Salary packaging

Salary packaging has been quite popular due to the Fringe Benefits Tax (FBT) concessions it offers, especially in the non-profit sector. While the new rules that have been progressively introduced and the successive tax cuts over the past few years have eroded some of these concessions and the overall tax effectiveness of salary packaging arrangements, employees may still benefit from these arrangements if their salary packages are structured to take advantage of the remaining concessions.

Broadly, salary packaging allows salary to be taken as non-cash benefits before tax which, in certain circumstances, may increase the after-tax income of an employee, in comparison with if the salary is paid wholly in cash.

Salary packaging involves an agreement between the employer and employee before the employee physically commences the employment duties to which the specific salary package relates. The employer will start with an annual pre-tax base package amount, which is the total cost the employer is prepared to incur to employ the employee. The base package amount will then be dissected into various cash and non-cash benefits components.

The cash component of the package will be subject to income tax in the hands of the employee. The non-cash benefits, albeit not subject to income tax, may attract FBT in the hands of the employer, which will form one of the pre-tax components of the salary package. All these components together form the base package amount.

There are many reasons why salary packaging may be attractive. As mentioned above, it may provide potential tax savings to the employee, especially in the non-profit sector where additional FBT exemptions and concessions are available, which enables the employer to attract, motivate, and retain good staff.

The Commissioner of Taxation accepts the use of salary packages as a legitimate means of employee remuneration, provided that the salary package arrangement is prospective, rather than retrospective.

A prospective salary packaging arrangement is one where the employee contractually forgoes a future entitlement to salary or wages before that entitlement has come into existence. To discharge the onus of proof that a salary packaging arrangement is prospective, it is strongly advisable to document the arrangement in a written agreement between the employer and employee before the salary package is physically implemented.

Given that the FBT rate is equivalent to the highest marginal income tax rate, currently at 46.5% (inclusive of Medicare Levy), packaging benefits that are subject to FBT will theoretically be revenue neutral if the relevant employee is paying tax at the highest marginal tax rate, ie, the benefit from the reduction in income tax due to the remuneration being paid as a non-cash benefit will be neutralised by the FBT payable on the benefit. On the other hand, if the employee is paying income tax below the highest marginal tax rate, packaging benefits that are subject to FBT may actually be detrimental to the employee.

Notwithstanding the above, certain benefits, such as a car fringe benefit, may still be concessional due to the specific valuation rules prescribed by law. Other benefits may be exempt from FBT altogether, which effectively render the benefits tax-free. Packaging ‘otherwise-deductible’ benefits, the cost of which include GST, will also be tax effective to the employee as the employer, being a registered entity for GST purposes, may claim back the GST paid as input tax credits and pass the GST savings onto the employee without incurring any FBT liability.

Further, employees of employers which are public benevolent institutions (PBIs) or rebateable employers (essentially employers who are income tax exempt entities) may be exempt from FBT up to a certain limit or entitled to claim a FBT rebate to reduce their FBT liability, which can also be passed onto the employees.