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Tax Law Notes Legal Issues, Governance, and the IMF
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Tax Law Note: How Should Tax be Withheld on Fringe Benefits? Legal Department Last Updated: December 02, 2004 Issue This note discusses the collection of income tax with respect to fringe benefits by way of withholding by the employer. Several issues are involved:
Country Practices 1. Valuation1 Most countries value fringe benefits for income tax purposes at fair market value as a general rule (i.e. the price the employee would normally pay for the benefit).2 In cases where it is difficult to establish the fair market value, countries often use rules of thumb, such as statutory formulas, presumptive values or other special valuation rules (e.g. the cost of the benefit to the employer). These rules of thumb usually make it easier for the employer to determine the amount to withhold. 2. Allocation to individual employees Problems of allocation arise where all employees have access to a given benefit, but the individual use of the benefit is hard to establish - for example, recreational facilities or a subsidized cafeteria. Employers may have a hard time determining which employees have actually used the facilities and to what extent. It may be easier to assign an average value to the right of accessing the facilities and regard that as income of the individual employee. This may also be considered fair, since all employees have a right of access. In practice this is the solution some countries adopt,3 while in certain cases benefits that are hard to individually allocate are exempted.4 3. Timing of withholding Some fringe benefits are valued according to the employer's cost of providing the benefit. Where benefits are paid for by the employer once a year and are enjoyed throughout the whole year by the employee (e.g. in the case of health insurance or a car) countries often use a formula to allocate the cost or the value of the benefit to be included in the employee's income in each period.5 For certain benefits the exact cost of the benefit for the year is not known until after the pay period for which withholding must be determined. Examples are subsidized meals or the direct coverage by the employer of expenses of medical services. Several countries use rules of thumb in these situations.6 Commonly encountered alternatives regarding the timing of the inclusion of benefits in the employee's income are either carrying out the collection through the ordinary periodical withholding system or including the value of the fringe benefits as an end-of-the-year payment.7 4. Tax rate Countries generally use the income tax rate applicable to the overall income (i.e. including cash and in kind benefits) of the employee.8 There are, however, countries that subject certain fringe benefits to withholding at a standard rate which satisfies the final tax liability with respect to the benefit.9 Fashioning a Solution Withholding on fringe benefits should ideally be the same as for cash wages. The valuation and reporting of the benefits included in employee income should be carried out by the employer. The employer should be required to inform the employee about the included value of the benefits. In the case of fringe benefits where it is difficult to assign the value of the benefit to the individual employee, the solution chosen should be a practical one. Requiring the employer to keep strict track of the actual use of facilities which are open to all (e.g. subsidized cafeteria or recreational facilities) by each employee is likely to be excessively burdensome. The problem of timing resulting from incurring the cost of a benefit once a year when the same benefits are enjoyed through the whole year by the employees may be resolved by establishing a formula for spreading the resulting taxable income through the year, or by giving flexibility to employers as to when to include fringe benefits in wages subject to withholding. For Further Reference Tax Law Note on Valuation of Fringe Benefits Lee Burns and Richard Krever, Individual Income Tax, in Tax Law Design and Drafting, 495, 515-563 (1998). The Taxation of Employee Fringe Benefits, Report of the IFA 47th Congress in 1993. The series of Tax Law Notes has been prepared by the IMF staff as a resource for use by government officials and members of the public. The notes have not been considered by the IMF Executive Board and, hence, should not be reported or described as representing the views of the IMF or IMF policy. 1See also the Tax Law Note on the Valuation of Fringe Benefits. 2See Lee Burns and Richard Krever, Individual Income Tax, in Tax Law Design and Drafting, 495, 515-563 (1998). 3In Canada, the test of fair market value assessment requires an estimate to be made of the price upon which a willing seller and a willing buyer would agree for a similar benefit. See Steen v. Canada, [1988](1 C.T.C.256 at 257, 88 D.T.C. 6171 at 6171 (Fed.C.A.). The fair market value may be established on the basis of resale value of the property received from the employer. See Wisla v. R., [2000] 1 C.T.C. 2823 (T.C.C.). This objective value may also be the cost of purchasing the item by the employee. See Richmond v. The Queen, [1998] 3 C.T.C. 2552, 98 D.T.C. 1306 (T.C.C.). Hogg & al., Principles of Canadian Income Tax Law, 118 (2002). In Australia, an employer may elect to use any one of the five methods under Div 10A, sec 39A to 39E of the Fringe Benefits Tax Assessment Act 1986 to calculate the taxable value of a car parking fringe benefit. Under sec 39D, the taxable value of the fringe benefit is the arm's length amount that the recipient could reasonably be expected to have paid the provider for the car parking facilities, reduced by the amount of the recipient's unreimbursed contribution. See Woellner et al., Australian Taxation Law 1579 (CCH Australia Limited ed., 11th ed, 2001). 4See Burns and Krever, supra note 2. In Canada no benefit is included in the employee's income if an employer acquires a number of parking spots which are available to all employees, as it is hard to identify the use of the spots. In Ireland employer-provided recreational facilities are not taxed due to the difficulties of assigning the use to individual employees. See The Taxation of Employee Fringe Benefits, Report of the IFA 47th Congress, 87-108, 130-137, (1993) [hereinafter IFA Report]. See also I.R.C. 132(e)(2), (f), (j)(4) (U.S.) (cafeterias where revenues cover direct operating costs, parking, on-premises gyms). 5In Austria 1.5% of the purchase price of the car is deemed to be the monthly income taxable to the employee. See IFA Report, supra note 4, at 67-76. 6In Luxembourg for meals provided on the premises a standard set amount is taken into account. In Belgium health services are taxed at a value that reflects the amount saved by the employee by not paying for the services. Id. at 140-145, 77-85. 7In Austria, Belgium, Luxembourg, the Netherlands and Germany fringe benefits are subject to withholding tax periodically just as cash salaries. Id. at 23-24. In the U.S., the employer is given flexibility as to when to take fringe benefits into account for withholding purposes, as long as the amount is taken into account by the end of the year. See Internal Revenue Service, Publicaton 15-B, sec. 4. http://www.irs.gov/publications/p15b/ar02.html#d0e3151. 8For example, Austria, Belgium, Luxembourg, the Netherlands. Id. at 23-24. 9In Germany, for example, in the case of employer-provided pensions, cars, or insurance premiums. Id. at 112-123.
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