Australian government budget initiatives give rise to board remuneration committee planning issues
30/04/2012
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Government initiatives to achieve a budget surplus give rise to potential contingencies that should be on a board remuneration committee’s radar.

One initiative is to double the 15% tax to 30% on superannuation contributions from the “rich”.  The second is the removal of tax concessions for living away from home allowances (LAFHA).

Superannuation

The increase in superannuation tax removes a tax concession that favours the more highly paid.  Currently, high-income earners, when they save for retirement, pay a 15 per cent tax rate on their superannuation contributions instead of the 45 per cent marginal income tax rate they would otherwise face, a difference of 30 percentage points.

In contrast, income earners who earn between $37,000 and $80,000 receive a concession of only 17.5 percentage points, which takes the tax rate on their superannuation contributions down from the 32.5 per cent marginal income tax rate to the same 15 per cent level.

That difference between the 30 percentage point concession to high-income earners and the concession of 17.5 percentage points to the lower income bracket is, the government claims, manifestly unfair.

The government has defined the “rich” as those with incomes on $300,000 or above, despite some skeptics noting that a ministerial salary is $291,375. 

Unfortunately, the government did not indicate what plans, if any, are in the offing for the middle income bracket.  Those on annual incomes of between $80,000 and $180,000, who are on a marginal rate of 37 per cent, will receive a 22 percentage point discount.

Ideally, to relieve distortions, the tax concession should apply equally to all. 

It is understandable that a government desperate to shore up support in this income group should continue to provide these tax concessions.  However, it is irrational, inequitable, and, at some point in the next few years, will need to be addressed.

The implication for the remuneration committee is how best to respond. 

The “rich” employees, while in an economic position to cope, will probably seek out after-tax increases to make up for the loss.  While many companies will say “bad luck”, others will provide a slightly larger pay increase. It will add to the expected executive pay increase pressures across the market.

For those companies with relatively low cost of capital and good cash flow, consideration should be given to loan backed executive share acquisition plans.  These are tax effective (as shares are capital gains taxed on vesting, and franked dividends are used to pay down the loan), and can be a useful retention payment.  Further, they provide alignment with shareholder interests. 

However, when, eventually, a government rationalizes the concessional taxes for middle income earners, a loan backed plan may not be feasible for extension, depending on a company’s balance sheet and other factors.  In these instances, companies may be tempted to offer an annual $5,000 employee salary sacrifice share plan.  While not tax concessional, it is tax deferred.   For professional employees seeking a method to increase savings and uncertain about where superannuation is going next, such plans may have increased appeal, and so position the company well in the attraction and retention stakes.

LAFHA

Of more severe impact to many companies are the government’s announced proposed changes to the tax treatment of living away from home allowances (LAFHA). 

While couched in populist terms of an executive perk, the changes will have a significant impact on companies with temporary overseas employees.  The number of employees receiving the tax break rose from 30,000 to more than 60,000 last year.  This contrasts with an estimated 300 KMP foreign sourced executives in the ASX300 companies receiving a LAFH allowance. 

Under the current arrangements, certain living away from home allowances paid to eligible temporary overseas employees are exempt from both income tax and fringe benefits tax. These significant LAFHA tax concessions have helped Australian companies to attract and retain temporary overseas employees and to compete for talent with companies in lower tax jurisdictions.

So, in effect, the government has reckoned that the $800 million saved towards a budget surplus from the LAFHA initiative has greater positives than the economic disadvantages stemming from an inability to cost effectively source scarce skills.

The changes are expected to take effect from 1 July 2012.

In the lead up to the implementation of these reforms, companies should consider how these changes will impact: 

  • Current employment arrangements for temporary overseas employees,
  • The employment costs of temporary overseas employees,
  • 457 visa holders’ immigration requirements,
  • Workforce recruitment and retention strategies.

Under the government’s proposed changes, the LAFHA tax concessions will only apply where temporary overseas employees are living away for work from a home that they maintain for their own use in Australia.  Overseas employees will be able to claim a tax deduction for certain accommodation and food expenses provided they can be substantiated. Certain exemptions from fringe benefits tax will apply but these will be subject to substantiation requirements.

In all other cases, living away from home allowances paid to temporary overseas employees will be subject to income tax and payments made to temporary overseas employees to reimburse them for their accommodation expenses will be subject to fringe benefits tax, which will be payable by the employer.

It is unlikely that many temporary overseas employees will be living away for work from a home that they maintain for themselves in Australia. Accordingly, most of them will cease to be eligible to receive the LAFHA tax concessions from 1 July 2012 if the proposed changes go ahead. 

The effect of the proposed changes therefore is that, like their Australian counterparts, most temporary overseas employees will have to meet their accommodation expenses out of their after tax income. Their gross remuneration will have to increase in order to maintain their after tax income at current levels.

For companies, the effect of the proposed changes is likely to be an increase in the costs of employing temporary overseas employees. In addition to employee demands to increase gross remuneration to offset the additional income tax liability and the employer liability for fringe benefits tax where accommodation expenses are reimbursed, employment on-costs such as compulsory superannuation contributions and state payroll tax obligations will also increase. 

In view of the impact that the proposed changes will have, companies should review their employment contracts for temporary overseas employees as well as their policies and procedures with regard to LAFHA to identify the available options. Companies will also need to consider a communication strategy to inform their temporary overseas workers of the proposed changes and to discuss the arrangements that will apply if the proposed changes go ahead.

Subject to the employment arrangements in each case, the options available to companies employing temporary overseas workers include:

  • Continuing to pay the living away from home allowance – the overseas worker will bear the tax liability under the income tax regime,
  • Increasing the overseas worker’s gross remuneration to ensure that there is no reduction in their take home (after tax) pay, or
  • Renegotiating the employment arrangements so that the living away from home allowance is paid as a reimbursement of accommodation expenses actually incurred – in this case the employer will bear a fringe benefits tax liability.

Companies will also need to consider visa conditions and requirements arising under the Migration Act and Regulations in relation to their temporary overseas workers, in particular 457 visa holders.

For executives relocated to Australia the changes will see companies increasing executive remuneration for these employees (and hence another pressure point in increasing executive pay) to make up for the increased taxes.  According to an ACSI study, 17% of executives are from overseas.  However, despite the high cost of living, the higher Australian dollar exchange rate will continue to assist companies in successfully recruiting higher value offshore executives.

© Guerdon Associates 2021
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