Chapter 2 - Tax changes

2.1 This chapter considers whether salary-substituted amounts that are currently untaxed should be subject to tax so that, after taking into account necessary compliance and administration cost trade-offs, the same amount of tax is paid on a salary package irrespective of how it is composed. It suggests, subject to certain provisos, that such amounts should be taxed if they are part of a salary trade-off. Two options are discussed on how this might be achieved.

2.2 Changes to the FBT rules are also considered that would:

• exclude all car park and childcare benefits from the on-premises FBT exemption and instead, depending on the mechanism chosen, separately subject these benefits to either PAYE or FBT when they are part of a salary trade-off; and
• remove the benefit of arrangements involving vouchers from the FBT exemption that may be available to charitable organisations in respect of non-cash benefits provided to their employees.

Current issues

2.3 Conceptually, anything that an employer provides to an employee that could be considered to be a substitute for salary and wages ought to be made taxable when it is of material value. We appreciate, however, that there are practical limitations. Based on past experience, the wholesale removal of certain FBT exemptions (such as that for on-premises car parks) would likely be contentious, partly because of resulting valuation and compliance cost concerns and partly because of the sensitivities associated with the exemptions themselves.

2.4 In these circumstances we have decided to focus primarily on situations of evident salary substitution, such as when the employee has been given a cash alternative to the benefit and equivalent situations. When salary has effectively been forgone, the tax treatment of those amounts should be aligned as much as possible with the tax treatment of salary and wages.

2.5 Currently, salary and wages are treated as employment income, and subject to PAYE, while most non-cash benefits received as a result of employment are treated as fringe benefits, and subject to FBT.[4] This means that although amounts that are included in a salary trade-off may not be directly taxed as salary and wages, they are in many instances indirectly taxed through the tax treatment that applies to the benefits received.

2.6 There are, however, instances when some salary substitutes, or the equivalent amount of salary or wages that has been traded off, are not taxed. Examples include the salary traded off for an employer-provided car park or childcare benefits when these benefits are provided on the employer’s premises,[5] and benefits provided to employees of charitable organisations as part of a salary trade-off.[6] Another example could be an employer payment in respect of a group life insurance policy, when part of a salary trade-off.

2.7 It is difficult to justify these trade-off situations being tax exempt on tax policy grounds when it is considered that the amounts would be taxed if provided as cash remuneration.

2.8 The exemption gives rise to equity and efficiency issues. A key principle of tax policy is horizontal equity: ideally a tax should apply equally to people on the same effective income. By being untaxed on the salary trade-off, and therefore choosing to receive part of their remuneration in kind, the employee receives a tax saving over other employees who may receive the same overall salary package but are fully taxed on their total remuneration through either, or a combination of, the PAYE system or the FBT system. This is not equitable.

2.9 In practice, the benefits of this subsidy or tax incentive that the Government is in effect providing are likely to be shared between the employer and the employee. To the extent that the employer pays less for their labour because of the tax exemption, it changes the relative price of labour and encourages the employer to over-invest in labour and under-invest in capital equipment. This is economically inefficient.

2.10 A more equitable and economically efficient outcome, including a lower likelihood of behavioural distortions, can be achieved by reducing this uneven tax treatment. This would enhance the integrity of the tax system.

Taxing benefits that form part of a salary trade-off

2.11 The suggested solution is, therefore, to tax amounts that are currently not taxed when they are part of a salary trade-off (which, as discussed later in this chapter, includes both explicit and implicit trade-offs).

2.12 This could be achieved by either:

• including the amount of salary traded off in the employee’s income and applying PAYE. This would be through a general rule covering all salary trade-offs, even those where the underlying benefits are already subject to FBT. To avoid double taxation, employers would be able when calculating their FBT liability, to treat those salary trade-off amounts (net of PAYE), to the extent that the underlying benefits are subject to FBT, as a contribution paid by the employee.[7] This would reduce and in many cases remove the relevant FBT liability; or
• through a rule confined just to salary trade-offs involving specific currently FBT-exempt benefits, being car parks or childcare provided on the employer’s premises, and certain fringe benefits provided to employees of charitable organisations. FBT would be applied to the salary trade-off amounts.[8]

2.13 Either option could be set up to largely achieve the same overall tax results, with appropriate minimum value thresholds to ensure this. Consequently, key in deciding which option is preferable, is which one imposes the least compliance cost while achieving the other key objective of ensuring that the amounts are taken into account when determining eligibility for various social assistance programmes. Submissions on which option is preferred would be welcomed.

