Fringe benefit tax

Sections CE 2, CE 5, CE 11, CX 6B, CX 17(2), CX 18B, CX 20, CX 20B, CX 21(2) and (3), CX 26B, CX 27B, DB 45, GC 17B, OB 1, OB 6, ND 1A, ND 1AB, ND 1, ND 1DB, ND 1IB, ND 1K, ND 1Q, ND 2(3), ND 8B, ND 13, ND 14 and Schedule 2 of the Income Tax Act 2004

Amendments to the Income Tax Act 2004 give effect to a set of changes to fringe benefit tax (FBT). The changes are designed to reduce compliance costs and remove anomalies in the rules while maintaining the objectives of FBT. Several changes also remove an FBT liability when the fringe benefits are small relative to the compliance costs involved. This means that fewer small businesses will need to file FBT returns on minor benefits that are part of normal business activities.

Background

FBT was introduced in 1985 in response to a growing trend in the 1980s for businesses to provide in-kind benefits in lieu of cash remuneration. By taxing fringe benefits, FBT was intended to buttress the PAYE system so that all forms of remuneration were taxed equally. FBT is, in effect, a tax on employee benefits, but for compliance cost-reduction reasons liability to pay the tax falls on employers.

Although there have been specific changes to the FBT rules, the FBT system has remained largely unchanged over the past 20 years. A review began in October 2002 when the government called for taxpayers to identify areas they wished to be addressed, and a discussion document, Streamlining the taxation of fringe benefits, was released in December 2003. Over 60 submissions were received, and officials undertook specific consultation with key submitters. A range of submissions was also received on the subsequent draft legislation and these were considered by the Finance and Expenditure Select Committee during the bill's passage through the House.

Key features

Motor vehicles

• Through amendments to section ND 1A and Schedule 2, employers now have the choice of calculating the value of a motor vehicle fringe benefit based on the vehicle's tax value for depreciation purposes (subject to a minimum value) or, as at present, its cost.
• Amendments to Schedule 2 reduce the valuation rate applying to motor vehicles to 20% of cost. The previous annual valuation rate was 24% of their cost. This means that for those employers who pay FBT quarterly, the rate has reduced from 6% to 5%. The equivalent rate under the alternative tax value option is 36% (or 9% if FBT is paid quarterly). This reduction is in recognition of lower real motoring costs since the rate was set in the mid-1980s.
• Other amendments to Schedule 2 better align the treatment of leased vehicles with that of owned vehicles so that the fringe benefit from a leased vehicle is based on its cost or tax value rather than, as previously, its market value. This removes the incentive for leases to be used to reduce an FBT liability.
• Similarly, new section CX 6B ensures that FBT cannot be avoided by employees leasing their own vehicles to their employers and "suspending" the leases when private use occurs through such arrangements as "9-to-5" and "flip-flop" leases. But a deduction for all costs incurred by the employee is now allowed under new section DB 45.
• New section ND 1AB enables employers to elect the start time for an FBT day. This is to ensure that two days' FBT liability is not incurred when a vehicle is occasionally taken home overnight and returned the next morning. An election applies to all vehicles and normally lasts for two years.

