated for in those cases and treated as if they satisfied the general rule or were a proxy for the general rule.

6.19 The question is whether, for the general rule, the current nexus test is the best approach, or whether there is another approach that could better achieve the necessary differentiation between an employee expenditure payment linked to a wholly work expense, a private expense and a mixed work/ private expense.

6.20 The current test does allow an employee expenditure payment in respect of expenditure incurred in earning the employee’s employment income to be exempted for tax purposes, but for anything which includes a private element to be taxed. This is consistent with the general aims of the tax system.

6.21 However, the current test does have some disadvantages:

  • The statutory tests require an assessment to be made concerning the deductibility of the employee’s expenditure in applying three hypothetical deduction tests that override the “employment limitation”: is the expenditure incurred in earning the employee’s employment income, to what extent is it private or domestic, and to what extent is it capital? Employees have not been able to claim deductions from their taxable income for over 25 years and applying a hypothetical deduction rule to amounts that could never be deductible may be seen by some as confusing.
  • A judgement must be made about the expenditure in question and its purpose. This may be relatively simple when it is or is not clearly a private expense, but this is not always the case – for example, study courses undertaken by an employee may have a benefit in the employer’s business, but also a private benefit to the employee in enhancing their human capital. The general rule provides no clarity in this case.

6.22 We have, therefore, considered some alternative approaches.


6.23 To address these issues, we have suggested the following approaches:

  • Incorporating into a general rule, the principles outlined in chapter 2 and followed in this paper in relation to specific payments – Being predominantly an exemption for low-in-value and incidental or hard-to-measure private elements. The benefits of this approach would be greater coherence and consistency in treatment across the range of payments. The disadvantage would be the potential for low-in-value and hard-to-measure items becoming more commonplace to take advantage of the exemption. An assessment would continue to have to be made about the quality of the employee expenditure.
  • Simplify the current exemption rule for determining the taxable amount – It is arguable that the private and capital limitations are not a necessary element of the current approach since such an expense is not incurred in earning the employment income. Therefore, a further option is to abolish the existing deductibility test and replace it with a simpler exception test focused on the linked expenditure having been incurred by the employee in earning the income from the employment.
    Changing the approach could remove the need to apply the hypothetical deduction test and the private and capital limitations. However, this is essentially the approach taken by the courts in interpreting the relevant legislation in any case and identification and apportionment issues around distinguishing employment and whether there was a private benefit would still arise.
    This option would require new rules for establishing the tax treatment of an employee expenditure payment. However, these might reflect a simplification of the current rules without a radical change in approach. And a significant change in the wording of the exemption rule might give rise to unintended consequences and a shift in interpretation by Inland Revenue, taxpayers and the courts.
  • Continue to apply the current exemption rule but introduce a power to exempt or otherwise specify the tax treatment of particular payments by Commissioner determination – This approach would leave the existing rules unchanged. However, in the event that issues are identified around the tax treatment of particular types of payment in defined circumstances, further rules would be introduced. This approach would provide a practical solution for employee expenditure payments that were sufficiently common or widespread to warrant a specific determination.
Feedback on preferred option

6.24 We have not expressed a preference for how the general rule should operate but would be interested in obtaining views on the options as well as any not considered in this section.

Expenditure on account of an employee

6.25 The statutory definition of “expenditure on account of an employee” is very widely drawn, so there is a comprehensive list of exclusions from this definition. Although most of the exclusions in this list cover specific types of payment, there are two general exclusions set out in section CE 5(3)(a) and (c). These are important exclusions because they cover employee expenditure payments in general.

6.26 There have been a number of significant changes to this legislation since it was first introduced in 1985.[33] The changes have reflected major and minor reform of the tax treatment of employee expenditure payments. As a result of these changes, the general exclusions have been amended and expanded and it is no longer clear how the exclusions should apply, particularly in relation to each other. The general exclusion in section CE 5(3)(a) which only covered the payment of an allowance when first introduced now has wider coverage so, arguably, it now covers a wider range of employee expenditure payments.


6.27 Removing the ambiguity around the interpretation of the exclusions from expenditure on account of an employee would improve certainty around the tax treatment of employee expenditure payments.

6.28 This would require legislative change to the two general exclusions, either by:

  • amending both general exclusions to make a clearer distinction between when they should apply. A distinction would need to be made between reimbursing allowances, expenses incurred by employees and expenses incurred on behalf of their employers. This would require the way in which an employee expenditure payment is made to be considered in applying the tax rules;
  • replacing both exclusions with a single general exclusion. This would consolidate the general exclusions into a single exclusion. Since there would only be a single such exception, the way in which an employee expenditure payment is made would not need to be considered; or.
  • repeal of paragraph (c) in section CE 5(3). This would leave the paragraph (a) exception unchanged as the only general exclusion.
Preferred option

6.29 The best option will be determined by the shape of the overall legislation relating to employee expenditure payments and a decision on the preferred option will not be apparent until that is clear.

