The Ultimate Guide to Salary Sacrifice

The word sacrifice usually suggests you’re foregoing something of value. But in the case of employees who salary sacrifice, it’s a win-win for the employee and the employer.

Employees who salary sacrifice are generally happier, which means they’re more likely to stay with their employer. As an employer, it’s far less expensive to retain employees than to attract and train new employees, so salary sacrifice has advantages for both sides of the fence.

However, for salary sacrifice to work well, it really depends on each employee’s individual circumstances and whether it’s ultimately an option that’s best suited for your business.

To help you decide whether salary sacrifice is something worth pursuing, here’s a comprehensive guide about salary sacrificing, how it works, different types of salary sacrifice, benefits and employer obligations.

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What is salary sacrifice?

Salary sacrifice is where an employee pays for products and services or contribute to their superannuation using pre-tax income. Or in other words, the employee agrees to receive less income before tax, in return for you providing them with benefits of similar value.

Your employee is using their pre-tax salary to buy something they would normally have purchased with their after-tax pay. This could include a car, superannuation or even a holiday.

Salary sacrificing is setup through an arrangement between you and your employee. Before getting started, you need to decide what products and services you will offer to your employees. There are also opportunities to use a third party to facilitate salary sacrificing.

Salary sacrifice is also commonly referred to as salary packaging or total remuneration packaging.

Where the benefit being provided by the employer is a taxable fringe benefit, salary packaging may still offer advantages to employees who are not taxed at the effective highest marginal tax rate of 47%.

Further, the benefits of salary packaging can still be maximised by the employee adopting an employee contribution strategy to reduce the taxable value of most fringe benefits including, the most popular car fringe benefits. This will also help the employer reduce Fringe Benefits tax payable (FBT).

How does salary sacrifice work?

Below are two examples that demonstrates how salary sacrifice works in practice.

Example 1: Salary sacrifice car plus laptop and superannuation

John is currently earning $150,000 p.a. for the 2020-21 financial year enters into a novated lease to acquire a new car costing $34,000 with lease charges being $9,070 (GST inclusive). John then travels 23,000 kilometres during the year and incurs $4,400 (GST inclusive) in running costs.

From the employer perspective FBT on the car is calculated using the statutory formula method.

Salary sacrifice saving

Employee Remuneration

Salary Sacrifice with Employee Contribution

100% Cash Salary (No salary sacrifice)

Cash salary $131,449 $136,986
Employer superannuation contribution (9.5% of salary plus packaged superannuation) $12,488 $13,014
Packaged benefit (i.e. cost for car) $6,063 Nil
FBT for employer Nil Nil
Total employer cost $150,000 $150,000

 

Cash salary pre-tax $131,449 $136,986
Less income tax payable (inc. 2.0% Medicare Levy) ($33,932) ($36,091)
Cash salary after-tax $97,517 $100,895
Less cost to employee of acquiring benefits where not salary sacrificed (car lease and running costs) Nil ($13,470)
Less employee contribution ($6,800) -
Compulsory superannuation (net of contribution tax) $10,614 $11,062
Benefit value $13,470 $13,470
John's salary after tax $114,801 $111,957

John’s total tax saving by setting up a salary sacrifice package under this scenario would be $2,844 each year. The employer under this option would also pay no Fringe Benefit Tax so a win/win for both parties.

Salary sacrifice is also great for you as the employer — by helping your staff pay less tax, you’re also keeping your employees happy and happy employees are less likely to leave.

The employer is also able to claim the GST for the running costs of the car under the above scenario.

Generally speaking, salary sacrifice is usually more tax effective for your staff on middle to high incomes, so typically salaries that are $100,000 plus, are a good starting point for your employees to benefit from tax savings.

Example 2: Public benevolent institution

A public benevolent institution (PBI) is a non-profit institution organised for the direct relief of poverty, sickness, and disability.

Public benevolent institutions (PBIs) must be endorsed by the Australian Tax Office to access the following tax concessions:

  • Income tax exemption
  • Goods and services tax (GST) charity concessions, or
  • Fringe benefits tax (FBT) exemption.

As a result of accessing the FBT Exemption, employees of PBI Organisations are eligible to Salary Package up to $15,900 of tax-free benefits per FBT year or $9,010 (GST free) if working for a public hospital or ambulance service. The employer will only have FBT payable if employees tax free benefits exceed these amounts.

