Salary packaging: Flexibility the key

Salary packaging continues to be offered to employees in many companies, despite the changes to tax rules over the last three years, which have made some salary packaging options less attractive.

The key factor behind this fall in popularity was the change to personal tax thresholds (upwards, firstly to $150,000 in July 2006 and to $180,000 from July 2008).

Additionally, changes to the Fringe Benefits Tax (FBT) rules have removed advantageous tax treatment from some items which were popular salary packaging benefits (such as laptop computers and PDA's). However, offering salary packaging to employees continues to provide them with an opportunity to tailor their reward to suit their lifestyle and needs. Companies are increasingly seeing this as not only a responsible approach to reward, but an important part of the value proposition they deliver for their employees.

What's it all about?
Simply speaking, salary packaging is an arrangement between an employee and an employer where the employee foregoes part of their salary in return for the employer providing benefits of a similar value. If the employee elects to 'pay' for the selected benefit from 'pre-tax' dollars the employer is also required to pay FBT on the value of the benefits provided. 

While strictly speaking the employer is liable for FBT, this cost is typically passed on to the employee under salary packaging arrangements, whereby the 'value' of the benefit provided (which is deducted from the employee's salary) incorporates the FBT liability. The financial advantage for employees comes when, in certain instances, they pay less FBT on the value of the benefits provided than the income tax they would have paid on the equivalent amount of cash salary.

Employees earning below the top tax rate don't typically receive a significant financial advantage by taking benefits in lieu of salary. This is because the FBT rate is equal to the top income tax rate plus Medicare levy, so the individual would potentially pay less income tax, compared to paying FBT on a benefit of equivalent value.

However there are still some benefits that receive concessional tax treatment, and therefore are worth considering:

• employer and employee superannuation contributions to complying superannuation funds are not subject to FBT, and attract lower tax than personal income tax rates, although they are subject to maximum contribution limits in any one year (depending on the employee's age)
• motor vehicles provided by the employer (for example under a novated lease arrangement) continue to receive concessional FBT treatment
• specific organisations such as public hospitals, trade unions and charitable organisations are fully or partially exempt from FBT up to certain limits, depending on their FBT status
• 'otherwise deductible' items such as self-education expenses and professional association memberships are not subject to FBT, and if paid by the employer under a salary packaging approach, the employee receives the tax advantage immediately, rather than having to claim this deduction in their annual tax return - a cash-flow advantage even if the end tax result is neutral.

There is no doubt that flexible packaging is a responsible remuneration strategy if appropriately applied in the right context. For example, where employees are finding that the reduced income tax rate is making the packaging of a novated lease less efficient, they could still make after tax contributions (known as the Employee Contribution Method - ECM) to reduce the FBT liability.

Similarly, those employers who provide health insurance on a salary packaged basis could simply allow for employees to participate on an after tax basis but still have the advantage of reduced costs, due to the buying power of the employer corporate. Also, employers are increasingly introducing other benefits that are not necessarily tax efficient but provide benefit in other ways, for example, by using corporate buying power to obtain discounted financial services and lifestyle benefits such as discounted travel programs.

Flexibility the key
Allowing employees the flexibility to vary their remuneration package offers them a number of advantages and may be considered a benefit in itself. Flexible packaging:

• provides employees with an opportunity to tailor their own reward to suit their lifestyle and needs. For example, an employee may choose a higher value of superannuation contributions and a lower-valued packaged car
• can be a motivating factor for employees who are able to make informed decisions about their reward packages
• may provide additional financial benefits to employees who take advantage of the concessional taxation arrangements for cars and superannuation, without extra cost to the employer
• is a way for organisations to recognise the achievements of high performing employees with rewards tailored to the individual
• can provide organisations with a competitive edge in attracting and retaining staff.

Ask your employees
The secret to getting the benefits list right is to ask your employees. Salary packaging and other benefits deliver the greatest value to the organisation when employees see it as 'adding value' to their lifestyle. Yet many organisations fail to ask what employees want.

This mismatch provides an opportunity for employers, if they're able to make the list of available benefits match what the majority of employees are looking for. In practice, this often means adding benefits to the list that don't create additional costs for the employer (such as self-education expenses, or providing individuals with access to private health insurance). Other times, it means taking out benefits that employees don't value (and may be costing the company significantly), and replacing them with more highly sought-after benefits.

Considerations
Salary packaging may not be for every organisation and consideration always needs to be given to salary packaging in the wider reward context. The number of employees who can benefit, as well as the costs and benefits to the employer, need to be considered from the outset.

The criteria for assessing whether salary packaging is appropriate includes:

• strategic fit: does it complement the reward plan and culture of the organisation?
• manageable: does it require major administrative effort or cost to administer?
• defensible: is it a practice which will withstand scrutiny?
• competitive: is it a common practice for a similar range of jobs?
• legal: is it within the intent as well as the rules of the taxation system?

In structuring a salary packaging approach there are a number of issues that need consideration:

• a consistent costing methodology
• coverage of policy
• limits on amount able to be packaged
• the calculation base for benefits and payments related to salary
• degree of flexibility
• range of benefits to be provided
• taxation
• administration
• financial counselling
• communication

Organisations also need to provide it with the degree of flexibility that's in line with their culture, HR practices and reward philosophies.

Salary packaging that provides freedom of choice for employees can work effectively in organisations that want to foster autonomy, empowerment, entrepreneurialism and higher levels of accountability. This is in line with the increasingly popular approach to remuneration management, which is to manage reward using a 'total fixed remuneration' or 'total employment cost' approach, where there are benefits for both employee and employer.

Future outlook
Tax thresholds may drift in employees' favour over the short and medium term but there is still no doubt that packaging continues to be tax efficient in certain instances. Perhaps more importantly, it provides employees with decision-making power over their rewards package. It is an effective tool for employers keen to remain competitive and position their organisation as an 'employer of choice', now and in the future.

About the author
Ken Gilbert is the human capital business leader at Mercer

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