Option 1 – PAYE approach

2.14 While some may argue that an approach that subjected all salary trade-offs to PAYE would be too comprehensive, in practice it would, like the targeted approach, only affect those FBT-exempt benefits where an employee has been prepared to trade off salary and, therefore, are presumed to have some value to the employee. This is because of the square up that would offset salary trade-off amounts when the underlying benefits are already subject to FBT, against the employer’s FBT liability in relation to those benefits.

2.15 There would be an additional compliance cost on employers through their having to do this square-up, which would need to be done for each FBT return-period.

2.16 On the other hand, since the salary trade-offs would be income to the employee and therefore automatically included in their social assistance income calculations, the employer would not need to separately advise employees, for social assistance calculation purposes, of the value of the underlying attributed fringe benefits and associated fringe benefit tax included in the salary trade-offs. This aspect is discussed more fully in chapter 3.

Option 2 – FBT approach

2.17 The second option would require only certain currently FBT-exempt benefits to be brought within the FBT net, when they are part of a salary trade-off.

2.18 Under this option, employers would need to advise employees of all the fringe benefits that have been attributed to them as part of the salary trade-off (together with the associated FBT) so that if applicable, they can include the amount in their social assistance calculations. This should be able to be obtained from the information that employers currently compile for the purposes of attributing fringe benefits to the relevant employees. This information would be particularly crucial in the case of implicit salary trade-offs (discussed below) as employees may not have information on what value their employers have ascribed to such trade-offs.

2.19 The Tax Credits Registration form – FS l – that employees complete when applying for Working for Families tax credits would need to be expanded to include these fringe benefits, as it currently only covers fringe benefits provided to shareholder-employees who hold voting interests of 50 percent or more in their respective companies. Employees would also need to obtain information from employers at year-end, or even during the year, if the value of the fringe benefits received differs from that expected when the employee completed the FS 1 form at the beginning of the year.

2.20 Providing the extra information to employees would be an additional compliance cost relative to the PAYE option. On the other hand, there would not be a need to square-up salary trade-offs with FBT liabilities under this option, given that the benefits being targeted would not be subject to FBT.

2.21 The FBT approach may be easier to apply to salary trade-offs provided by charitable organisations given the range of exemptions in the FBT rules which would need to be reflected in the minimum value thresholds in the PAYE approach as discussed below. In the case of charitable organisations, this FBT option would involve a narrowing of the current FBT exemption for benefits provided to their employees. On the other hand, the tax would be imposed directly on charitable organisations which would have to put FBT systems in place rather than just extend their use of PAYE systems.

Minimum values

2.22 Under the PAYE option it may be appropriate to have a minimum value threshold specific to aggregate salary trade-offs involving what would be unclassified or other exempt benefits under the FBT rules. A suggested threshold is $1,800 per annum (equivalent to that in the FBT rules, after including tax,[9] for low-value unclassified benefits). This would be to avoid these amounts being taxed under the PAYE rules when they have been exempted from FBT. The threshold would be limited to implicit salary trade-off situations on the basis that if an employee has accepted an explicit trade-off, it is assumed that the employee has decided that the benefits are of sufficient value to them and, therefore, the amount of salary traded off (irrespective of the trade-off value) should be taxable. We are seeking the public’s views on whether this approach is appropriate, and whether the minimum value threshold should be extended to explicit salary trade-off situations.

Implication for the FBT rules

2.23 The focus on salary trade-off situations is not a signal of a more general change of approach to the taxing of fringe benefits. As noted in chapter 1, this approach is being adopted in recognition of the contentious nature of past suggestions in relation to the currently untaxed key benefits, and the proposal in effect represents a compromise approach to obtaining certainty in these areas and a more equitable and efficient approach overall.

2.24 Although it is recognised that FBT gives rise to its own compliance costs, particularly for employers, it is still considered to be an effective tax for buttressing the taxation of salary and wages by reducing the incentive to provide remuneration through benefits rather than cash. This review is not intending to change the current general approach to determining what constitutes a fringe benefit, and fringe benefits will continue to be taxed under the FBT rules.

Salary trade-off defined

2.25 The risk with focussing on pure salary trade-offs involving the sacrifice of a specific amount of salary for a specific benefit, rather than on all material situations when the underlying benefits are provided, is that economic decision-making could be affected – for example, contracts could be altered over time to provide benefits outside of explicit salary trade-offs. Some employees could still receive the benefits on an untaxed basis. To some extent, employment relationships may reduce these risks, particularly if an employer has a large number of employees. These risks can be further ameliorated through the way in which a “salary trade-off” is defined.

