Tax on Payments to Employees - Allowances, Benefits, and Lump Sums

From time to time, you might make payments to your employees beyond their regular wages - things like:

• allowances
• benefits
• holiday pay
• lump sum payments

While some of these can be tax-free, most are taxable. In some cases, the employer pays the associated tax directly. In others, tax is deducted through PAYE on behalf of the employee.

You may also provide non-cash benefits — such as perks or reimbursements - as part of an employee’s total package. Even though these aren’t paid in cash, they still have a value that may be taxable.

The correct tax treatment depends on what the payment is for and the circumstances around it.

Allowances

There are several types of allowances, but the key question is whether they’re true reimbursements of work-related costs.

If an allowance simply covers out-of-pocket expenses incurred while doing the job, it’s generally not taxable. Examples include mileage, meals, or tools (including phones and laptops).

However, if the allowance amount exceeds the actual cost, the excess is taxable. In that case, you’ll either deduct PAYE or pay fringe benefit tax (FBT) on the difference.

Travel allowances

When it comes to travel payments, the tax treatment depends on what the payment covers:

• If you’re reimbursing the employee for their own travel costs, PAYE applies.
• If you cover the travel directly, FBT may apply.

For a travel allowance to be tax-free, the travel must be “on work” - not simply travel to and from work. The specific circumstances will determine which rules apply.

Claiming GST on employee payments

If you’re GST-registered, you may be able to claim GST on work-related allowances, provided you keep all relevant tax invoices.  However, GST can’t be claimed on non-work-related items or general benefits, as these don’t qualify as business expenses.

Benefits

Employee benefits can take many forms. They’re not part of wages, but they still represent value to the employee.

As they’re considered perks, the employer usually pays FBT (or sometimes PAYE) on their value.

Benefits generally fall into one of three categories:

• non-cash benefits
• cash benefits
• special benefits

Holiday pay

Holiday and leave payments are straightforward - they’re subject to PAYE, just like normal wages.

Lump sum payments

Lump sums cover everything else that doesn’t fall neatly into the categories above, such as:

• bonuses and gratuities
• back pay
• cashed-in annual leave
• redundancy or retiring allowances
• payments for restrictive covenants or exit inducements
• overtime payments

Employees generally pay PAYE on these payments. Keep in mind:

• PAYE rates will vary based on the employee’s total taxable income.
• ACC earners’ levy doesn’t apply above the maximum income threshold.
• Redundancy and retiring allowances are not subject to the ACC levy.

Need clarity?

Working out the correct tax treatment for employee payments can be confusing.

If you’re unsure how the rules apply to your situation, get in touch — we can help ensure your business meets its obligations and avoids unnecessary tax surprises.