Edited version of private ruling

Authorisation Number: 1011832908769

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Ruling

Subject: FBT - House construction and in-house residual benefits

Question 1

Does an in-house residual fringe benefit arise for a company (the employer) when an employee enters into a contract with a related constructing company for a new house to be built on land owned by the employee, for a price that is 75% of the usual arms length price?

Answer

Yes

Question 2

Does a loan fringe benefit arise when a company employee enters into a salary sacrifice agreement with their employer for 25% of the usual arms length contract price under which they are required to pay any amount not already forgone via salary sacrifice on termination of their employment?

Answer

A valid salary sacrifice arrangement has not been entered into. The amount which is purportedly salary sacrificed is income of the employee, being salary and wages.

Question 3

Would the Commissioner of Taxation make a determination under section 67 of the Fringe Benefits Tax Assessment Act 1986 in respect of the arrangements or any part of the arrangements considered in this private ruling?

Answer

No

This ruling applies for the following period:

Year ending 31 March 2012

Year ending 31 March 2013

Year ending 31 March 2014

The scheme commences on:

1 April 2011

Relevant facts and circumstances

The employer is related to a number of constructing companies that builds residential dwellings under a number of brands.

The employer, through a constructing company, is proposing to enter into arrangements with particular employees, whereby the constructing company will build a new home on land owned by the employee.

The employee will enter into a contract with the constructing company for the construction of the employee's new home at a contract price that is 75% of the full arm's length price the constructing company would normally charge the general public for such construction of a home identical to that being built for the employee.

The employee will subsequently pay the constructing company, from the employee's own funds, the contract price for the construction of the employee's new home.

The employer will enter into a contract with the constructing company whereby the employer will pay the constructing company an amount equal to 25% of the full arm's length price that the constructing company would normally charge the general public for the construction of a home identical to the employee's new home. The payment from the employer to the constructing company will be done via an 'in-house' journal entry.

The employee will never have a personal obligation or liability to pay the constructing company any amount other than that specified in the employee contract with the constructing company, being 75% of the arm's length amount normally charged by the constructing company In respect of the construction of the house.

However, alternatively, instead of there being two separate contacts drawn up, the above agreements may be incorporated into a single contract between all the relevant parties. This will not materially affect the obligations described above.

The employee will enter into an arrangement with the employee's employer to forego future salary for an amount equal to 25% of the full arm's length price that the constructing company would normally charge the general public for the construction of a home identical to the employee's new home. The employee forgoes part of the employee's cash compensation in return for the provision of a non-cash benefit. The arrangements to forego future salary for an amount equal to 25% of the full arm's length price involve mutual commitments by the employer and the employee.

In the event that an employee resigns or their employment is otherwise terminated, and it is deemed an insufficient amount has been recovered under the arrangements, the employee will be obliged to pay the balance then outstanding. This obligation would only arise In the event that both insufficient payments have been made, and the employee's employment is terminated.

There is no enforceable debt between the employer and employee in respect of the 25% discount other than on termination of employment. There is no loan from the employer or an associate of the employer although there is the repayment mechanism that takes effect on a termination of employment if so required.

The arrangements for payment after termination of employment will be dealt with in a written agreement between the employee, employer and/or constructing company (as relevant) which will be executed when the arrangements commence. In this written agreement, the employee will acknowledge that payments made after the termination of employment are for the employee's benefit and amount to a reasonable requirement to make a payment to a former employer or related entity for the purposes of the Fair Work Act 2009 (Cth).

The relevant part of the above written agreement will be structured as follows:

Solely in the event that the employee leaves the employment of the employer (or any related group company), if the employer has entered into a contract relation to the construction of the employee's house and the discount allowed to the employee in respect of the construction has not already been earned in full by the employee at that time, the employee will upon termination of employment have an obligation to pay the employer or the building company the amount (if any) as determined by the following formula:

R = A - B

Where:

R = Amount to be paid by the employee to the employer upon leaving the employment of the employer:

A = The total discount under the building contract (being the amount paid by the employer to the building company):

B = So much of the discount allowed to the employee as has already been earned by the employee prior to the employee leaving the employment of the employer, whereby B will not be greater than A.