2.26 We envisage a “salary trade-off” being defined to include:

• an amount of salary or wages that is traded off for a non-cash benefit;
• any other income related to employment and payable in money that is traded off for a non-cash benefit; and
• any attributed or currently untaxed benefit for FBT purposes that is offered to a group or class of employees not involving an explicit trade-off for salary or wages, where the employee has an enforceable right to the benefit and has taken up the benefit. The benefit must also be available to the employee. We refer to this as an implicit salary or wage trade-off.

2.27 This broader definition recognises that not all salary trade-offs involve the employee actively choosing to forgo an amount of salary in exchange for the benefits. A group or class of employees may be offered non-cash benefits outside of an explicit salary trade-off, similar to those offered under a salary trade-off but with no cash alternative being offered to those that do not wish to take up the benefit. For equity and base-protection reasons, we consider that the proposed new rule needs to cover these implicit salary trade-off situations provided the employee has an enforceable right to the benefit and has taken up the benefit.

2.28 The requirement that the employee has an enforceable right means that the benefit will have been either specified in an employment agreement or in documentation[11] associated with an employment agreement rather than being provided by the employer as an incidental perk or on a casual basis. Limiting the requirement this way is intended to reflect that the employee is more likely to consider it to be of value, particularly if the employee has taken up the option. The agreement may even ascribe a value to it. Likewise, the requirement that the benefit has to have been taken up is to ensure that employees are not taxed on terms in their employment agreements that they do not take up, presumably on the basis that there is minimal value to them. The requirement that the benefit has to be available for use ensures that the employee is not affected if the benefit is unable to be provided by the employer as might be the case for a car park in the central business district red zone in Christchurch.

Value of trade-off

2.29 The value of the salary trade-off would, in most cases, be the amount of employment income traded off for the benefit.

2.30 If there was an implicit salary trade-off, the employer would need to ascribe a value to that trade-off for those employees who had chosen to take up the offer. We acknowledge that valuing the benefit may be more readily achievable in some cases than in others – for example, it may be the amount paid by the employer to a third-party providing the benefit but in other cases another valuation mechanism will be needed. A standard value could be considered to ease compliance costs in such cases.

2.31 Given these valuation issues, submissions are also sought on alternative ways in which the risks and costs associated with implicit salary trade-offs might be mitigated.

Salary trade-off examples

Implications for on-premises exemption – car parks and childcare

2.32 The changes we are suggesting would also provide an important opportunity to address a long-standing issue with the current boundary used to determine whether the provision of a car park is a fringe benefit.

2.33 One of the key determinants of whether an employer-provided car park is a fringe benefit is whether the benefit is enjoyed on the premises of the employer. What constitutes “premises” of the employer is based on the common law distinction between a lease and a licence – the former being exempt and the latter being taxable on the basis that a lease, like ownership, provides an exclusive right of possession. Therefore, a car-parking benefit provided to an employee as part of his or her remuneration is taxable if the benefit is provided on licensed premises of the employer, but is exempt if provided on the employer’s leased premises.

2.34 The same test applies to employer-provided childcare facilities. Some employers offer or arrange childcare facilities for their employees to assist their participation in the workforce. Whether FBT applies to these benefits is determined by whether they are provided on the employer’s premises.

2.35 Regardless of their legal character, from a policy perspective, the tax treatment of these benefits should be the same when it provides the employee with the same private benefit.

2.36 Furthermore, the lease/licence boundary has become increasingly difficult to sustain in relation to car parks, with some interpretations of the current tax provision tending to suggest that the boundary is not so clear-cut, and that conceivably some types of licensed car parks that provide substantially exclusive possession also qualify for the exemption.

2.37 Accordingly, it is suggested that this distinction be removed so that car parks and childcare benefits be excluded from the on-premises FBT exemption. Instead, the boundary would be based on the more general approach of whether there had been a salary trade-off for the benefit(s). If so, the amount of salary traded off would be taxable either in the hands of the employee, through the deduction of PAYE, or in the hands of the employer, through applying FBT. If the benefit is not salary traded off, it would be excluded from the fringe benefit tax rules.

Implications for charitable organisations

2.38 The suggested approach would potentially affect charitable organisations and their employees as, like other employers, charitable organisations may offer their staff some form of non-cash benefit. This may, either implicitly or explicitly, involve a salary trade-off.[12]

2.39 Currently, these benefits are generally tax-exempt. They are exempt from income tax, and FBT does not apply other than when the employees are employed in the organisation’s business activities – for example, when a charity operates a manufacturing or retail business. For the purposes of the FBT exemption, charitable organisations are defined widely to include entities and funds set up for benevolent, charitable, cultural or philanthropic purposes. This definition, however, specifically excludes local and public authorities, and universities. A salary trade-off rule would in effect narrow this general exemption, but the benefits provided outside of a salary trade-off would still be tax exempt.[13]

2.40 In addition to applying a salary trade-off rule, a legislative clarification to the FBT exemption should in our view be made to remove any doubt that vouchers are excluded from the exemption, for the reasons explained below.

