Tax treatment of payments for relocation, overtime meals and certain other allowances

Sections CE 1(c), CE 5(3)(bb), CW 17, CW 17B, CW 17C, CX 19(1)(b), DD 4(3), DD 10(a), EA 3(7) and YA 1 of the Income Tax Act 2007; sections CE 1(c), CW 13, CW 13B, CW 13C, CX 17(1)(c), DD 4(3), DD 10(a), EA 3(7) and OB 1 of the Income Tax Act 2004; sections CB 12(1), CB 12(1B), CB 12(1C), CB 12(1D), CI 1(o)(v), EF 1(5A) and OB 1, schedule 6A of the Income Tax Act 1994; section 91AAR of the Tax Administration Act 1994

Amendments have been made to the Income Tax Acts 1994, 2004 and 2007 and the Tax Administration Act 1994 to specifically ensure that payments by employers when relocating their employees, and providing them with overtime meal allowances and certain other allowances, are exempt from income tax and fringe benefit tax when certain criteria are met. Most of these changes were signalled in the officials’ issues paper, Tax-free relocation payments and overtime meal allowances, released in November 2007, with some additional changes being made at the Select Committee stage. The changes are designed to remove uncertainty about whether and when these payments are tax-free to the employees who receive them.

Background

Over recent years there has been uncertainty over the tax treatment of employer payments for relocations and overtime meals, and whether these payments constitute income of the employees who receive them. For many years these two types of payment have been generally treated as non-taxable by both taxpayers and Inland Revenue. Developments over time have, however, complicated the situation.

Before 1995 taxpayers required approval from Inland Revenue if a particular payment was to be treated as non-taxable, but since then taxpayers have self-assessed whether a payment is taxable or non-taxable.

In 2007 Inland Revenue attempted to identify more generally the circumstances under current tax law, including case law, when amounts paid by employers in relation to employee-related expenses would be exempt from income tax. These circumstances were outlined in a draft Interpretation Guideline (IG03162), which was released for public comment on 24 October 2007. The Interpretation Guideline specifically focused on those situations covered by section CW 13 of the Income Tax Act 2004.

The draft guideline concluded that there were three criteria that must be met:¹

• The employee was performing an obligation under the contract of service at the time the expenditure was incurred.
• The obligation served the purpose of the income-earning process of deriving income from employment.
• The expenditure incurred by the employee was necessary as a practical requirement of the performance of the obligation.

Apart from relocations, these criteria also had implications for overtime meal allowances as these would have been taxable under the criteria, but had traditionally, in practice, been treated as non-taxable.

In response to these various developments, the government decided it would introduce amendments to the Income Tax Act to ensure these payments would clearly be exempt from income tax and, where relevant, fringe benefit tax, subject to clear limitations to prevent their use for purposes of salary substitution. This was announced in a joint media statement released by the Minister of Finance and the Minister of Revenue on 24 October 2007.

There are several reasons why these two employer payments should be non-taxable:

• The element of private benefit involved is considered to be small.
• The degree of private benefit is hard to measure.
• There is relatively little risk of recharacterisation of taxable salary and wages as non-taxable payments for relocation or as overtime meal allowances.

The changes also help employers and employees in making efficient employee relocation decisions by ensuring that tax considerations do not distort their decisions.

This is particularly crucial given the mobility of skilled labour.

To further reduce uncertainty, the government announced that the changes should apply to payments made over the past four years, as well as to future payments. By statute, Inland Revenue is generally unable to increase an income tax assessment beyond four years from the time of the end of the tax year in which the taxpayer provided the tax return. Similarly, for taxpayers who have not filed an income tax return, Inland Revenue is generally unable to issue an income statement beyond four years from the time of the end of the tax year that follows the tax year to which the income statement would apply. This meant backdating the changes to the beginning of the 2002-03 income year.

The changes were detailed in the officials’ issues paper, Tax-free relocation payments and overtime meal allowances, and following submissions, were subsequently included in the Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill.