There will be no obligation to pay any amount to the Employer other than in the circumstances referred to above.

The employee will be presented with a copy of the standard schedule and building contract.

The total shown in the above schedule will be the full price normally charged to the general public for constructing a home identical to the employee's new home. However the employee will never sign the above schedule.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 Section 40

Fringe Benefits Tax Assessment Act 1986 Section 45

Fringe Benefits Tax Assessment Act 1986 Section 49

Fringe Benefits Tax Assessment Act 1986 Section 67

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Fringe Benefits Tax Assessment Act 1986 Section 149

Fringe Benefits Tax Assessment Act 1986 Section 153

Fringe Benefits Tax Assessment Act 1986 Section 158

Fringe Benefits Tax Assessment Act 1986 Section 159

Reasons for decision

Issue 1

Subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) contains the following definitions:

"benefit" includes any right (including a right in relation to, and an interest in, real or personal property), privilege, service or facility and, without limiting the generality of the foregoing, includes a right, benefit, privilege, service or facility that is, or is to be, provided under:

(a) an arrangement for or in relation to:

(i) the performance of work (including work of a professional nature), whether with or without the provision of property;

(ii) ...

"provide"

(a) in relation to a benefit - includes allow, confer, give, grant or perform; and

(b) in relation to property - means dispose of (whether by sale, gift, declaration of trust or otherwise):

(i) if the property is a beneficial interest in property but does not include legal ownership - the beneficial interest; or

(ii) in any other case - the legal ownership of the property.

The constructing companies offer project homes and house and land packages. They build a person's home on land owned by that person.

The provision by one of these constructing companies of the new home (and associated preliminary works) to the employee constitutes the provision of a benefit(s) for the purposes of the FBTAA.

Section 40 of the FBTAA states:

40 PROPERTY BENEFITS

Where, at a particular time, a person (in this section referred to as the ``provider'') provides property to another person (in this section referred to as the ``recipient''), the provision of the property shall be taken to constitute a benefit provided by the provider to the recipient at that time.

Section 45 of the FBTAA states:

45 RESIDUAL BENEFITS

A benefit is a residual benefit for the purposes of this Act if the benefit is not a benefit by virtue of a provision of Subdivision A of Divisions 2 to 11 (inclusive).

Subsection 136(1) of the FBTAA includes the following definitions:

"property" means:

(a) intangible property; and

(b) tangible property.

"intangible property" means:

(a) real property;

(b) ...

(c) any other kind of property other than tangible property;

but does not include:

(d) ...

"tangible property" means goods and includes:

(a) ...

It is accepted that part of the business of the constructing companies is the building of residential housing and that in the furtherance of that building process they normally enter into building contracts with third parties.

The building contract entered into between the constructing companies and the employee is for the provision of a new home.

It is essential to correctly characterise what is being supplied to determine what benefit(s) is being provided.

One of the leading Australian cases on how materials should be characterised when used in construction is the decision of the High Court in Hewett v Court (1983) 149 CLR 639. In that case a builder of transportable houses agreed to construct a house for a purchaser, transport it to the purchaser's site and stump it on that land. The High Court held that the contract was for work, labour and materials and not the sale of goods.

Wilson and Dawson JJ in their joint judgment stated that the erection and installation of an article such that it became a fixture resulted in the contract being one for work done and materials supplied, in contrast to a contract for the sale of goods:

The ordinary tests which are applied to distinguish a contract for the sale of goods from a contract for work and labour draw a distinction between the degree to which emphasis is placed by the contract upon the exercise of skill in producing the end product and end product itself. The distinction is often artificial and difficult to draw. But there is a line of authority which establishes that where a contract is not only to supply an article but to erect or install it so that it becomes a fixture or part of the land, the contract is for work done and materials supplied. (at p.655).