Other changes

• New section ND 1DB has been amended to allow lenders to the general public, such as banks and financial institutions, the additional option of using the relevant market interest rate as the benchmark for valuing the benefit from their loans to employees.
• Amendments to section ND 1Q increase the minimum-value thresholds that have to be exceeded before unclassified fringe benefits are subject to FBT. The employee minimum value threshold has been increased to $200 per quarter and the employer minimum value threshold has been increased to $15,000 per annum.
• New section CX 18B allows the private use of an employer-owned or leased business tool, such as a cellphone or laptop, to be exempt from FBT when the tool is provided mainly for business purposes, as long as its cost price does not exceed $5,000.
• Previously, benefits that might arise as a result of employers carrying out their health and safety obligations (for example, health checks) fell within the scope of FBT if they were not provided on the premises of the employer. New section CX 20B allows these benefits to be exempt from FBT irrespective of whether the benefits are provided on or off the employer's premises.
• New section CX 26B exempts income protection insurance premiums paid by employers on behalf of their employees from being a fringe benefit provided any claims under the policies are treated as assessable income of the employees.
• Amendments to sections CX 20(1) and (2) extend the "on-premises" exemption to the premises of other companies in the same group when there is 66% or greater common ownership with the employer company.
• Similarly, as a result of an amendment to the definition of "subsidised transport" any benefits provided by a public transport operator to employees of other companies within the operator's group of companies can be valued at the same rate as that which the public transport operator would be able to use in relation to its staff for FBT purposes.
• An amendment to section CX 9 ensures that fringe benefits that arise from advances against salary and wages are now exempt from FBT when the aggregate amount of outstanding advances to an employee does not exceed $2,000 and the advances are not part of an employment package.
• Section OB 6 has been amended so the Income Tax Act's general anti-avoidance rule also applies to FBT.
• New section CX 27B and an amendment to section ND 1K clarify that FBT does not apply to benefits that arise when an employer secures bulk discounts or provides services to employees provided the price paid for the goods or services is no less than that available to other comparable-sized groups on an arm's-length basis.
• Section CX 21 has been amended to specifically exclude the provision of credit cards and other short-term charge facilities from the exemption that charities have from FBT when the aggregate value of the benefits in a year exceeds 5% of an employee's salary or wages.
• Section CX 17 has been amended to provide an exemption from FBT when an employer pays for a member of an employee's family to travel to visit the employee. This exemption is limited to the amount that would have been exempt from FBT if the employee had made the visit.
• An amendment to section CE 2 clarifies that share options cancelled in exchange for cash are a "disposal" and therefore covered by the employment income provisions of the Act.
• Amendments to sections ND 2(3), ND 13 and ND 14 provide more administrative flexibility in relation to elections to pay FBT on a quarterly, annual or income-year basis. An election to pay FBT quarterly can now be made at the time of filing irrespective of whether FBT is actually paid, and an election to change to paying FBT annually or on an income-year basis ¹ can be made by telephone rather than having to be in writing.
• Another amendment to section ND 14 ensures that when a small close company with a non-standard balance date chooses to pay FBT on an income-year basis rather than quarterly it is required to undertake the section ND 10 quarterly payment calculation in relation to any incomplete year that arises by virtue of the election.
• New section ND 8(3) allows employers that cease to employ staff during the year, and have no intention of replacing them, the option of applying the 64% FBT rate rather than the multi-rate for their final quarterly return.

Application date

The amendments apply from 1 April 2006 or, if an employer pays FBT on an income-year basis, from the income year beginning on or after that date.

Detailed analysis

Motor vehicles

The issue most frequently raised in consultation on the FBT review concerned the valuation of motor vehicles.

Valuation basis

A motor vehicle fringe benefit is calculated on a quarterly or annual basis by taking a set percentage, which reflects the costs of motoring, and multiplying it by the original cost of the vehicle. The result is reduced by the number of days in which the vehicle is not available for private use. Some taxpayers perceived this approach to be unfair because the FBT liability remains constant while the vehicle declines in value over time.

To address this issue, subsections ND 1A(1B)-(1D) have been added and Part A of Schedule 2 has been amended. These changes enable employers to use a motor vehicle's depreciated value (tax value) as the basis for valuing the fringe benefit, but at a higher rate than under the cost price option. A higher rate is needed to produce the same overall tax result as the rate takes into consideration all the costs, including depreciation, over the average period a vehicle is held privately (five years). Expressing these costs as a percentage of a lower base results in a higher percentage. However, the overall FBT liability, while higher in earlier years, is lower in later years.

Under the tax value method there is a minimum tax value of $8,333 to reflect the on-going benefits that an employer-provided vehicle affords even when it has depreciated significantly. This is because the employee still continues to save the costs of running a vehicle.

"Tax value" is defined in relation to subpart EE (depreciation), and is the depreciated value at the beginning of the relevant tax or income year as determined under that subpart, unless the vehicle has been acquired after during the year in which case the vehicle's cost is used.

As has been the case with the cost price method, the tax value is inclusive of any GST paid on the acquisition of the vehicle. If the employer wishes to use a GSTexclusive price or value then the valuation rate is proportionately increased to ensure that the same amount of FBT is paid.

Amendments to Schedule 2, Part A(1) reduce the percentage applied to a vehicle's cost price to 20% annually or to 5% quarterly (previous rates were 24% and 6% respectively). The equivalent percentage using the tax value as the base is 36% annually and 9% quarterly.