2.41 These suggested changes would not affect the FBT treatment of benefits provided to employees of charitable organisations who do not qualify for the current exemption, in other words, those employees who are employed in a business whose activities are outside the charitable organisation’s benevolent, charitable, cultural, or philanthropic purposes. Their benefits would remain fully subject to FBT.

Charities and the FBT exemption

2.42 Successive governments have provided a range of financial assistance measures to charitable organisations. This assistance has increased in recent years through, for example, the removal of the cap on the donations rebate.[14] These forms of government support are based on the concept that the services that charitable organisations provide are complementary to the programmes that the Government provides as part of its social objectives, and assist in furthering those objectives. This form of assistance can also result in a better targeting of resources compared with simply increasing state provision in these areas, as the donations people make to a charitable organisation are an indicator of the causes that people feel need their support. Subsidising charities through the income tax exemption ensures that those members of society who do not donate to charitable organisations but who nevertheless benefit indirectly from them contribute through their general tax payments.[15] Hence there are good reasons for the Government providing some form of tax assistance to charitable organisations.

2.43 However, unlike the expanded rebate for donations and the income tax exemption for charities, providing additional assistance through an FBT exemption can give rise to the efficiency and equity issues referred to earlier. For example, because other entities do not have such a broad FBT exemption, it may provide a charitable organisation with a competitive advantage both in terms of attracting employees and when competing with other entities to provide services. To the extent that the FBT exemption attracts employees away from other organisations, it may be economically inefficient as it can enable the tax-exempt entity to expand at the expense of non-exempt entities.[16]

2.44 While there may be debate about the size of the equity and efficiency losses and the extent to which the offsetting benefits provided by charities should be taken into account, the distortions have the potential to grow as there will always be an incentive for further fringe benefits to be substituted for cash remuneration, increasing the relative tax advantage. Any further salary substitution also reduces the tax base.

2.45 The general suggestion to tax salary trade-offs provides a step towards achieving an overall more equitable and efficient outcome across the variety of returns to labour services. However, we consider that it is necessary to go a step further in the case of the charitable organisations’ FBT exemption.

2.46 When the exemption was last considered in the 2003–05 review of FBT, the then Government concluded the exemption should not be extended[17] but rather be limited to exclude short-term charge facilities[18] whose value exceeds 5 percent of an employee’s salary. The key concern was that such facilities were a close cash-equivalent when they could be used to purchase items that all employees want, such as groceries.

2.47 More recently, there has been further testing of the boundaries of the exemption, with a number of entities marketing schemes to charities that involve offering employees more of their remuneration package in non-taxable benefits. This might be achieved, for example, through the provision of vouchers which cover employees’ normal everyday living expenses.

2.48 Arguably, vouchers may be excluded from the exemption on the basis that they are a short-term charge facility but it would be preferable to put this beyond doubt. Our concern is that because these types of arrangements provide such a readily substitutable alternative to salary and wages (and there is argument over whether they are taxable), they could pose a material risk to the tax base.

2.49 The Concise Oxford Dictionary defines a voucher as “a document which can be exchanged for goods or services as a token of payment made or promised by the holder or another”. Hence, like money, a voucher is a store of wealth and, although it may not always be transferable to others, is a medium of exchange.

Suggested change to exemption in relation to vouchers

2.50 In the case of vouchers, we are suggesting a legislative clarification to confirm these types of arrangements are clearly excluded from the FBT exemption. FBT would therefore explicitly apply to the provision of arrangements involving vouchers consistent with the current exclusion of short-term charge facilities.

2.51 If such an arrangement also involved a salary trade-off and the PAYE approach becomes the mechanism for implementing the salary trade-off rule, the amount of salary traded off would be treated as income of the employee (and subject to income tax), with the employer treating the net of tax amount as an employee payment,[19] to reduce or even eliminate the fringe benefit and associated FBT liability.

Defining “voucher”

2.52 We would envisage adopting a wide definition of “voucher”, similar to that used overseas. In Australia, a “voucher” is defined as a voucher, token, stamp (but not a postage stamp), coupon or similar article, or a prepaid phone card or facility which, in each case, has a stated monetary value and which is redeemable for other supplies in accordance with its terms.

2.53 Likewise, United Kingdom tax legislation adopts a very wide definition of a non-cash voucher. It includes not only conventional retail vouchers but also “any voucher, stamp or similar document or token”. This definition may therefore catch documents in letter form as well as plastic discs or tokens inserted into machines. Generally, the voucher needs to be capable of being exchanged for goods and services.