Although the judgment of Wilson and Dawson JJ was a dissenting judgment the dissent concerned whether or not a lien applied and not the characterisation of the contract as one for the supply of labour and materials. Gibbs J agreed with Dawson and Wilson JJ in respect of the contract not being one for the sale of goods (647):

Although it does not appear from the contract itself in what manner the house was to be placed on the stumps, the fact that it was to be a home leads to the inference, in the absence of the evidence to the contrary, that it was intended to be annexed to the land in which the stumps stood, irrespective of the manner of it annexation: see Reid v. Smith (31). A contract to construct a house and erect it on the land which is intended to be its site is not a contract for the sale of goods. (at pp 646-647)

Murphy J similarly concluded that the contract is one for work and materials and is not a contract for the sale of goods. (at p.650)

The contract is one for work and materials, and not for sale of goods (see Aristoc Industries Pty Ltd v. RA Wenham (Builders) Pty Ltd (43). Hence the Sale of Goods Act 1895 (W.A) is not applicable.

It is our view that the building contract entered into between the constructing companies and the employee is a contract for the supply of work and materials.

The supply of the construction materials constitutes the provision of a property benefit and the associated application of labour and machinery to those construction materials represents a residual benefit.

However, section 153 of the FBTAA states as follows:

153 RESIDUAL BENEFITS TO INCLUDE PROVISION OF PROPERTY IN CERTAIN CIRCUMSTANCES

For the purposes of this Act, where:

(a) a person carries on a business that consists of, or includes, the entering into of contracts for the provision of property together with the provision of residual benefits;

(b) the person provides property (other than food or drink) and residual benefits to another person;

(c) but for this section, the provision would constitute a property benefit and a residual benefit; and

(d) the provision is made in the same, or substantially the same, circumstances as a provision of the kind mentioned in paragraph (a);

the provision of the residual benefit shall be taken to include the provision of the property and the provision of the property shall not be taken to constitute a property benefit.

Satisfaction of all the requirements of section 153 of the FBTAA will result in the relevant separate property and residual benefits being deemed to be residual benefits only.

The building of a house by the constructing companies and associated works meets the requirements of paragraph 153(a) of the FBTAA.

The requirements of both paragraph 153(b) and paragraph 153(c) of the FBTAA are also met. The provision of the building materials is a property benefit being provided to the employee and the application of the associated labour constitutes a residual benefit being provided to the employee and, in the absence of section 153, these two benefits would otherwise arise.

Paragraph 153(d) of the FBTAA requires that the provision of the relevant benefits are made in the same, or substantially the same, circumstances as the provision of the benefits mentioned in paragraph 153(a) of the FBTAA.

What comprises 'the same, or substantially the same, circumstances' is not defined in the FBTAA and, therefore, such expressions take their ordinary meaning in the context in which they are used.

The main differences between the house building arrangements normally offered by the constructing companies to their clients and the relevant house building arrangements between the constructing companies and the employee are that the arrangements:

(a) concern an employee of an employer associated to the constructing companies for the purposes of the FBTAA (per sections 158 and 159 of the FBTAA which, respectively, deem that a wholly owned subsidiary of another company is related to the holding company and, consequently, such companies are associates of each other);

(b) involve a tender document being presented to the employee stating the full arm's length price normally charged by the constructing companies for such building work but provided in the knowledge of both parties that there is no intention that the tender will ever be signed by the employee.

(c) are for a direct building contract price that is 25% less than the normal full arm's length price charged by the constructing companies for such building work.

(d) are related to an arrangement being entered into between the employer and the constructing company whereby the employer will pay an amount that is equal to 25% of the full arm's length price normally charged for the relevant building work.

(e) are related to the employee entering into an arrangement with their employer for the employee to forego a future salary amount equal to 25% of the full arm's length price normally charged by the constructing company for the relevant building work.

The circumstances surrounding the arrangements for the provision of the relevant benefits to the employee are not exactly the same as those normally provided by the constructing companies to their clients. The major difference is the price reduction offered to employees. We do not, however, consider that the price difference is of sufficient weight to result in the circumstances not being substantially the same. The employee will be receiving exactly what members of the public received when entering into a contract with the constructing companies. The house provided to the employee is identical in nature to the houses which are provided to arm's length clients.

The requirements of section 153 of the FBTAA are satisfied and the, otherwise, separate property benefits and residual benefits are deemed to be residual benefits only.