Example comparing the rates and methods

Company Zed buys a new Holden Commodore for $63,000 GST-inclusive and makes it available for employee John's use. The table below provides a comparison of the taxable value on which the FBT liability is based before and after the legislation change.

Taking the example above and assuming the vehicle is purchased on 1 April 2006 and is made available to the employee from that day, the tables below show the FBT payable using the new valuation rates, firstly under the cost price option and then under the tax value option.

Although the fifth and subsequent years will produce ongoing savings, an employer will pay significantly more FBT in the first three years under the tax value option.

Leased vehicles aligned with owned vehicles

FBT on leased vehicles was previously assessed on the vehicle's market value at the beginning of the lease. This meant that leasing a vehicle on a yearly basis could produce a lower FBT impost by setting a new (lower) market value annually.

Changes to Schedule 2, Part A(1)(b) remove the incentive to lease vehicles by providing lessees with the same options as proposed for owners - in other words, a rate of 20% on the cost price or a rate of 36% on the tax value of the vehicle.

In both cases it is the cost price and tax value of the owner/lessor that is relevant. To reduce compliance costs for lessees, a lessee can request the relevant cost price or tax value from the lessor and under Schedule 2, Part A(8) the lessor is required to disclose this information.

Previously leased vehicles

The only case when market value can now be used is when a previously leased vehicle is leased again to a completely separate party. In such cases the market value becomes the cost price (see Schedule 2, Part A(7)). To qualify:

• the new lessee cannot be associated with the previous lessee or with the lessor or owner of the vehicle;
• the employee cannot be the lessor or owner of the vehicle or associated with the lessor owner of the vehicle.

Switching between methods

Having made their choice between the cost and tax value options in the initial FBT return for the vehicle, employers must continue to use their chosen option until either:

• the vehicle is sold; or
• the vehicle ceases to be leased; or
• a period of five years has elapsed from the beginning of the initial return.

This means that vehicles that were already subject to FBT before 1 April 2006 can be valued after 1 April 2006 under the tax value option if they have already been valued for FBT purposes for a period of five years at cost.

9-to-5 and flip-flop leases

New sections further align leased vehicles with owned vehicles by addressing "9-to-5" and "flip-flop" leases. Over the past decade an increasing number of employees (usually shareholder-employees) have entered into arrangements to lease their own vehicles to their employers for business use during specified hours (usually 9 a.m. to 5 p.m.) in exchange for a market rental. The objective of the leases is to enable the employees to enjoy private use of the vehicles when they are not being used for business purposes. Because the leases are in effect "suspended" when private use occurs, the argument is made that there is no FBT liability.

Changes have been made to ensure that these types of leases are subject to FBT. Under new section CX 6B, when there is agreement or an arrangement between an employer and an employee transferring a right to use a motor vehicle to the employer, the employer is treated as having a right to use that motor vehicle for a period when the employee uses the vehicle privately or has the right to use the vehicle privately. This rule also extends to persons associated with the employer.

Full deduction of costs available

Under section DB 45 parties to 9-to-5 and flip-flop leases can now fully deduct their private motoring costs for vehicles covered by the leases when the expenses have been incurred during a period for which the employer or associated person is treated as having a right to use the vehicle. This provides consistency with other situations when FBT applies. Previously, an employee/lessee could only deduct expenses that were business-related.

Reimbursement for use of a private motor vehicle

Lessees should note that Inland Revenue has also recently clarified the options that are available in relation to reimbursing employees, including shareholder-employees, for the use of their private motor vehicles for business purposes. The reimbursement options are discussed more in the Remedial Matters section of this TIB.

Employers able to elect start time of an FBT day

If a vehicle is available for private use at any time during the day, it is considered to be available for the whole day. This means that if an employee takes a vehicle home at night to take it to another work site the following morning, the vehicle is regarded as being available for private use for two days.

New section ND 1AB means an FBT day is now defined as any 24-hour period rather than a calendar day.

An election applies across all the employer's vehicles and lasts for two years, although section ND 1AB(6) enables the Commissioner to accept a change if an employer can show that there has been a material change in circumstance. An election has to be made to the Commissioner at the same time as the return to which it relates is provided. If an employer makes no election, the current treatment of a calendar day would apply.