At the Select Committee stage, although submissions were generally supportive of the two allowances being non-taxable, one submission suggested that sustenance allowances paid to postal delivery workers should also be explicitly treated as tax-free in certain circumstances.

It is important to note that these changes do not remove the more general provision that determines whether allowances are tax-free or taxable. All they do is carve out particular allowances from the general provision (section CX 17 in the case of the Income Tax Act 2007) to ensure that they are non-taxable when the general provision might otherwise suggest that they were taxable. Consequently, making these payments and allowances tax-free does not imply that other allowances are automatically taxable.

A change has also been made to the general provision to ensure that allowances that incorporate some element of depreciation are not precluded from being non-taxable purely because of the depreciation element. A number of allowances, such as tool allowances to compensate employees for the costs associated with the use of their own tools at work, fall into this category.

Key features

Relocation payments

To be tax-free, all of the following criteria need to be met:

• The employee’s relocation needs to be as a result of the employee:
  • taking up new employment with a new employer; or
  • taking up new duties at a new location with the employee’s existing employer; or
  • continuing in the employee’s current position, but at a new location.
• The employee’s existing home must not be within reasonable travelling distance of the new work place (unless accommodation is provided as an integral part of the job).
• The expense needs to be on the list of eligible relocation expenses.
• The payment needs to reflect the expenditure incurred.
• The expenditure has to be incurred within certain time limits.

Tax will have already been paid on some past relocation payments. Because the legislative changes have been backdated, some employers and employees could be entitled to tax credits. Employers, in the first instance, will receive the tax credits that arise in relation to past relocation payments that were subject to PAYE deductions.

Overtime meal payments and certain other allowances

For an overtime meal allowance to be tax-free, the employee must have worked a minimum of two hours beyond their ordinary hours on the relevant day and:

• either the employee’s employment contract needs to specify that the employee is eligible for a payment in relation to overtime hours worked, or an employer has to have a policy or practice of paying an overtime meal allowance; and
• the allowance needs to reflect the actual expenditure incurred by the employee or, alternatively, the allowance could be a reasonable estimate of the expected costs likely to be incurred by the employee or group of employees.

A specific definition of "overtime" has been provided.

For a sustenance allowances to be tax-free, all of the following need to be met:

• The employee works a minimum of seven hours on the day.
• Their employment requires them to work outdoors and away from their employment base for most of the day, and to undertake a long period of physical activity in travelling through a neighbourhood or district on foot or by bicycle.
• It is not practicable for the employer to provide sufficient sustenance on the day for the period when the employee is working outdoors.
• The allowance recognises both the arduous physical nature of the employee’s work and that the employer would normally provide tea, coffee, water, or similar refreshments at the employment base in the course of their business.

Allowances with a depreciation component

Section CW 17 has been amended to refer to both "expenditure" and "depreciation loss".

Application date

The amendments largely apply from the 2002–03 income year. It was decided not to change this date despite the time that has passed since the policy was announced.

Detailed analysis

Because the changes have been back-dated to the 2002–03 income year, they have been replicated in the three income tax acts that cover the period:

• the Income Tax Act 1994, which applied up to 31 March 2005;
• the Income Tax Act 2004, which applied from 1 April 2005 until 31 March 2008; and
• the Income Tax Act 2007, which came into force from 1 April 2008.

However, for the purposes of the discussion below on individual section changes we refer primarily to the 2007 Act unless otherwise stated. The wording used in the other two Acts may differ because of the difference in language used in those Acts, but the changes are intended to have the same effect as those in the 2007 Act.

The Tax Administration Act 1994 has also been amended.

Relocation

What payments are covered?

The changes relate to employer payments that cover the costs that employees have incurred in connection with carrying out their employment obligations. The circumstances in which these payments are treated as tax-free have traditionally been covered by section CW 17 of the Income Tax Act and its predecessors, section CW 13 of the Income Tax Act 2004 and section CB 12(1) of the Income Tax Act 1994.