Is the residual fringe benefit an in-house residual fringe benefit?

Subsection 136(1) of the FBTAA defines an 'in-house residual fringe benefit' as:

"in-house residual fringe benefit", in relation to an employer, means a residual fringe benefit in relation to the employer:

(a) where both of the following conditions are satisfied:

(i) the provider is the employer or an associate of the employer;

(ii) at or about the comparison time, the provider carried on a business that consisted of or included the provision of identical or similar benefits principally to outsiders; or

(b) ...

Therefore, an 'in-house residual fringe benefit' requires that:

(a) there is a residual fringe benefit in relation to the employer; and

(b) the provider of that benefit is either the employer or an associate of the employer; and

(c) at the relevant time, the provider carried on a business that consisted of the provision of identical or similar benefits principally to outsiders.

As determined above, residual fringe benefits are being provided in relation to the employer and the provider of the residual benefits is an associate of the relevant employer. Paragraphs (a) and (b) of the definition of 'in-house residual fringe benefit' are satisfied.

'Identical benefit' is defined in subsection 136(1) of the FBTAA as:

"identical benefit", in relation to the recipients benefit in relation to a residual fringe benefit, means another benefit that is the same in all respects, except for differences (if any) that are minimal or insignificant and do not affect the value of the other benefit.

For the reasons previously discussed it is considered that although the benefits provided to the employee cannot be said to be identical to those normally provided to clients of the constructing company, they are considered to be similar. Consequently, the building of the new house by the constructing company for the employee is an in-house residual fringe benefit.

A 'period residual fringe benefit' is defined in subsection 136(1) of the FBTAA as meaning 'a residual fringe benefit that is provided during a period'. Section 149 of the FBTAA provides the following meaning (as relevant here) of the provision of a benefit during a period:

149(1)

For the purposes of this Act, a benefit shall be taken to be provided during a period if, and only if, the benefit:

(a) is provided, or subsists, during a period of more than 1 day; and

(b) is not deemed by a provision of this Act to be provided at a particular time or on a particular day.

149(2)

As the provision of materials and labour for building of a house takes some time (and certainly more than 1 day), and no other part of the FBTAA would deem such construction process as being provided on a particular day, then the provision of such a benefit would be a 'period benefit' under paragraph 149(1)(a) of the FBTAA.

Therefore, the building of the new home by the constructing company for the employee constitutes an in-house period residual fringe benefit.

Taxable value of in-house period residual fringe benefit

The taxable value of an in-house period fringe benefit is determined by section 49 of the FBTAA which states:

Subject to this Part, the taxable value of an in-house period residual fringe benefit in relation to a year of tax is:

(a) where, at or about the comparison time, identical overall benefits were provided by the provider:

(i) in the ordinary course of business to members of the public under an arm's length transaction or arm's length transactions; and

(ii) in similar circumstances and subject to identical terms and conditions (other than as to price) as those that applied in relation to the provision of the recipients overall benefit;

an amount equal to 75% of the lowest amount paid or payable by any such member of the public in respect of the current identical benefit in relation to an identical overall benefit so provided; or

(b) in any other case - an amount equal to 75% of the notional value of the recipients current benefit;

reduced by the amount of the recipients contribution insofar as it relates to the recipients current benefit.

It is not considered that the benefits provided to the employee are subject to identical terms and conditions (other than price) to those normally provided by the constructing companies to their clients. Therefore, paragraph 49(a) of the FBTAA does not apply in this case

Accordingly, the taxable value of the in-house period fringe benefit is determined by paragraph 49(b) of the FBTAA. The 'notional value' will be the full arm's length contract price the constructing company would normally charge the general public for building a house for the employee. Under paragraph 49(b) of the FBTAA the taxable value is 75% of this amount less the recipient's contribution.

As the employee will pay a contract price that is 75% of the full arm's length contract price, the taxable value is equal to the amount paid less that recipient's contribution, resulting in a nil taxable value.

Conclusion

The entering into a contract between an employee and the constructing company for the construction of a new home on land already owned by the employee will give rise to an in-house residual fringe benefit. Where the employee's contribution towards this benefit is 75% of the usual arms length price, no FBT liability will arise from the provision of this benefit.