Salary sacrifice saving

Kelly works for a PBI and is paid a total salary of $40,000 (plus superannuation). Kelly’s tax on $40,000 is $4,578 (including Medicare levy). This results in Kelly receiving an after-tax cash amount of $35,422 per year from which to pay all her mortgage payments, bills and living expenses.

After Kelly enters in to the salary sacrifice agreement for her mortgage payments, Kelly’s new taxable salary is $24,100 ($40,000 – $15,900). The tax payable on this amount is $1,218 (including Medicare levy) leaving Kelly $22,882 in after tax cash.

As Kelly is employed by a PBI, the $15,900 paid in mortgage payments (as fringe benefits) are tax free.

The benefit to Kelly of salary packaging her mortgage is now the difference between her after tax salary before salary sacrificing of $35,422 and her new after-tax salary sacrificed salary of $38,782. This difference results in Kelly being better off by $3,360 as a result of salary sacrificing her mortgage repayments.

Separate entertainment cap

A separate single cap of $2,650 applies to fringe benefits that are salary packaged meal entertainment and entertainment facility leasing expenses. This cap is available only to employers able to access an FBT exemption and could also potentially be on top of the $15,900 FBT cap for PBI and $9,010 if working for a public hospital or ambulance service.

The following types of salary packaged entertainment are subject to the cap:

  • Entertainment by way of food and drink
  • Accommodation or travel in connection with, or to facilitate the provision of, such entertainment
  • Entertainment facility leasing expenses.

Typically, these meal costs are packed into a meal entertainment card that can be used to purchase meal and entertainment up until the $2,650 limit but within a 12-month period. Again, if eligible meals and entertainment could be purchased and paid for using pre-tax salary income which is shown in Example 2, this could provide considerable tax savings for the employee.

What can I salary sacrifice?

Although you can offer salary sacrifice benefits that your employees would normally pay for with their after-tax income — such as computers, cars, childcare or super — there are tax consequences for both your business and your employees to be aware of.

It’s important for employers to understand what these tax consequences are and for your employees to consult a tax professional, that can walk them through their options.

Offering salary sacrifice for super to your employees will be typically be acceptable, dependant on superannuation cap limits discussed below, however there maybe restrictions on who can salary sacrifice other benefits.

Salary benefits fall into three categories: fringe benefits, exempt benefits and super.

Fringe benefits

Fringe benefits can include:

  • Cars
  • Property (including good, real property such as land and buildings, and shares or bonds)
  • Health insurance
  • Loan repayment
  • School fees
  • Childcare fees
  • Phone costs
  • Other personal expenses.

Your business pays fringe benefit tax (FBT) on these benefits, so it’s vitally important that your employee’s salary sacrifice packages are structured in a way to account for this fringe benefit tax, so as to avoid being hit with excessive fringe benefits tax. This is usually done via structuring your employees pay via a pre-tax and post-tax payment from each pay period.

To learn more about FBT, visit the ATO website here.

Can I salary sacrifice a car?

Yes, you can salary sacrifice a car by using a novated lease.

A novated lease is essentially a contract between you, your employer and a finance provider. When you enter into a novated lease agreement, your vehicle repayments are made to a third-party finance company by your employer on your behalf. Those repayments come out of your pre-tax salary and fall under fringe benefits, incurring the fringe benefits tax.

Many people choose to salary sacrifice a car because of the tax break it provides. Because your employer is making the payments from your pre-tax salary, your taxable income is less, which means you’ll have a smaller tax bill.

Here are some additional benefits for employees:

  • Avoid GST. Vehicles purchased through a novated lease program can be GST-free, which means the cost won’t be passed on to the employee through their lease repayments.
  • GST-free maintenance. Operating costs can also be GST-free as the employer will claim an Input Tax Credit for them.
  • Fixed repayment costs. The cost of owning and maintaining a car usually has an element of uncertainty due to changes in costs and unknown future expenses. However, with a novated lease the employee only pays one amount straight from their pre-tax income, making it simpler to budget and plan for.
  • No upfront deposit. If an employee is buying a car outright, they usually need a lump sum deposit. Salary sacrificing avoids this because the employee is making the lease payments over a period of time.
  • Includes petrol and servicing costs. The novated lease agreement will be based on an estimated annual kilometre allowance. It covers all petrol and servicing costs within these limits, which means the employee can drive without worrying about changing prices.