Payments may be made in several ways. Employers may directly pay an account that is in the name of an employee (this is known as a payment on account of an employee). Alternatively, employees might seek reimbursement of an amount they have already paid, or the employer might provide them with an allowance to cover the estimated costs they are expecting to incur. Likewise, the relocation may arise from employees migrating to New Zealand, or migrating from New Zealand, or moving within. New Zealand. The legislative changes cover all these types of situations.

These situations differ from those covered by the fringe benefit tax rules, although ideally the outcomes should be similar. Accordingly, some changes have been made to the fringe benefit tax rules too.

New section CW 17B(1) provides the specific income tax exemption for payments that cover expenses in connection with a "work-related relocation", with new section CW 17(5) making it clear that the more general provisions as set out in section CW 17 do not apply to amounts covered by new section CW 17B.

An equivalent change has been made to section CX 19 to cover any fringe benefits that arise from a work-related relocation.

This means that provided the various requirements are met, the relocation payment will be exempt from income tax and fringe benefit tax, irrespective of how the employer makes the payment.

The reason for limiting the scope of the exemption is to avoid the recharacterisation of other forms of expenditure or income. Although employers can largely be relied upon to confine their reimbursements to reasonable relocation expenses because their natural inclination is to minimise the costs that they incur, an exemption for one form of expenditure naturally creates an incentive to recharacterise other forms of expenditure or income to take advantage of that exemption.

Requirements

Actual expenditure

Section CW 17B(2) requires the amount paid must be no more than the actual eligible relocation expenses that the employee incurs from the work-related relocation. To be an eligible expense, it must be one of those listed in a determination issued by the Commissioner of Inland Revenue. Section CW 17B(6), in conjunction with new section 91AAR of the Tax Administration Act, enables the Commissioner to issue such determinations.

Although the legislation refers to actual expenses, this should be sufficiently wide to enable employers to provide an advance to an employee in anticipation of relocation expenditure being incurred, provided there is ultimately a square-up. Estimates of costs would not, however, be allowed, on the basis that it is not unreasonable to expect employees and employers to keep track and provide evidence of actual expenditure given the relatively small number of employees involved and the magnitude of the costs associated with a relocation.

Time limit

Section CW 17B(3) places a time limit on when the expenses must be incurred by, which is the end of the tax year following the tax year in which the employee relocates.

The purpose of this requirement is to avoid expenditure some years later being attributed to the relocation when that expenditure would have no bearing on the employee’s decision to relocate.

The earlier draft legislation additionally required the expenditure to have also been incurred no earlier than the beginning of the income year in which the relocation takes place. This was too restrictive and has been removed, in acknowledgement that significant preparatory expenditure can take place ahead of the actual relocation.

The provision also now refers to "tax year" rather than "income year" to remove any doubt over which income year is involved. "Tax year" is a defined term and generally means the period from 1 April to 31 March.

Treatment of temporary moves that become permanent

The legislation generally does not distinguish between temporary and permanent relocations. For example, there is no minimum length of time that an employee has to stay in the new location. The only reference to "temporary moves" is in relation to allowing more flexibility around the time limit.

The legislation now says what time limit applies when a temporary move becomes a permanent relocation. The intention is that if the earlier temporary move has not been treated as an eligible relocation against which claims had been made, the temporary move is to be ignored and the time limit applies just in relation to the permanent relocation. If, however, an eligible relocation claim has been made in respect of the temporary move, then the time limit applies in relation to that temporary move.

In practice, most relocation costs will be incurred close to the time of relocation so the time limitation will not generally be a difficulty. 

Work-related relocation defined

Section CW 17B(4) defines what is meant by "work-related relocation". Under the definition, the relocation will need to be as a result of an employee:

• taking up new employment with a new employer; or
• taking up new duties at a new location with the existing employer; or
• continuing in the employee’s current position, but at a new location.

Reasonable distance requirement

A further requirement is that the relocation of the employee’s residence (or home base) must be necessary to carry out the job. If the employee could have commuted to the new job from an existing residence there would be a clear monetary private benefit involved when the employer pays for the relocation costs and, in principle, this should be taxable. The specific legislative test set out in section CW 17B(4) is that the employee’s existing residence must not be within reasonable daily travelling distance of the new workplace (the distance test).