Other issues

Loans to employees

Generally, the value of a fringe benefit arising from an employee loan is the amount by which interest calculated according to the FBT prescribed rate of interest exceeds actual interest paid. The prescribed rate is set by Order in Council before each quarter begins but uses data from the previous quarter. This means the prescribed rate can become out of date, resulting in fringe benefits arising even when current market rates of interest are charged. Accordingly, under the revised section ND 1D and new section ND 1DB employers, such as banks or financial institutions, who are in the business of lending money to members of the public now have the option of using market rates rather than the prescribed rates. Certain criteria apply to what constitutes a market rate. An election to use a market rate need not apply to all loans but an employer will need to identify which classes of loans are covered by their election if it is to be applied selectively.

For all other employers the value of the loans must continue to be calculated using the prescribed rates.

Market interest calculation

The market rate is, in effect, the rate that the lender charges other comparable groups of a sufficient size on an arm's-length basis. Specifically, section ND 1DB requires that the comparable group meets the following requirements:

• the group is assessed as having a comparable credit risk to the employee group;
• membership of the group arises from factors that do not include a link between a member and the employer; and
• the group is big enough to ensure the transaction is completed on an arm's-length basis.

Depending on the circumstances, this is intended to be sufficiently wide to cover rates offered to the general public as well as rates offered to groups that are unrelated but comparable to the employee group.

Switching between valuation options

When an employer has chosen the market rate method of calculating interest they must use that method for the income year to which the choice relates and for the following income year. If they wish to subsequently change back to using the prescribed rate, they must advise Inland Revenue at least one year before the beginning of the income year in which the change will take place.

Wage advances

Loans which are provided by employers as an advance against future salary or wages will not incur an FBT liability provided the aggregate amount outstanding for an employee does not exceed $2,000 and the contract of employment does not require the employer to make the advance. The latter requirement is to ensure that the loan has not been provided to the employee as part of an employment package.

The exemption does not apply to loans which have been secured against real property, such as a mortgage.

Minimum thresholds

Employers are not required to return FBT on miscellaneous (known as unclassified) fringe benefits that do not exceed certain thresholds. This exemption does not apply to loans, which are specifically listed in sections CX 6 to CX 15.

Section ND 1Q has been amended to substantially increase both the employee and employer minimum thresholds. A comparison of the old and new thresholds is provided below. Raising the thresholds should generally lower compliance costs for employers who provide only small miscellaneous fringe benefits (such as most Christmas gifts) as these benefits would then fall out of the FBT net.

The revised employer threshold has been set to effectively exclude miscellaneous fringe benefits provided by small and medium-sized businesses (20 employees or fewer). Also, employers who are required to file quarterly returns now have more flexibility in terms of providing unclassified benefits and not incurring FBT, given that the employer threshold is now expressed on an annual basis. The maximum amount of $15,000 is a rolling total and takes into account the benefits provided in the current quarter and the three previous quarters.

Business tools

The government noted that it is difficult and costly for employers to monitor and value the incidental private use of small items such as laptops and cellphones when they are provided by employers mainly as business tools. The difficulty in measuring any private benefits that do arise effectively precludes them from being encompassed in the minimum value thresholds.

Accordingly, new section CX 18B specifically exempts the private use (and availability for private use) of a business tool from FBT when the tool is provided for mainly business use and its cost does not exceed $5,000. If a business tool is kept at the employee's home rather than being returned to the employer's premises it will still qualify for the exemption if the employee performs a significant portion of his or her employment duties at home. A business tool is defined in section OB 1 as an item that is used by an employee in the performance of their work duties and in the absence of section CX 18B would give rise to an unclassified benefit.

Specific exemption of employer health and safety-related benefits

Incidental private benefits can arise as a result of employers carrying out actions to meet their health and safety obligations. Previously such benefits could incur an FBT liability if the actions were done outside the employer's premises but would be exempt if the benefits were provided on the employer's premises. There was considered to be no logical reason for this distinction. Therefore, new section CX 20B provides an exemption in all cases.