Here are some drawbacks to consider for employees:

  • The employee doesn’t own the car. Although the employee has full-time access to the car, they don’t technically own it. This may be more of an issue for some people than others.
  • The employee is liable for the car. Although the employee doesn’t fully own the car, they are completely liable for it. Should they lose their job, the car is still their responsibility, including the repayments.
  • Less take-home pay. It may be cheaper overall to salary sacrifice a car, but an employee will receive less take-home pay because of it.
  • Employer must agree. Everyone is eligible to salary sacrifice, but ultimately the employer needs to agree to it.
  • More complex tax affairs. If you have a relatively straightforward tax situation and can complete your own tax returns, salary sacrificing may make it more complex and possibly too difficult for an employee to do it alone.

To learn more about novated leases, click here to visit the ATO website.

Can I salary sacrifice a mortgage?

The short answer is, it depends. Being able to salary sacrifice your mortgage will depend on the company and the industry an employee works in.

It’s typically only offered by employees in the health (e.g. public or private hospital), charity and other not-for-profit industries and is only available for owner occupier home loans, not investment properties.

An employee also needs to check that their lender will accept salary sacrifice payments on their mortgage.

Some banks will simply refuse salary sacrifice repayments outright, so an employee may need to shop around and refinance your existing loan.

Exempt benefits

There are a number of benefits that are exempt from fringe benefits tax (FBT).

Some of these exempt work-related benefits include:

  • Portable electronic devices
  • Computer software
  • Protective clothing
  • Briefcase
  • Tools of the trade.

The work-related items exemption is limited to:

  • Items primarily for work-related use
  • One item per FBT year for items that have a substantially identical function, except
    • if the item is a replacement item
    • more than one work-related portable electronic device that small businesses provide employees in an FBT year.

Superannuation

Employees that salary sacrifice into their super from their pre-tax income, reduces their take-home pay but puts more money away for their retirement. These are not fringe benefits when paid for by an employee to a complying super fund and are referred to as concessional contributions.

Employees can ask you as their employer to pay part of their pre-tax salary into their super account. This is on top of what an employer is required to pay under the Superannuation Guarantee, which should be no less than 9.5% of your gross (before tax) annual salary.

Because salary sacrificed super contributions are classified as employer super contributions rather than employee contributions, they are taxed at 15%, which for most employees, will be lower than their marginal tax rate.

Salary sacrificed super contributions also do not attract fringe benefits tax.

If your employees are looking to boost your retirement savings or they’re a first home buyer, salary sacrificing into super could be an option for them to think about.

Generally speaking, making extra concessional contributions is tax effective if your employee earns more than $37,000 per year.

If an employee earns $37,000 or less, they may be eligible for a low-income superannuation tax offset (LISTO) of up to $500 per year.

The ATO will automatically work out eligibility and pay the money into your employee’s super account.

Click here to learn more about the low-income super tax offset from the ATO website.

How much super can I salary sacrifice?

While salary sacrificing into super can have certain benefits as outlined above, there are some issues that your employees need be aware of.

For instance, salary sacrifice contributions may push them over the concessional (before-tax) contributions cap, which is $25,000 per financial year and they will most likely attract additional tax on the excess contributions. Concessional contributions include super guarantee contributions, salary sacrifice contributions and personal before-tax contributions.

Employees can also make contributions to their super from after-tax pay.

These payments are called non-concessional contributions, because employees have already paid tax on the money. Employees can make up to $100,000 in non-concessional contributions each financial year.

If your employee earns less than $52,697 per year (before tax) and makes after-tax super contributions, they may be eligible for a matching contribution from the government, called a co-contribution.

The government will work out how much they are entitled to when your employee lodges their tax return. If your employee is eligible, the government will pay the co-contribution directly into their super fund. Click here to learn more about super co-contribution from the ATO website.

If your employee has owned their home for more than 10 years and they sell it, they may be able to contribute up to $300,000 from the sale to their super. To be eligible, your employee must be age 65 or older and meet the eligibility requirements. See downsizing contributions into superannuation on the ATO website.

How does salary sacrifice affect the super guarantee?

An employee’s salary sacrifice contribution is counted towards their employer’s contributions. That is why they are generally taxed at 15% in the super fund.