GST and non-profit bodies

2.54 Normally for an entity to receive a GST input tax credit or deduction it must be providing taxable supplies. An exception to this taxable supply requirement is provided for non-profit bodies so that GST-registered non-profit bodies (including charities) receive GST input tax credits in relation to all of their activities, other than the making of exempt supplies (such as the sale of donated goods at a stall operated by a charity).

2.55 This means non-profit bodies can claim input tax credits on any asset that they purchase (such as a car) even if it involves providing private benefits to their employees. Other entities are generally required to pay output tax on the provision of the private benefit as fringe benefits are generally subject to output tax. The rationale for this is that the employee is in effect the final consumer in such cases. In the car example, the value of the car’s services will be consumed by the employee over a number of years, with a corresponding gradual reduction in the residual value of the vehicle.

2.56 Not applying GST output tax to the private benefit provided by a non-profit body to its employees is inconsistent with the general intent of the GST rules. Accordingly, we would suggest an amendment to the GST Act to ensure output tax applies in such cases as if a fringe benefit had been provided. In other words section CX 25 of the Income Tax Act 2007 which excludes a private benefit provided to an employee of a charitable organisation from being a fringe benefit would be ignored when determining output tax. This would not affect non-profit bodies’ ability to claim input tax credits.

Application date

2.57 The tax changes suggested in this chapter would apply from 1 April 2014, with the changes being included in a tax bill later this year.

4A brief outline of the FBT rules is provided in the Appendix.

5See section CX 23 of the Income Tax Act 2007 under which benefits provided on the premises of the employer are specifically excluded from FBT. Premises of a person include premises that a person owns or leases.

6FBT applies only when the employment consists of the carrying on by the charitable organisation of a business whose activity is outside its benevolent, charitable, cultural, or philanthropic purposes.

7In accordance with section RD 54(2) of the Income Tax Act 2007. An adjustment to the rules that already treat some non-cash benefits, such as employer-provided accommodation, as income of the employee may also be necessary to clarify that the same amount is not taxed again when a salary trade-off is involved.

8An alternative would be to tax such specific amounts (on a grossed-up basis) as employment income and subject to PAYE.

9The FBT threshold is $1,200 per annum, with the maximum FBT rate being 49.25%.

10This example does not take into account ACC earner premium on salary and wages.

11Which could include material on employers’ internal electronic websites.

12Recent survey data indicates that the most common form of non-cash benefit provided by not for profit bodies involves some provision of a motor vehicle, with 8 percent of the employees of the survey respondents being provided with that benefit. This benefit could range from provision for pure private use to provision for home to work travel. Other non-cash benefits noted in the survey included employer provided or paid club/professional fees (received by 3 percent of employees in the survey), medical insurance (2 percent) and car parks (2 percent).

13The exemption would be directly narrowed if the FBT approach were adopted as the charitable organisation would pay FBT on the salary traded-off benefits whereas under the PAYE approach the exemption would not be altered but the employee would pay the tax, which would indirectly narrow the exemption. However, irrespective of whether the tax is paid by way of FBT or PAYE, who ultimately bears the tax will depend on the circumstances and each party’s bargaining power.

14A recent study commissioned by Philanthropy NZ and undertaken by BERL, indicates that charitable giving, particularly by individuals, has increased significantly over the past five years. As regards the income tax exemption this is estimated, based on Charities Commission data, to be worth at least $300 million per annum.

15For further discussion on this point see Tax and charities, a government discussion document, June 2001 (available on www.taxpolicy.ird.govt.nz).

16Possible examples of this could be teachers in private schools that are charities receiving untaxed non-cash benefits. Those same benefits, if provided to teachers in state schools, would be subject to FBT. Likewise, benefits provided to university staff are specifically not exempt but benefits provided to staff of other tertiary institutions may face the legal uncertainty over whether polytechnics, colleges of education and wananga are public authorities.

17The exemption has been part of the FBT rules since their inception in 1985, although it was removed for a brief period in 1990. Since then, various reviews have considered the exemption’s merits and whether it should be retained.

18Defined in section CX 25 of the Income Tax Act to be an arrangement that – (a) enables an employee of a charitable organisation to obtain goods and services that have no connection with the organisation or its operations by buying or hiring the goods or services or charging the cost of the goods or services to an account; and (b) places the liability for some or all of the payment for the goods or services on the organisation; and (c) is not a fringe benefit that is an employment-related loan.

19In accordance with section RD 54(2) of the Income Tax Act 2007.