Do you offer salary sacrifice arrangements to your employees? This article discusses the timing issues that you need to consider where an employee is required to contribute towards the costs of non-cash benefits provided under an effective salary sacrifice arrangement.
Effective salary sacrifice arrangements
Most organisations offer salary sacrifice arrangements as part of remuneration packaging strategies, allowing employees to forgo a portion of their pre-tax salary in return for the employer (or the employer’s associate) providing benefits of similar value. To be an effective salary sacrifice arrangement (ESSA), the arrangement must be entered into before the employee becomes entitled to the income (e.g. before services are performed that will result in the payment of the employee’s salary etc.).
Certain benefits provided by an employer under an ESSA are subject to fringe benefit tax. As a starting point, the taxable value of the fringe benefit is the cost of the benefit to the employer (inclusive of GST). The pre-tax salary that is sacrificed under an ESSA does not reduce the taxable value.
Popular benefits provided under ESSAs: Car fringe benefits
One of the more popular benefits provided under an ESSA is the provision of a fully maintained car. The employee ordinarily forgoes a portion of their pre-tax salary in return for the employer agreeing to pay all the running costs of the car (including lease repayments if the car is leased).
Depending on the terms of the ESSA, an employee may also be required to contribute from their after-tax salary towards the rental and/or running costs of the car. The amount that would otherwise be the taxable value of a car fringe benefit can be reduced by the amount of any employee contributions, as well as any running costs incurred or paid by the employee to a third party (e.g. fuel, oil, etc.) less any reimbursement of those expenses.
Employee contributions/Recipient’s payments
Where an employee’s contribution is in the form of their after-tax salary, usually, the amount required to be contributed would be an amount equivalent to the taxable value of the car fringe benefit so as to reduce the employer’s FBT liability to nil. Because the taxable value may only be able to be ascertained after the end of a FBT year, the after-tax employee contribution amount may be calculated annually and paid as a lump sum after the end of an FBT year.
The payment of this lump sum can be made in a number of ways. For example, the employer may retain a portion of an employee’s post-tax salary. Alternatively, employee contributions can be made over the course of an FBT year. In this case, where the total amount contributed is less than the taxable value, a payment of a top-up amount (from after-tax salary) is required from the employee under the ESSA to reduce the taxable value to nil.
It is clear that an employee contribution (or, alternatively, a top-up payment) received by an employer before the end of the FBT year can be applied to reduce the taxable value of the car fringe benefit subject to substantiation rules. However, this then raised the question of whether an employee’s contribution (or top-up payment) made after the end of a FBT year but prior to the due date of lodgement of the relevant FBT return can be applied to reduce the taxable value of the car fringe benefit.
Sections 9 and 10 of FBTAA provide two alternative methods for calculating the taxable value of a car fringe benefit. Both methods enable the taxable value to be reduced by the amount of the recipient’s payment. The term ‘recipient’s payment’ is defined in s. 9(2)(e) and 10(3)(c). According to both definitions, the amount of the recipient’s payment is the sum of:
‘(i) in a case where expenses were incurred to the provider or employer during the holding period by recipients of the car fringe benefits by way of consideration for the provision of the car fringe benefits—the amount of those expenses paid by the recipients less any amount paid or payable to the recipients by way of reimbursement of those expenses;
(ia) in a case where car expenses in respect of fuel or oil for the car were incurred during the holding period by recipients of the car fringe benefits and:
(A) the persons incurring those expenses give to the employer, before the declaration date, declarations, in a form approved by the Commissioner, in respect of those expenses; or
(B) documentary evidence of those expenses is obtained by the persons incurring the expenses and given to the employer before the declaration date;
the amount of those expenses paid by the recipients less any amount paid or payable to the recipients by way of reimbursement of those expenses…’
In summary, the definition of a recipient’s payment includes employee contributions from after-tax salary and/or the employee incurred expenses for the car (which are not reimbursed).