Section CW 17B(5) includes an exemption from the distance test when a person’s accommodation forms an integral part of his or her work. The exemption recognises that some employees may be provided with a house as a necessary part of their job, and that when they are required as part of that job to move to a new location, their residence automatically changes irrespective of the distance. This issue was originally raised in the context of the clergy, but it can also be relevant to other occupations.

In developing the policy in this area, two options were considered: that the employee’s existing home must not be within reasonable daily travelling distance of the new workplace (the United Kingdom approach) and a specific minimum distance test (the United States approach). The United Kingdom’s approach requires assumptions to be made about what is "reasonable", although reasonableness is a common concept within accounting. The United States’ approach is more certain in this regard but is less flexible in handling genuine local relocations, such as within a major city where traffic congestion and transport difficulties may make shorter distance relocations more justifiable. The United Kingdom’s approach of a reasonable daily travel distance has been adopted.

Guidance on reasonable daily travelling distance

"Reasonable daily travelling distance" is not defined in the United Kingdom legislation. Instead, taxpayers are expected to apply common sense and take account of local conditions. The usual time taken to travel a given distance is an indication of whether that distance is reasonable. For example, in the United Kingdom employees living within larger cities commonly travel much greater distances or take longer to travel the same distance to work than do employees elsewhere. In New Zealand, transport difficulties, such as traffic congestion on main arterial routes and limited public transport options in the major cities, may make long-distance commuting less likely.

A number of submissions during consultation asked for guidelines from Inland Revenue on what is meant by "reasonable travelling distance". As a result, some guidance will be provided in a subsequent Tax Information Bulletin.

Eligible relocation expenses

New section 91AAR of the Tax Administration Act 1994 provides some parameters around the Commissioner’s power to issue determinations, and lists the types of expenditure that would qualify as eligible relocation expenses.

In particular, section 91AAR(3) sets out the factors that the Commissioner may take into account when considering whether a type of expenditure arises from a relocation of an employee rather than being costs, including capital costs, that would have been incurred gradually over time, irrespective of whether an employee had relocated. Factors that may be relevant are whether the expenditure is really a substitute for salary and wages, whether employers generally treat the expenses, as relocation expenses and the difficulty and costs of measuring any private benefit element. Losses on the sale of a house, for example, would not be considered to qualify as they are a potentially sizable capital loss that may have accumulated over time.

Section 91AAR(4) provides for a determination to be altered, subject to a minimum 30-day notice period before any change is implemented. The aim is to get from the outset as comprehensive a list as possible so that changes to the list items will need to relate only to future income years. Nevertheless it is important to have the ability to backdate changes as taxpayers may subsequently realise that a relocation expense item they have been paying or reimbursing tax-free in the past has been omitted from the list and should be on the list.

A person affected by a determination may dispute or challenge the determination under parts 4A (Disputes procedures) and 8A (Challenges) of the Tax Administration Act (see new section 91AAR(5)).

The Commissioner has exercised this power to issue a determination. A copy of the determination can be found on Inland Revenue’s website (www.ird.govt.nz). It will also be included in a subsequent Tax Information Bulletin.

It is acknowledged that the passage of time may make it more difficult to substantiate that previous payments covered actual eligible expenses, particularly given that full evidence dating back possibly to October 2001 may not be available to employers. Accordingly, a degree of pragmatism is required in applying the test. Rather than trying to reflect this in the legislation, this will be handled administratively. Practically, the issue is likely to be of relevance for the relatively few employers who are likely to seek refunds or credits because tax has been paid on the relocation payments. These employers are more likely to have the standard necessary information, given that many of these cases are likely to have arisen from reassessments. An example would be greater lenience on the part of Inland Revenue in seeking information on whether the time limits associated with certain eligible expenses (such as accommodation expenses, which have to be incurred within three months) had been met.