Under that exemption, employers who are undertaking hazard management, such as the provision of protective clothing or health checks, will not incur an FBT liability in respect of any benefits that arise out of that management irrespective of where the benefit is provided. To qualify, the measures must be aimed at addressing hazard management in the work place as contemplated in the Health and Safety in Employment Act. It does not extend to items such as gym memberships or employerpaid health insurance premiums.

Extension of "on-premises" exemption to group company employees

Previously, the exemption from FBT for benefits provided on an employer's premises did not necessarily extend to the premises of another member of a group of companies. For example, an employee could be employed by one member company, but receive a benefit on the premises of another member company while on a secondment. This benefit would have been subject to FBT.

In recognition that entities within a group may operate more like a single economic entity, the general "onpremises" exemption in section CX 20 has been extended to include the premises of other companies in the same group that share 66% or greater common ownership with the employer company.

Benefits provided by public transport operators

A related change is that as a result of an amendment to the definition of "subsidised transport" any benefits provided by a public transport operator to employees of other companies within the operator's group of companies can be valued at the same rate as that which the public transport operator would be able to use in relation to its staff for FBT purposes.

Income protection insurance

The FBT treatment of income protection insurance policies should put the employee in the same position as if the employer had paid the employee a cash amount, and the employee had then paid the premium directly. Previously, this was not the case. Employees who paid the premium directly were eligible for a deduction for the premium paid, on the basis that it was to ensure future income, but employees did not receive a deduction when the employer was liable to pay the premium on their behalf.

New section CX 26B exempts income protection insurance premiums paid by employers on behalf of their employees from being a fringe benefit, provided any claims under the policies are treated as assessable income of the employees. This achieves a similar result to an employee receiving a deduction, but with lower compliance costs as the employee does not need to make a separate deduction claim because of the fringe benefit exemption.

Consequential amendments include:

• An amendment to section CE 5 which excludes the amount of the premium that the employer is liable to pay from being expenditure on account of an employee.
• New section CE 11 clarifies that an amount derived under the policy is income to the employee.

Application of the general anti-avoidance rule

FBT has its own anti-avoidance provisions in the Income Tax Act. However, unlike many other specific antiavoidance rules, they were not also bolstered by the Act's general anti-avoidance rule (see section BG 1), which enables a tax avoidance arrangement to be voided and any associated tax advantage to be counteracted. The omission arose because of the wording in section BG 1, when read in conjunction with section OB 6 (definition of income tax). Section BG 1 voided arrangements for income tax purposes but section OB 6 specifically excluded FBT from the definition of income tax.

Section OB 6 has been amended to make FBT income tax for the purposes of section BG 1. A new section GC 17B enables the Commissioner to alter a person's tax liability when an arrangement involving FBT is voided by section BG 1.

This change means that arrangements to which the specific anti-avoidance rules do not apply might still be treated as avoidance.

Bulk discounts and services to employees

Previously, if an employer entered into an arrangement with a third party to provide employees with a benefit, the employer was deemed to have provided a fringe benefit even if the employees could have been in a group unrelated to their employment and still received a comparable discount.

Under new section CX 27B, a fringe benefit will not be incurred by the employer when the third party offers at least the same, if not more of, a discount to a group of individuals that:

• has negotiated their discount on an arm's-length basis, and
• does not include the group of employees; and
• is comparable in number to the group of employees.

A similar amendment has been made in relation to the valuation of services because of uncertainty about what constitutes an arm's-length price offered to the public in the open market in New Zealand on ordinary trade or professional terms. The price to the public is used as the benchmark so that if the price charged to the employee is the same as that charged to the public then no FBT arises.

Under revised section ND 1K, a person providing services to a group of employees is treated as providing the same or similar services to the public if the person provides the same or similar services to a group that has negotiated the transaction on an arm's-length basis and is comparable in number to the group of employees. Any price charged to the employees below that charged to the other group would be subject to FBT. ²

Changes to charities exemption

Cash remuneration to employees of charitable organisations is taxed through the PAYE system, as for other employees. Non-cash benefits provided to employees of charitable organisations are, however, generally exempt from FBT, other than when the employees are employed in a charity's business.