Question 2

Under the proposed arrangements, the employee will forego part of their cash compensation in return for the provision of a non-cash benefit. The arrangements to forego future salary for an amount equal to 25% of the full arm's length price involve mutual commitments by the employer and the employee.

Also under the proposed arrangements, there is no enforceable debt between the employer and employee in respect of the 25% discount other than on termination of employment. There is no loan from the employer or an associate of the employer although there is the repayment mechanism that takes effect on a termination of employment if so required.

The employee is thus purporting to enter into a salary sacrifice arrangement in respect of a mutual commitment which constitutes neither a loan nor an enforceable debt. The characterisation of the relationship between the employer and employee in this way raises the question of whether salary sacrifice can apply to a mutual commitment.

A salary sacrifice arrangement (SSA) is generally considered effective if the arrangement is set up within the guidelines provided by Taxation Ruling TR 2001/10, Income tax: fringe benefits tax and superannuation guarantee: salary sacrifice arrangements.

TR 2001/10 provides the following guidance concerning salary sacrifice arrangements:

19. 'Salary sacrifice arrangement' - in this Ruling, the term salary sacrifice arrangement means an arrangement under which an employee agrees to forego part of his or her total remuneration, that he or she would otherwise expect to receive as salary or wages, in return for the employer or someone associated with the employer providing benefits of a similar value. The main assumption made by the parties is that the employee is then taxed under the income tax laws only on the reduced salary or wages and that the employer is liable to pay FBT, if any, on the benefits provided.

20. ...

21. 'Effective SSA' - an effective SSA involves the employee agreeing to receive part of his or her total amount of remuneration as benefits before the employee has earned the entitlement to receive that amount as salary or wages.

22. 'Ineffective SSA' - an ineffective SSA involves the employee directing that an entitlement to receive salary or wages that has been earned (see paragraph 23 of this Ruling) is to be paid in a form other than as salary or wages.

One of the key principals of salary sacrifice is that the relevant benefit is convertible into money. As specified in paragraph 67 of TR 2001/10 a benefit provided in an effective salary sacrifice must be something that can be convertible into money:

For an amount received to be income according to ordinary concepts, it must be money or something that can be converted into money (see Alexander Tennant v. Robert Sinclair Smith [1892] 3 TC 158; [1892] AC 150; FC of T v. Cooke & Sherden 80 ATC 4140; (1980) 10 ATR 696). Accordingly, if a benefit provided in an effective SSA is convertible into money, the amount will form part of the employee's ordinary or statutory income and, as discussed in paragraphs 69 to 78, will be derived as either 'salary or wages' assessable income or 'fringe benefits' exempt income.

The benefits provided under an effective SSA are expected to be of similar value to the salary or wages foregone. Paragraph 77 of TR 2001/10 discusses accordingly:

However, if an employee enters into an effective SSA, he or she foregoes an expected entitlement to an amount of salary or wages, before that entitlement has been earned, in return for benefits of a similar value. We accept that, when personal services have been performed by an employee in that situation, he or she becomes entitled to the agreed value of benefits. The benefits, when provided, are ordinary or statutory income provided by way of 'fringe benefits' within the meaning of subsection 136(1) of the FBTAA. The benefits, therefore, are not assessable income under section 6-5 or 6-10 of the ITAA 1997.

It is our view that an unenforceable mutual commitment does not constitute a benefit of similar value to the salary proposed to be salary sacrificed to pay an amount equal to 25% of the full arm's length price for building the relevant dwelling.

We also do not consider that an unenforceable mutual commitment can be converted into money.

Therefore, the proposed arrangements for the employee to forego future salary do not constitute valid salary sacrifice arrangements as defined and discussed in TR 2001/10.

a 'loan fringe benefit' is defined in subsection 136(1) of the FBTAA as meaning 'a fringe benefit that is a loan benefit'.

However, paragraph (f) of the definition of 'fringe benefit' in subsection 136(1) of the FBTAA excludes from that term a payment or salary or wages.