Tax and associated adjustments

Given that the legislative changes are being backdated to the 2002-03 income year, some taxpayers will be entitled to a credit for over-paid tax if they paid tax on past qualifying payments. These adjustments are being handled through Inland Revenue’s standard administrative practices.

There was general agreement with the suggestion in the Issues Paper that employers should receive the credit for over-paid PAYE when they have grossed up the payment to compensate the employee for the tax impost. No special legislative mechanism is needed to achieve this. Inland Revenue already has administrative practices in place that enable credits to be given for over-payments of PAYE. Even if an employee has not grossed up a payment but has nevertheless deducted PAYE, the employer, in the first instance, will receive the tax credit. An employer can request an adjustment to a past Employer Monthly Schedule (EMS), which the Commissioner will accept on the receipt of standard corroborating material. As noted earlier, given the passage of time since some past payments were made, Inland Revenue will apply lenience when seeking verification of whether the time limits associated with certain eligible expenses had been met.

Likewise, as would normally occur, employers receiving such credits should, where relevant, be adjusting their taxable income when they have treated the past PAYE payment as a cost of business.

Even when employers receive a credit for over-paid PAYE, employees will still be eligible for adjustments to their entitlements (to family tax credits) and liabilities (to pay child support and student loan repayments) that arise from readjusting their taxable income to exclude a previously taxed qualifying relocation payment. These adjustments redress the fact that some employees will have received lower entitlements and had higher liabilities as a result of the payments being previously subject to income tax.

Overtime meal payments

New section CW 17C(1) provides the specific income tax exemption for overtime meal payments, with new section CW 17(5) making it clear that the more general provisions as set out in section CW 17 do not apply to amounts covered by new section CW 17C.

The fringe benefit tax rules have not been changed. Fringe benefits arising outside of on-premises meals seem unlikely. If they do arise, they may get the benefit of section CX 5(3). That section states that to the extent to which a benefit that an employer provides to employees in connection with their employment would have been exempt income if it had been paid in cash, the benefit is not a fringe benefit.

Section CW 17C(3) specifies that for the payment to be eligible for the exemption, the employee must have worked at least two hours beyond his or her ordinary hours on the day of the overtime and either:

• the employee’s employment agreement must provide for pay for overtime hours worked; or
• the employer must have an established policy or practice of paying for overtime meals (This is to cover situations when salaried staff are required to work overtime in special periods of work pressure).

A time limit is important to avoid an employee working only a few minutes of overtime to get a non-taxable overtime meal allowance. The general understanding is that two hours is the standard time either specified in employment contracts or that employers require before they pay an overtime meal allowance, so this limit is likely to fit with current practice.

Section CW 17C(5) provides that the overtime meal payment must only cover either actual expenses or a reasonable estimate of those expenses. This is similar to the options available under the more general allowances provisions in section CW 17. If actual expenses are being reimbursed, documentation is required to verify expenditure when the meal costs more than $20.

Section CW 17C(6) defines what is meant by "overtime". This is defined as the time worked for an employer on the day beyond the person’s ordinary hours of work as set out in the person’s employment agreement.

It is important that the amounts paid for overtime meals should either represent actual costs incurred or a reasonable estimate of those costs rather than having particular amounts automatically sanctioned. If amounts are paid out with no intention of expenditure actually being incurred, the amount paid equates to a salary substitute and should be taxed. Nevertheless, the legislation is intended to be sufficiently wide to accommodate situations when amounts have been specified in industrial awards, on the assumption that the award amounts are based on a reasonable estimate of the costs incurred, on average, across a group of workers.

Sustenance allowances

The exemption originates from a submission in relation to the tax treatment of an allowance paid to several thousand postal delivery workers, which covers the costs of their purchasing adequate food or liquid to ensure that they maintain their energy levels while completing their mail deliveries. It recognises that these employees do not have access to the usual employer-provided drink facilities that employees working in offices would normally have access to at no or little cost, and the additional costs associated with their particular situation.