Where an employee contribution is in the form of cash, it will be treated as consideration for a taxable supply for GST purposes and the employer is required to remit the GST. The taxable value of the car fringe benefit is in turn reduced by the GST-inclusive amount of the employee contribution. Where applicable, employers should ensure that the amount required to be contributed by an employee from their after-tax salary includes the GST component.
Timing of employee contributions: Journal entries
The above definition does not require a recipient’s payment be made at any particular time. Employee contributions can be made in a number of ways including by way of a journal entry. MT 2050 (the Ruling) explains the conditions that need to be satisfied in order for an employee contribution to be made by journal entry.
Paragraph 2 of the Ruling states:
‘Journal entries in an employer’s accounts are a payment of a ‘recipients contribution’, ‘recipient’s payment’ or ‘recipients rent’ only if all of the following conditions are met:
(a) the employee has an obligation to make a contribution to the employer towards a fringe benefit;
(b) the employer has an obligation to make a payment to the employee;
(c) the employer and employee agree to set-off the employee’s obligation to the employer against the employer’s obligation to the employee.’
In respect of the employee having an obligation under condition (a), paragraph 7 of the Ruling states in part:
‘Consequently, journal entries can only be used for the payment of an employee’s contribution towards a fringe benefit if the employee is obliged to make that contribution. It is the employer (being the taxpayer) who needs to prove that such an obligation on the employee exists.’
Example: PBR 53460
In PBR 53460, the ATO considered the timing of an employee contribution. Under the proposed remuneration package arrangement an employee could elect for a fully maintained car (or equivalent cash salary in lieu of the car). If an employee elected for the car benefit, the employer would pay all the running costs.
At the end of each FBT year, if the total of the running costs exceeded the specified ‘salary equivalent’, the employee was required to reimburse the amount by which the costs exceeded the ‘salary equivalent’ amount. This amount was paid from the employee’s after-tax income. The payment from the employee occurred after the end of the FBT year because it was not possible to calculate the amount of this payment until that point.
The ATO considered that while the definition of recipient’s payment did not require the payment to be made by any particular time, the definition expressly requires that the payment by the employee must be by way of consideration for the benefit. That is, the employee must be required to make the payment in return for obtaining the benefit. For example, this test would be satisfied where, at the time the benefit is provided, it was intended that the employee would make a future payment for the benefit equal to the taxable value of the benefit before deducting the employee contribution. The ATO then concluded the payment made by the employee under the written arrangement was a recipient’s payment if it was made after the end of the FBT year but prior to the lodgement of the FBT return.
What does this mean for your employee contributions?
Based on the above, where an employee is required under a written ESSA to make a cash contribution towards the costs of the car, and that contribution is to be funded by a portion of unpaid after-tax salary to be retained by the employer, the payment of that contribution can be accounted for via a journal entry. Provided the set-off of the cross-liabilities occurs before the lodgment due date of the relevant FBT return, it constitutes a recipient’s payment capable of being applied to reduce the taxable value of the car fringe benefit subject to the above substantiation rules.
In relation to top-up payments and car expenses incurred by an employee (which are not reimbursed), provided the payment of the top-up amount is made, or the car expenses are incurred, before the lodgment due date of the relevant FBT return, they are also treated as recipient’s payment capable of being applied to reduce the taxable value of the car fringe benefit. Where applicable, the top-up amount should include the GST on the value of the cash contribution received. The term ‘declaration date’ (in sections 9(2)(e) and 10(3)(c) of the FBTAA) is defined as the date the employer lodges the FBT return for the relevant FBT year or such later date as allowed by the Commissioner. However, the ATO treats the declaration date as the due date for lodgement of the FBT return (refer to the definition section of the ATO’s FBT guide for employers). This add further support to the above proposition.
Finally, care should be taken to ensure that the contribution from the employee is towards the costs of the car rather than the FBT liability. Due to s. 136A of the FBTAA, any amount paid in respect of FBT does not constitute consideration for the provision of fringe benefit or any other matter. In other words, an employee who bears the whole or part of the FBT liability of their employer will not be taken to have made a recipient’s payment.