A necessary review of allowances
An Official Issues paper released by Inland Revenue in November 2012 reviewed the treatment of employee allowances and other expenditure payments. In particular it focused on meal, accommodation and clothing allowances and highlights how the position has not been clearly defined in the legislation. Consequently it has resulted in varying tax outcomes, depending on how the rules are applied in practice.
Further announcements by the Inland Revenue and recent media speculation around the potential tax liability faced by plain-clothed police officers highlights the importance of treating employee allowances correctly in the first instance…and the necessity of regularly reviewing historical positions.
Principles regarding Clothing Allowances
In general, where clothing allowances are paid to employees towards the costs of their uniform, protective or specialist clothing that is required for a particular occupation and is not suitable for private use, it may be a non-taxable allowance.
However, when an employee wears ordinary clothing to work, the cost of purchasing, maintaining and replacing that clothing is generally considered to be a private expense. Therefore, clothing allowances used to cover these costs are generally fully taxable even if the clothing is considered to be for work purposes. Similarly, any allowance paid to cover the costs of cleaning and maintaining this clothing would also be taxable, unless the working conditions are considered unnecessarily dirty or hazardous.
Determining whether an item of clothing is regular clothing or clothing that is considered a uniform or specialist clothing for work is a contentious area. Speaking as a tax advisor and owner of a large selection of shiny, threadbare suit trousers but immaculate suit jackets, I would argue that my suits are specialist work clothing – after all, given a choice, I’d be comfortable wearing shorts and a t-shirt and the quality of my tax advice is in no way influenced by whether or not I wear a suit. Nevertheless, my employer much prefers that I do so.
However it is the Inland Revenue’s view that my suits could just as equally be worn when going to the theatre, watching the kids play sport on a Saturday or to the family BBQ on those long sunny summer weekends. Whether I choose to do that or not, you have to say that there is a certain logic to it, and the same couldn’t perhaps be said of the uniformed policeman or the local volunteer fireman!
A clothing allowance made in relation to ordinary clothing worn at work is therefore substantially private in nature – we all need to wear clothes – and the private element arguably goes beyond being merely incidental to the work purpose.
On this basis, if the item of clothing is indistinguishable from clothing that is suitable for a person to wear outside of work, it seems hard to argue against any allowance to buy that clothing being taxable.
Issues with the clothing allowance provided to the police
The Inland Revenue’s recent pronouncements on taxing clothing allowances paid to plain-clothed officers serves to remind us that historical positions cannot be relied on, and further highlights not only the need to constantly review remuneration policies and collective agreements, but also that historical positions cannot be relied on…regardless of whether or not the Inland Revenue previously provided tacit agreement. You only have to look at the Commissioner’s recent announcement on the tax treatment of accommodation to realise that previously agreed or published positions can retrospectively be dismissed or changed with scant regard for the historical consequences of such a belated change of heart.
Where to from here?
The landscape of taxing employment income is changing and, in the absence of clear legislation and consistent application by the Inland Revenue, employers face a great deal of uncertainty when trying to establish a correct tax position. This is often not helped when collective employment agreements or negotiated group positions are effectively rolled over without considering the evolution of taxation.
We welcome the Inland Revenue’s efforts to provide some clarity around this area…but have significant reservations around a tendency to apply any changes retrospectively, and a general one-eyed view that everything should be taxable.
The implications of applying evergreen allowances and remuneration policies could result in adverse consequences given the Commissioner’s increased scrutiny over the taxability of allowances.
Deloitte would therefore always recommend that collective agreements and other group arrangements be carefully reviewed on a regular basis to ensure that any tax position taken is robust and consistent with current thinking.
For more information, please contact Mike Williams or your usual Deloitte tax advisor.
Tax Alert August 2013 contents:
- Tax Alert - August 2013
- Clarity, controversy, or both: Inland Revenue’s finalised guidance on tax avoidance
- Succession and divestment
- Clarifying the tax consequences for deregistered charities
- Research and development expenditure: Deja vu?
- Bloodstock investors finish down the track
- A necessary review of allowances
- Deloitte announces new tax partner