Therefore, as the proposed arrangements for the employee to forego future salary do not constitute valid salary sacrifice arrangements then no type of 'fringe benefit' can arise and, consequently, no 'loan fringe benefit', as defined, can arise.

Question 3

Section 67 of the FBTAA uses the term 'arrangement' as opposed to 'scheme'. Due to the very wide ambit of the term 'arrangement', as defined in subsection 136(1) of the FBTA, it is considered that the particular arrangement now proposed encompasses:

(a) The constructing company entering into a building contract with the employee for the building of a new house, on land owned by the employee, for a price that is 75% of the usual arm's length building price.

(b) The employer and the constructing company entering into a contract to pay 25% of the usual arm's length building price in respect of the construction of the new house.

(c) The employee concurrently entering into an arrangement to forego future salary for an amount equal to 25% of the usual arm's length building price in respect of the construction of the new house.

(d) The combination of all the circumstances outlined in points (a), (b) and (c) given that none will happen without any and all of the others simultaneously occurring.

One of the requirements for the application of section 67 of the FBTAA is the identification of a (fringe benefit) tax benefit in connection with an arrangement. Subsection 67(2) of the FBTAA specifies that a tax benefit is obtained when an amount is not included "in the aggregate fringe benefits amount of the employer of the year of tax in respect of that benefit where the amount would have been included, or could reasonably be expected to have been included, in that aggregate fringe benefits amount if the arrangement had not been entered into".

There is a reasonable expectation that the employee would have opted to pay full consideration to the constructing company for house construction if the arrangement had not been entered into in the way proposed. In other words, the employee would have been in the same position as a member of the public, paying full price, and no payment would have been made by the company to the constructing company. In such circumstances a liability for fringe benefits tax does not arise due to there being a nil taxable value. The taxable value is nil because a zero amount arises after the recipients contribution is taken away from the value of the benefit provided.

In addition to identifying a tax benefit in respect of an arrangement section 67 of the FBTAA requires a person(s) to have entered into the arrangement for the sole or dominant purpose of obtaining a tax benefit. It is our view that the dominant purpose of the arrangement is to provide the employee with an opportunity to forego future salary in return for the provision of a non-cash benefit. In view of this conclusion it is not considered that the sole or dominant purpose of the arrangement is to exclude an amount from the aggregate fringe benefits amount of the employer.

Accordingly section 67 of the FBTAA does not apply to the proposed arrangement nor any part of the proposed arrangement as is described above.

Further issues concerning possible application of Part IVA

Although the current request is for a private ruling is in respect of fringe benefits tax matters the possibility of the subsequent application of Part IVA of the Income Tax Assessment Act 1936 to the proposed arrangements also needs consideration.

Although Part IVA cannot be applied until all of the relevant facts and information have been obtained it is appropriate to advise of the Commissioner's preliminary view on Part IVA in relation to the proposed arrangements.

In providing our preliminary view however it is necessary to assume that a valid sacrifice is, in fact, entered into between the employee and the employer.

This could occur if an enforceable debt for an amount equal to 25% of the usual arm's length building price in respect of the construction of the new house was, in fact, created between the employer and the employee.

On the basis of this assumption there is a strong probability that the Commissioner would seek to apply Part IVA to the arrangements.

Under the proposed arrangements the employee ends up paying exactly the same amount that any other customer would pay. It is the way in which the payments are structured that is the key difference. As opposed to paying all of the consideration for the house to the constructing company, 75% of the sum payable is paid to the constructing company and the remaining 25% is paid to the employer.

The arrangements are thus designed to create a situation where the outstanding 25% is repaid by salary sacrifice. As a consequence the repayments by the employee are excluded from the assessable income of the employee.

If the arrangements had not been entered into it could reasonably be expected that the employee would have paid 100% of the consideration for the house directly to the constructing company, as opposed to paying 75% of the consideration to the constructing company, and 25% of the sum payable to the employer.

Should the company restructure arrangements such that a valid salary sacrifice arrangement is entered into with an employee and clarification in relation to Part IVA is sought, it will be necessary for an employee to lodge an application for a private ruling seeking the Commissioner's views on the application of Part IVA.