The importance of adequate and current substantiation of salary packaged expense reimbursements

What happens if an employee has not (and cannot) provide an employer with adequate and current substantiation of salary-packaged expense reimbursements? Are there problems for both the employer and the employee?

Consider this.

Mary commences employment with a PBI in 2017 and elects to enter into a salary sacrifice arrangement to access her PBI exemption cap. Mary sacrifices her full entitlement by way of salary sacrificed reimbursement of her twins’ year Year 11 school fees. It’s now FBT 2020/21 and Mary is still sacrificing her full PBI entitlement and being reimbursed but her twins have finished school – any problems?

The purpose of this article is to remind employers of the need to ensure adequate and current substantiation is held for expenses reimbursed under salary package arrangements.

As simple as it seems, we often request substantiation of salary packaged expense reimbursements only to find that ‘paperwork’ supporting salary sacrifice arrangements may not be as up to date as it should be. The issue is generally caused by a breakdown in processes between the employee, employer and (where an external salary packing provider is used) external provider.

Any FBT liability arising from the provision of fringe benefits to employees is that of the employer.

If the ATO seeks to recover underpaid FBT, the FBT risk sits squarely with the employer. In addition to any underpaid FBT, the prospect of penalties and interest also arises.

So what is the problem with Mary’s scenario?

In the usual salary sacrifice arrangement, a pre-tax deduction is made by the employer from the employee’s salary/wages with the employee receiving the sacrificed amount by way of payment to the employee’s bank account (either by the employer or the salary packaging provider) as reimbursement of an expense.

The terms of and conditions of salary packaging arrangements (including those under which external salary packaging providers operate) would normally require the employee:

• to provide adequate and current substantiation of expenses being reimbursed; and
• make good any FBT exposure of the employer incurred as result of the salary sacrifice agreement.

Procedurally, an employee would be expected to provide substantiation of the expenses to be reimbursed with such substantiation being updated progressively to ensure adequate documentation is held to support the quantum of expenses being reimbursed.

This treatment is compromised where there is no expense for which the reimbursement relates but the pre-tax salary deduction is nevertheless paid to the employee by way of reimbursement. This scenario will most commonly arise where the employee initially provides substantiation when the packaging arrangement is established but there is inadequate monitoring to ensure substantiation is updated.

The breakdown in process is often attributable to a combination of:

• the employee not being fully aware of their obligations and the technical interaction between salary packaging, FBT and personal tax; and
• the employer assuming substantiation is dealt with by the salary packaging provider.

For example, in Mary’s scenario with school expenses having ceased by 2020/21, on face-value she is now receiving untaxed money from her employer which is being treated as exempt from FBT, being within her PBI exemption cap. If Mary is not otherwise able to provide substantiation as to the expenses to which the alleged reimbursements relate, there is a major problem.

In this situation the ATO could reasonably argue the amount is not an effective salary sacrifice arrangement and the amount reimbursed to Mary retains the character of salary and wages paid to the employee. The amounts therefore should have been subject to PAYGW and included by the employee as income in their tax return (and not treated as Reportable Fringe Benefits). The ATO’s views set out in TR 2001/10 support its long term view of what constitutes an effective salary packaging arrangement.

An employer that is aware the employee is receiving pre-tax amounts purportedly as expense reimbursements may find itself in a difficult position with the ATO and the employee, should it be discovered there is an ongoing absence of adequate and current substantiation as to the quantum of packaged expenses.

Both the employer and employee are therefore faced with tax risks as a result of this breakdown in process. Generally, the salary packaging provider would point to the terms of their service provision that would suggest any problem is that of the employer/employee.

Best practice would suggest that an employer should periodically check that employees have provided adequate and current substantiation for expenses that have been reimbursed. The role of the salary packaging provider in this process should also be reviewed and agreed.

This article provides a general summary of the subject covered as at the date it is published. It cannot be relied upon in relation to any specific instance. TaxEd Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.