What Is Salary Sacrifice?

Salary sacrifice is an arrangement with your employer to swap part of your salary for benefits which are paid for or provided by the employer.

Packaging benefits in a salary agreement has long been popular, because of the progressive structure of the Australian income tax table.

“Progressive” in this context means that the higher your taxable income, the higher the tax rate. The tax scale increases in progressive steps.

For example, the 2018 tax scale looks like this:

Taxable IncomeTax On This Income
0 to $18,200Nil
$18,201 to $37,00019c for each $1 over $18,200
$37,001 to $87,000$3,572 plus 32.5c for each $1 over $37,000
$87,001 to $180,000$19,822 plus 37c for each $1 over $87,000
$180,001 and over$54,232 plus 45c for each $1 over $180,000

* excludes Medicare Levy

A salary packaging arrangement which removes potential income from the progressive tax scale and replaces it with a benefit of equivalent or higher value provided by the employer, would on the face of it save (up to) 47 cents for every dollar of income replaced.

Salary packaging super – preventing exploitation of the “super gap”

An amendment to the super guarantee laws is on the way, to prevent employers exploiting the relationship between salary packaging and the super guarantee requirements.

When a nominal salary is divided into salary plus voluntary super contributions, the current law allows employers to count the salary sacrificed super towards its super guarantee obligation calculated on the (reduced) salary component of the package.

This is referred to as a superannuation gap.

The Treasury Laws Amendment (Improving Accountability and Member Outcomes in Superannuation Measures No. 2) Bill 2017 has been introduced to outlaw this practice with effect from 1 July 2018.

FBT – the tax system’s antidote to salary packaging

The Fringe Benefits Tax (“FBT”) was introduced to counteract this tax benefit, by imposing a tax-deductible tax on the employer at the rate of 47% of the grossed up benefit including GST. The FBT formula is designed to balance the after-tax value of the benefit.

In addition to the tax, adding back Reportable Fringe Benefits to income reduces access to certain tax concessions – for example, medicare and the superannuation co-contribution.

Why salary sacrifice?

The answer lies in the fact that for some benefits, the tax impact is lower when the benefits are paid for under a salary sacrifice agreement, than if paid for by the employee directly.

This happens when:

  • the tax law arbitrarily assigns lower values to the benefits for FBT purposes, and;
  • there are concessions and exemptions available, for example for certain non-profit organisations or in relation to specific kinds of expense

The aim is to replace salary with a benefit with a taxable value which is significantly less than the actual, market or cash value, or is completely exempt, to produce a higher after-tax cash flow for the employee, whilst being tax-neutral for the employer.

In the best case scenario, tax on the employee’s salary at the top marginal rate is avoided, with zero FBT payable by the employer.

 

A Simple Example: How Salary Packaging Can Save Tax

A simple example to illustrate the potential tax benefits of a salary sacrifice by packaging superannuation.

Without PackagingPackaging Super
Remuneration (top tax rate 32.5%)$80,000$80,000
Less super salary sacrifice$10,000
Taxable income$80,000$70,000
Income tax (2015-16 tax rate)$17,547$14,297
Basic Medicare Levy$1,200$1,050
Tax on superannuation by the super fund (15% in the fund)$1,500
Total tax and Medicare levy paid$18,747$16,847

(Adapted from: ATO example)

This is not tax advice. This example is provided to illustrate a principle only. 

When Salary Sacrificing May Not Be Worthwhile

Salary packaging won’t necessarily always be advantageous.

Considerations include:

  • whether there is a statutory formula (such as for vehicles) or rule which provides a favorable tax valuation, exemption or exclusion of the benefit
  • whether the value of benefits counts as income when qualifying for some government concessions or charges, e.g. medicare –  See Reportable Fringe Benefits
  • whether the employee’s salary reaches the top or one of the lower marginal tax rates
  • whether the benefits are relatively trivial, and/or outweighed by administration costs or the inconvenience of the necessary record-keeping.

What to do next..

One implication you could draw from the above example, is that the cash flow consequences of a salary sacrifice arrangement are a crucial aspect to consider at the outset.

In the example above, the employee “sacrifices” (i.e. reduces) her salary by directing $10,000 into a super fund.

As a savings device it makes sense, but since the proceeds of superannuation are not usually available until retirement age, the employee has to manage in the meantime without the extra cash.

Superannuation is one special case. Other types of packaged benefits can operate to increase after-tax cash available to the employee, if it is the kind of benefit which has a reduced taxable value, and which the employee would otherwise have to pay for on an after-tax (i.e. more expensive) basis.

It would cost the employee more (by the amount of the tax) than if paid by the employer on a non-taxable or reduced tax value basis. Car benefits can fall into this category, as can other FBT exempt or concessional items.

Negotiation with your employer:
Another practical consideration is the willingness or otherwise of your employer to “play ball” by packaging expenses, which necessarily involves a level of administration work, compliance activity and usually the oversight of a tax professional to ensure it’s done properly on an on-going basis. Salary packaging calculations can be complex.

To successfully salary-sacrifice, you need:

  • a demonstrated benefit based on your tax position
  • manageable cash flow after implementation
  • co-operation from the employer
  • professional advice to ensure compliance (and hence be tax-effective)

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This page was last modified 2018-11-30