From 1 January 2020, salary sacrificed super contributions will not:

  • reduce the ordinary time earnings that an employer is required to calculate an employee’s super entitlement on
  • count towards the amount of super guarantee contributions that an employer is required to make for their employee for them to avoid the super guarantee charge.

How do salary sacrifice arrangements affect employees?

Employees need to be aware of how entering into a salary sacrifice arrangement with their employer will affect them. For example:

  • Employees pay income tax on their reduced salary or wages.
  • Employers may be liable to pay FBT on the non-cash benefits provided.
  • Employers may be required to report certain benefits on their employee’s income statement or payment summary.
  • An employee’s salary sacrificed super contributions are taxed in the super fund and are classified as employer super contributions, rather than employee contributions.
  • An employee’s salary sacrificed super contributions cannot be used to reduce the minimum amount of super guarantee that your employer needs to pay (from 1 January 2020).

What are the employer obligations for salary sacrifice?

As the employer, your business needs to set up a salary sacrifice arrangement with your employee before they start the work. If the arrangement is not put into place until after they have performed the work, it may be ineffective.

It is advisable that you and your employee clearly state and agree on all the terms of any salary sacrifice arrangement. The contract is usually in writing but may be a verbal one.

What are the benefits of salary sacrifice for employers?

Offering salary sacrifice incentives to staff can be highly advantageous for employees but also for the employers that offer them. Offering salary sacrifice options for the first time to staff requires both systemic changes and a shift in the culture of how your business operated from how payroll is calculated, how employees are recruited and even from a human resource perspective, how new talent contracts are drafted.

Therefore, it’s understandable that employers may be nervous about implementing salary sacrifice incentives. Any organisational change will obviously need to be carefully planned to ensure all salary sacrifice advantages and disadvantages are examined first to minimise any risk of miscalculations occurring.

Here’s a list of some of the employer benefits of offering salary sacrifice for your employees.

Happier employees

Salary sacrifice allows your employees to deduct a portion of their salary and contribute it directly towards something vital, such as childcare, a gym membership, a holiday, a car or even mortgage payments.

These services may be far more accessible through salary sacrifice than they would for employees to purchase themselves.

Also, salary sacrifice lets employees break up the costs of items which they might not be able to afford a particular asset all in one hit, but they can afford one-twelfth of the asset each month.

Attract and retain great employees

Employers that offer salary sacrifice programs are typically popular places to work.

One of the most basic benefits of all for employers is that, in offering salary sacrifice options, employees will see their place of employment as a desirable destination.

Thus employers are more likely to attract the best talent and then retain it, giving the employer a competitive advantage in the long run against their competitors.

Equipment savings

Either via managing a fleet of cars, or buying laptops and phones for employees, equipment can be an expensive part of the business.

By enabling employees to buy their own equipment via salary packaging and then use it for work purposes, the business is able to reduce a lot of that expense and risk.

What are some potential drawbacks of salary sacrifice for employers?

Not all employees benefit

Salary sacrifice isn’t beneficial for everyone.

Unless an employee is a not-for-profit organisation, where the employer receives fringe benefit exemption, employees on low incomes will find it difficult to gain a financial benefit as they are already on a low marginal tax rate.

There is also the potential for division between senior management who are salary sacrificing and obtaining significant tax savings, and lower paid employees, who due to lower marginal tax rates, will get no real tax savings. Therefore, if salary sacrifice communication to staff is not handled carefully, it could cause a rift within the business.

Increased admin cost

Given salary sacrifice arrangements are new to the business, there will be an administrative burden that comes with it.

Time spent enrolling staff and dealing with employee questions, will increase the burden on human resources or whoever is responsible for the program.

Having a human resource manager or consultant will help guide you through the compliance burden to ensure you focus on your core business services whilst keeping all the benefits of the salary sacrifice initiative.

Conclusion

Is salary sacrifice right for your business? If you’re looking for a way to support your employees and offer benefits that improve employee retention, while making savings for your company, then there’s a very good chance that salary sacrifice is a win.

Working with an experienced accountant is a way to ensure implementation and management of salary sacrifice runs as smoothly as possible. In addition, an experienced accountant will ensure that you’re kept abreast of any changes to the way salary sacrifice operates, safe in the knowledge that your program will be able to adapt.

If you have any questions at all about salary sacrifice, or how to implement a salary sacrifice program or would like any more information, please don’t hesitate to contact us, we’re here to help.