Personal Income Tax

Understanding Fringe Benefits

For some people the subject of Fringe Benefits Tax is best left to financial advisers or tax specialists, but the more you know about the system the more you can make it work for you. You don't have to become an expert - you can leave that to the professionals who have the time and motivation to get into the minutia. Having a better understanding of Fringe Benefits Tax, though, will help you when dealing with your employer, your financial adviser, or your accountant. You will be able to ask the right questions, while making sure the right arrangements are in place to meet your financial objectives.

Salary Packaging - What Is It And Why Is It Important?

When you look at your income you will probably think of it as incomings and outgoings - how much money you are earning versus how much you are spending. The typical way to improve your monthly cash flow, or your overall wealth position, is to work out ways to either earn more or spend less.

Salary packaging is a way for you to increase your overall wealth without earning more or spending less. Instead, it is about using your money in a different way.

An example would be making additional concessional contributions to your superannuation fund through your employer, rather than spending that money on another form of investment (such as making the contribution yourself). When you make this contribution through salary packaging it is exempt from income tax and Fringe Benefits Tax. In other words, you have spent the same amount of money and you haven't earned anything extra, but your overall wealth position is improved because you don’t have to pay as much tax.

How Salary Packaging Works

You might be thinking that saving on Fringe Benefits Tax is good, so sign me up. Unfortunately, it is not as simple as that, so here is how the system works.

Firstly, it is your employer who controls whether or not you can take advantage of a salary packaging opportunity. You can't insist on it, and they are not obliged by law to offer any opportunities. It doesn't matter how great the opportunity is: if your employer doesn't offer it, you can't do it.

The reality is that many employers do offer salary packaging opportunities - they have to in a competitive employment market. Think about a situation where you had a job offer from two different companies where the job and the pay were pretty much the same. One thing that might separate the offerings from the two companies is the level of salary packaging opportunities that they offer. If you ever find yourself in this situation, and you ask for advice from a good financial adviser or tax specialist, they will tell you to go for the job that offers the wider range of salary packaging opportunities.

The fact that employers don't have to offer them, though, is important as there are differences from organisation to organisation. Your only option, therefore, is to find out from your employer what they allow.

The second thing to remember when considering salary packaging is that it can't be applied to money that you have already earned. In tax-speak, it is prospective. In other words, it can only be applied to monies that you may earn in the future.

The reason for this is that money that you have already earned - such as salary, commission, or a bonus - is subject to income tax. Once that income tax is applied, it is your money.

Let’s go back to the example mentioned earlier of a salary packing opportunity that may be open to you - making additional concessional contributions to your superannuation fund. The key word in that sentence is concessional, i.e. contributions made before income tax is applied. Your employer cannot make a non-concessional contribution to your super fund because the money is yours. You can ask them to do it, but in law it is regarded as a personal contribution, so they are in essence doing it on your behalf.

So, in simple terms, this is how the process works:

  • You find out what salary packaging opportunities your employer allows
  • You then make a request to your employer, outlining how you would like certain parts of the money that you earn in the future (salary, commission, or bonus payments) to be dealt with
  • Your employer will then decide whether to honour this request or not. If they do they will do it while the money is still "theirs", i.e. before they apply income tax to it

Now For The Really Tricky Part

If you are not involved in finance and tax you are probably thinking the system is complicated enough already, but there is another thing you need to understand. Again, you don't have to become an expert in this, as it is enough to make your head spin. The important thing to remember is the principle that even if your employer does allow you to take advantage of particular salary packaging options, they can implement them in various different ways.

Crucially, the way that your employer makes the calculation could have a significant impact on your wealth position over time.

So, what should you do?

Here are three steps:

  1. Read through the rest of this explanation to get an overview of what employers can do
  2. Talk to your employer to find out what they do specifically
  3. Get advice from a financial adviser or tax specialist

Here are a few of the things that employers can choose to do:

  • They can add the Fringe Benefits Tax cost into the salary package so that you pay for it (most employers do this).
  • They can calculate their superannuation guarantee contribution on the cash part of your salary, i.e. minus the salary package and Fringe Benefits Tax. This reduces the level of their contribution.
  • They can decide to offset a super fund contribution salary package against their superannuation guarantee, which essentially means you are meeting their superannuation guarantee liability. This reduces their costs, but you are worse off.

There are two important things to remember when looking at this list. Firstly, these are just three options that employers have available. Your employer might do some of this, all of it, none of it, or something completely different. In addition, depending on the type of salary package you are considering, lots more options and combinations are available to your employer. It is particularly complicated when superannuation guarantees and packaging additional contributions are involved.

Secondly, whatever your employer decides to do in the above examples is perfectly acceptable in law. You can’t, therefore, think of them as doing something wrong. It is up to you to find out how they make the calculation, however. Even if you don’t fully understand it, find out so you can pass the information on to your tax or financial adviser.

Remember, the end result of the calculation can have a significant impact on your wealth. Let's say your salary is $100,000 and you ask your employer to make an additional concessional contribution to your superannuation fund of $10,000. Depending on how your employer completes the calculation, the contribution made to your super fund and your take-home pay can vary by thousands of dollars.

Your Salary Packaging Options, And How Much You Will Benefit

In law (Fringe Tax Benefits law or Income Tax law) just about anything can be packaged. It doesn't necessarily mean that you should, though, or that you can (remember, it has to be allowed by your employer).

If the package comes out of your earnings after income tax is applied, the tax benefit to you is reasonably simple to work out - you have to pay tax on it.

More variations exist in the Fringe Tax Benefits system, with the options and calculations varying depending on a number of different factors, including whether your employer passes the cost for Fringe Benefits Tax onto you (most do), whether they can claim credits known as GST, and what industry you are in.

You will need to take advice from a tax specialist to find out how all this applies to you, but it is important to understand that benefits are treated differently in the Fringe Benefits Tax system, depending on the type of benefit that you receive.

There are three main categories:

  • Exempt - no Fringe Benefits Tax is liable on these benefits. There should therefore be nothing for your employer to pass onto you. So long as this benefit is paid out of your earnings before income tax is applied, you should see an improvement in your long-term financial position.
  • Reduced cost - benefits in this category have Fringe Benefits Tax applied based on a value that is lower than what it costs to actually pay for them. One of the most common examples is a car purchased through a salary package. You don't get as much benefit with this option as with a fully exempt benefit, but they can still improve your position.
  • Fully taxable - benefits in this category have the full Fringe Benefits Tax applied to them. While not as attractive as the other two options, they can still be beneficial in some circumstances.

Should You Explore Salary Packaging Opportunities?

Now here is the most important question - is salary packaging right for you? As with most things in the Australian tax system, it depends on your situation.

If the benefits that you are packaging are liable to the full level of Fringe Benefits Tax, and your employer passes that liability onto you, it will probably not be beneficial unless you are on the highest marginal tax rate. This is because the rate of Fringe Benefits Tax is equivalent to the highest marginal tax rate plus the Medicare levy plus the Budget Deficit Repair levy.

It might make more financial sense, on the other hand, to explore options of packaging benefits that are exempt from Fringe Benefits Tax, or even those that are charged at a reduced rate.

And, of course, none of this takes into account the administration and discipline side of the argument, i.e. that salary packaging is a way of paying for something without you having to worry about it or budget for it.

So the answer to whether you should explore salary packaging opportunities is probably yes, but whether or not you should implement them (or request them to be implemented) will depend on your current overall salary package, your employer, the type of benefit, and your long-term versus short-medium-term financial objectives.


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