10 Jul 2012
Proposed Taxation of "Salary Trade-Offs" – Impact on Charities
IRD proposals to tax salary trade-offs (STOs) will potentially have a significant impact on employee salary packaging options for charitable organisations and other employers.
This FYI summarises the proposals and briefly comments on the implications for charities. The main implication is that the current fringe benefit tax (FBT) exemption for charities would be substantially overridden, so that charities would be left with little scope to provide tax-exempt, non-cash benefits to their employees.
Proposed taxation of STOs & other changes affecting charities
Status of the proposals
The STO tax proposals are set out in an issues paper called 'Recognising salary trade-offs as income', which was released by IRD and Treasury in mid-April.
The opportunity to make submissions on the issues paper closed at the end of May. Submissions have been made opposing the proposals and in particular their impact on the FBT exemption for charities - but it remains to be seen whether the government is prepared to withdraw or modify the proposals on account of such submissions.
Notably, in a speech delivered on 21 June, Revenue Minister Peter Dunne advised that new rules arising out of the proposals will be included in draft legislation later this year - so it appears that the proposals will be pursued, in one form or another. There will, however, be an opportunity to make submissions on the draft legislation.
The issues paper indicates any resulting legislative changes would not take effect until 1 April 2014.
Summary of the key proposals
STOs, as defined under the proposals, involve non-cash benefits being provided to employees where the employees have explicitly or implicitly "traded off" their cash remuneration for the benefits.
Currently, such non-cash benefits are tax-exempt when provided by most charitable organisations to their employees, provided that:
- The employee is not employed in a 'business' that falls outside of the organisation's charitable purposes.
- The benefits are not 'short-term charge facility' benefits, such as the use of a credit or debit card (unless the value of such benefits provided to an employee is less than 5% of the employee's salary or wages for the year).
The main proposals in the issues paper are that STOs would be taxed and that they would also be treated as income for social assistance purposes:
- STOs would be taxed under either the PAYE rules or the FBT rules, and the new rules would apply to both 'explicit' and 'implicit' STOs:
• Explicit STOs cover situations where there is a choice between cash remuneration and non-cash benefits - for example, a choice between $70,000 salary or $60,000 salary plus private use of a car.
• 'Implicit' STOs, according to the issues paper, would cover any situation where an employee has an enforceable entitlement to a non-cash benefit - for example, providing the private use of a car to an employee as part of their remuneration package, without offering a cash alternative.
- The existing FBT exemption for charities would not be repealed, but it would be overridden by the new rules taxing STOs. The same would apply in relation to the current FBT exemption for non-cash benefits enjoyed by employees on their employer's premises, such as car parks and childcare.
- STOs, and also vouchers, would be treated as income for social assistance purposes - for example, in determining eligibility for 'Working for Families' tax credits.
There are two further changes that would affect charities:
- The carve-out from the existing charity FBT exemption for 'short term charge facility' benefits, noted above, would be extended to apply to 'vouchers' provided to employees.
- Non-cash benefits provided by GST-registered charities to their employees would be subject to GST, even if the benefits are FBT-exempt.
What do the proposals mean?
The existing FBT exemption for charities is a deliberate concession that is intended to assist charities by permitting them to provide tax-exempt non-cash benefits to employees. It is justified by the public benefit inherent in the work undertaken by charities. The exemption effectively subsidises charities' operations and assists them in attracting and retaining staff, because a charity can offer more attractive mixed remuneration packages - instead of just cash remuneration - at the same or less cost to the charity.
However, the issues paper setting out the proposals barely acknowledges the policy reasons for the FBT exemption for charities. Instead, it focuses on perceived 'inequity' and 'economic inefficiencies' created by the exemption.
For example, the issues paper refers to the ability of private schools and some other educational institutions to provide tax-exempt non-cash benefits to employees, whereas state schools and universities cannot do the same (because 'public authorities' are excluded from using the exemption, even if they are charitable organisations). The issues paper suggests this gives those private schools and other educational institutions an inappropriate 'competitive advantage' in attracting staff and allows them to 'expand' at the expense of public institutions. The paper does not acknowledge the public benefit from private schools, namely reducing pressure on the public system.
For charities that utilise the existing FBT exemption, the proposals have significant implications. The main implication is that charities would be left with little scope to provide tax-exempt non-cash benefits to employees. The existing exemption would be substantially overridden by the new tax rules for STOs - it would only apply to incidental, discretionary non-cash benefits, and other benefits to which an employee does not have an enforceable entitlement.
Charities will also need to consider whether, and if so how, mixed remuneration packages currently offered to employees would be restructured if tax-exempt non-cash benefits included in such packages were to become taxable. If a charity does choose to continue to provide non-cash benefits to its employees, it will need to deal with both the application of the new tax rules for STOs and also accounting for GST in relation to such benefits.
For further information regarding these proposals and the implications for you and your organisation, please contact us.