Capital limitation

6.30 An employee is denied a deduction for expenditure that is capital in nature. However, section CW 17(4) allows for a payment to include an amount of depreciation loss. The depreciation rules also allow low value assets (costing $500 or less) to be deducted in the year of acquisition.

6.31 In practice, this issue might arise when an employee is reimbursed for expenditure relating to the purchase of a capital item. An example includes purchase of a laptop computer for work purposes and the employer reimburses the employee for the cost of the laptop. Another example is a mileage allowance that includes a component for depreciation of the employee’s motor car when it is used for work purposes. The capital limitation would also be relevant to expenditure relating to a capital item, such as reimbursement of expenses relating to the cost of converting a room into a home office when an employee works from home. It is useful to bear in mind that often this type of expenditure will also have a private or domestic element to it.

6.32 To the extent that capital expenditure is incurred in acquiring an asset for use in the employee’s job, it would seem reasonable to continue to allow a deduction for an amount of depreciation loss.

Estimated expenditure of employees

6.33 When an employee incurs expenditure for which he or she expects to be compensated, the employee will often itemise the amount of each expense. This will be the case when the employer makes a payment on account or reimburses particular expenses. However, many employers prefer to reduce administrative costs by paying an up-front allowance with the tax-free element supported by an estimate of the underlying allowable expense.

6.34 This approach is allowed by section CW 17(3). This section provides for the amount incurred for a relevant period to be based on a relevant estimate of the expenditure likely to be incurred by the employee or a group of employees. The legislation is fairly broad and does not provide any further guidance or direction on how the estimate should be made, except that the estimate must be reasonable.

6.35 While many employers base their employee expenditure payments on the actual expenditure incurred (for example, setting a maximum amount the employee can spend on meals and accommodation and then reimbursing up to that amount) others, prefer to pay an allowance based on a daily rate. These daily amounts based on an estimated cost of hotel accommodation and meal costs, with different rates depending on location or the meals in question.

6.36 The advantage to employers of paying a daily amount is that they do not have to check individual expense claims for particular journeys. There is a saving on administrative costs in checking claims when the amount they pay out under either approach is broadly similar.

6.37 Provided a daily amount is supported by evidence to show that the employer has taken reasonable steps to establish that the amounts reasonably reflect the expenses their employees incur, this would satisfy the requirements of section CW 17(3). However, we would expect employers to monitor the level of expenditure and remain satisfied that the amounts are reasonable in the particular circumstances.

6.38 Framing the legislation in this way allows employers considerable flexibility in how they go about making an estimate, provided it is reasonable. We are not aware of particular problems in applying the rule and, therefore, are not proposing to make any changes to it.

Delivery mechanisms

6.39 The proposals in this document will require changes to the Income Tax Act 2007. However, supporting rules may be better addressed through other mechanisms. These supporting rules may include, for example, how the Commissioner would propose to exercise the discretion to extend the 12-month period under which accommodation payments may be made tax-free. Importantly, they may also serve to provide clarity on the treatment of allowances not previously considered, including those where exemption is warranted because the amounts involved are low in value and incidental or hard to measure.

Commissioner determinations

6.40 The Commissioner may issue binding determinations about various tax issues. These determinations generally represent statutory discretions exercised by the Commissioner relating to a specific tax issue. The determinations may, for example, set rates, values or types of deductible expenditure.

6.41 An example of a binding Commissioner’s determination is the power to provide, extend and modify the list of eligible relocation expenses under section CW 17B(6).

6.42 One of the options considered in this paper is an upper time limit for treating a visit to a particular workplace as temporary for the purposes of determining whether an accommodation payment can be made tax-free. Our preferred option is to set an upper time limit of 12 months but subject to a power to extend that in certain exceptional circumstances. We have suggested that those circumstances might include when a contract originally scheduled to finish within the upper time limit overruns because of some unforeseen event. It might be appropriate to introduce a power to set those circumstances by way of a Commissioner’s determination.

6.43 The taxability or exemption issues relating to particular allowances that are not covered by specific rules could also be dealt with through a determination process. We would expect these to be fairly limited and only made when the payment in question was widespread and its treatment demonstrably in need of identification.


28 Stagg v CIR [1959] NZLR 1252 (SC), CIR v Parson (No 2) [1968] NZLR 574 (CA), Sixton v CIR (1982) 5 NZTC 61,285 (HC) and Mutual Acceptance Co Ltd v FCT (1944) 69 CLR 389.

29 M76 (1990) 12NZTC2469.

30 Section CE 5(1).

31 Section CE 5(3).

32 Section CE 5(3)(a) and (c).

33 Income Tax Amendment (No. 2) Act 1985 – see Public Information Bulletin No. 136 Part 3 February 1986.