Because these workers are required to carry bags of mail, either on foot or by bicycle, they do not have the capacity to carry energy drinks and other sustenance with them and therefore, must purchase these items along their mail route. It was agreed by the Finance and Expenditure Committee, and subsequently by Parliament, that this sustenance allowance should be non-taxable and that the legislative changes should be widened to encompass it. There was a concern that without the specific exemption the allowance might be treated, under section CW 17, as a taxable meal allowance.

The wording of section CW 17C(2) picks up a number of the key attributes of a postal delivery worker’s job. It is, however, possible that there are one or two other employment situations that have comparable features or circumstances and would, therefore, also qualify.

For a sustenance allowance to be tax-free, all of the following conditions must be met:

• The employee works a minimum of seven hours on the day.
• Their employment requires them to work outdoors and away from their employment base for most of the day, and to undertake a long period of physical activity in travelling through a neighbourhood or district on foot or by bicycle.
• It is not practicable for the employer to provide sufficient sustenance on the day for the period when the employee is working outdoors.
• The allowance recognises the arduous physical nature of the employee’s work and that the employer would normally provide tea, coffee, water or similar refreshments at the employment base in the course of business.

A further requirement is that the employer must have an established policy or practice of paying a sustenance allowance (see section CW 17C(4)). Also, as with overtime meal allowances, the amount paid must be either the actual cost to the employee or a reasonable estimate of the cost likely to be incurred by the employee or a group of employees eligible for the payment.

Allowances including a depreciation component

Many employees use assets that they own during the course of their work, such as tools, computers and motor vehicles. Accordingly, employers often provide allowances to reimburse employees for the costs associated with the use of private assets for work purposes. Tool allowances and mileage allowances are common examples. Arguably, part of the reimbursement relates to the depreciation of those assets.

The main provision in the Income Tax Act determining whether allowances are non-taxable, section CW 17, refers only to payments to cover expenses. The Income Tax Act treats depreciation as a capital loss rather than as an expense. Accordingly, there was an issue over whether the wording in section CW 17 adequately covered all elements that an allowance might cover. To remove doubt, section CW 17 has been amended to refer to both "expenditure" and "depreciation loss" (see new section CW 17(4)).

These changes have also been backdated to the 2002–03 income year so that equivalent provisions have been included in the 1994 and 2004 Income Tax Acts. For the period before the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009 gained Royal assent, however, these changes are confined to past positions taken to ensure that only those taxpayers that had genuinely included a depreciation element in their allowances are able to use this change.

Inter-relationship with other parts of the Income Tax Act

Accommodation element of employment income

Section CE 1(c) ensures that the market value of accommodation provided by an employer to an employee is treated as income of the employee. If the provision of accommodation would qualify as an eligible relocation expense, it should be excluded from being income to the employee. An amendment has been made to section CE 1(c) to ensure this.

Inter-relationship with entertainment tax

The limitation rule in the entertainment tax rules that limits entertainment expenditure deductions to 50% does not apply to payments for overtime meals. To achieve this, section DD 4(3) of the Income Tax Act has been amended so that it refers also to new section CW 17C.

Expenditure on meals that qualifies as eligible relocation expenditure has also been exempted from the limitation on entertainment expenditure deductions.

Other consequential changes

Several references in other sections of the Income Tax Act 2007 that previously referred to the main provision that determines whether allowances are taxable or non-taxable (CW 17) now also refer to the new provisions relating to relocation payments and payments for overtime meals and certain other allowances. The relevant sections in the 2007 Act are:

• subsection DD 10(a) relating to reimbursement and apportionment of entertainment expenditure;
• subsection EA 3(7) relating to prepayments; and
• the definition of "employee" in section YA 1.

<p->Comparable changes have been made to the 2004 and 1994 Income Tax Acts. </p->

These amendments are merely consequential changes as a result of carving out the relocation payments and overtime meal allowances from the more general provision. They ensure that the rules covered by the amendments referred to above continue to apply also to the carved-out allowances.

 

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¹ The criteria would not apply to payments that already have their own rules in legislation; for example the rules relating to reimbursment of additional transport costs are already set out in section CW 14 of the Income Tax Act 2004 (or CW 18 of the Income Tax Act 2007).