New subsection CX 21(2) further restricts the exemption by specifically excluding from the exemption benefits arising in relation to short-term charge facilities when the aggregate value of the benefits to an employee in a tax year from the facilities exceeds 5% of the employee's salary or wages in that year. This change is designed to reduce the potential for charitable organisations to provide a significant proportion of their employees' remuneration in the form of fringe benefits. This is more likely to occur if a benefit can readily be substituted for cash and a wide range of goods and services can be purchased as is the case with credit and debit cards.

Subsection CX 21(3) provides a definition of what constitutes a short-term charge facility. Basically, the focus is on arrangements that enable an employee to charge non-business related purchases or hire costs to an account that the employer is liable to pay. It does not include employment-related loans under section CX 9.

New section ND 1IB indicates that the value of the benefit in these cases would be the cost to the employer of the non-business purchases of goods and services plus any interest incurred in relation to those purchases and, if a credit card is provided solely for non-business use, any account and service fees associated with the card.

For employers who file quarterly FBT returns, new section ND 8B indicates how the employer is to calculate whether there is an FBT liability in relation to the 5% threshold in any particular quarter.

Employer-paid family travel

In certain circumstances an employer can now pay the travel costs of an employee's spouse, civil union or de facto partner and/or family to enable them to visit an employee who is required to temporarily work out of town or offshore and no FBT will apply. To qualify for the exemption in new section CX 17(2), the value of the travel must not exceed the amount that would have been provided as a tax-free allowance to the employee had the employee travelled home instead. This exemption is therefore provided on the basis that the outcome is the same as if the employee had been provided with a reimbursement allowance for their additional travel costs.

Section OB 1 has been amended so that paragraph (a) of the definition of "relative" applies to section CX 17. That definition covers blood relatives within the second degree of relationship and those married to them, and adopted children, including those of persons within the first degree of relationship.

Share options cancelled in exchange for cash

Share options provided to an employee by an employer are treated as employment income, with the value of the benefit being the difference between the value of shares on the date of acquisition - that is, on the exercise of the options - and the amount paid by the employee for them. To avoid double taxation, the FBT rules specifically exclude such benefits (see section CX 4).

A question arose over whether the treatment of options that are cancelled in exchange for cash rather than exercised and converted into shares would be treated as either employment income or a fringe benefit. This was because of an argument that a cancellation did not constitute a disposal.

The policy intent is to treat the cancellation of a share option the same as if the share had been disposed of. The reality is that the employee is receiving a payment for some form of benefit in this situation.

To rectify this position, an amendment has been made to section CE 2 to clarify that the cancellation of share options in exchange for cash is a disposal of rights in terms of section CE 2(3), and is employment income of the employee.

Administrative simplifications to choosing when to pay FBT

These remedial changes are aimed at providing greater administrative flexibility and lower compliance costs. An amendment to section ND 2(3) enables an employer to choose to pay FBT on a quarterly basis at the time of filing irrespective of whether or not FBT has to be paid. Also, through amendments to sections ND 13 and 14, an election to pay FBT annually or on an income-year basis rather than quarterly will be able to be made by telephone rather than having to be in writing.

Non-standard balance date taxpayers and income-year FBT elections

Small close companies are allowed to file and pay FBT on an income-year basis. Clarification was required on an issue concerning such companies with non-standard balance dates who elected to switch from paying FBT on a quarterly to an income-year basis. An election should apply from the beginning of the next income year so that all the necessary steps relating to the last year of quarterly payment, including the end-of-year multi-rate square-up, take place before the election applies.

New subsection ND 14(2B) provides the necessary clarification by requiring that in the case of a small close company, the employer must undertake the section ND 10 final quarterly payment calculation in relation to any incomplete year that arises by virtue of the election.

Employers ceasing to employ staff

Employers ceasing to employ staff during the year with no intention of replacing them now have the option of applying the flat rate of 64% in their final return rather than having to undertake the multi-rate calculation. New section ND 8(3) gives effect to this change.

Employers choosing this option are still required to undertake a square-up in that the 64% rate is applied to fringe benefits provided from the beginning of the year up to the time staff ceased to be employed (with a credit for FBT already paid during the year). In other words, the 64% rate does not apply to just the last quarter. The difference from the previous approach is that the employer no longer has to calculate the appropriate multirates in relation to the employees.

¹ An income basis will differ from an annual basis when the employer has other than a 31 March balance date.
² This approach is also used in valuing low-interest loans (see ealier discussion).