02.12.11 Australian Expatriate Important Tax Change: LAFHA Taxable for Foreign Nationals in Australia

On 29 November 2011, the Australian Government delivered a bombshell announcement that will affect all foreign nationals coming to Australia. The change will substantially increase their Australian tax costs.

The change will also increase the employment on-costs of their employer. If you are an HR executive with assignees in Australia, you will need to have an immediate HR and tax discussion with your assignees.

We recommend you take immediate action if you have 457 visa workers in Australia, or if you are a 457 visa employee.

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1. The Government’s 29 November 2011 LAFHA Announcement

To date, most foreign nationals coming to Australia on the common, four-year “457” work visa are eligible for tax-free rent and food. This applies for the visa holder and their accompanying family, during the four-year duration of their Australian assignment.

This is called the Living Away From Home Allowance or “LAFHA”. A cash LAFHA (or its equivalent non-cash benefit of free Australian rental accommodation and food) for a 457 worker is usually tax-free for the employee and also benefits from nil Fringe Benefits Tax (“FBT”) for the employer company. So it is entirely tax-free. It also reduces the company’s State Payroll Tax (which in Western Australia, for example, is 5.5%). All of this will change from 1 July 2012.

From 1 July 2012, a LAFHA will no longer be tax-free for foreign workers in Australia on a 457 visa. This is a clearly political decision, apparently aimed at taxing the huge number of (non-voting and hence voiceless) foreign nationals working in Australia, ostensibly to balance the Government’s budget deficit. Australian nationals will still be entitled to claim LAFHA. Foreign workers will not (with a very rare exception).

The only stated case where a foreign national on a 457 visa will still be able to receive a LAFHA tax-free is where the individual maintains a home in Australia (say in Perth) and then temporarily works away from that Australian home in another part of Australia (say Queensland). The example given in the Government announcement is for “fly in-fly out” (“FIFO”) workers who live in one part of Australia and work at a remote mine site in another part of Australia. But this stated example is irrelevant, as the LAFHA in that case would only cover their temporary Queensland rent and food costs, not their Perth home rent and food costs. They would normally be provided with campsite accommodation and food in Queensland in most circumstances anyway. In addition, remote area housing benefits are already covered by a separate tax exemption so this concession is mainly irrelevant.

In addition, any employees (foreigners or Australians) who remain eligible for a tax-free LAFHA will now need to provide proof of their actual accommodation and food costs, above a statutory amount. It will no longer be a case of “reasonable” housing costs being tax-free under LAFHA.

Currently, we save the average expatriate in Australia around $20,000 pa in tax by salary-sacrificing, converting some of their taxable salary into tax-free LAFHA to cover their Australian rent and food costs. This also saves their employer around $10,000 in total over a four-year assignment period. From 1 July 2012, this tax-free salary structuring into LAFHA will no longer be effective for foreign nationals working in Australia on a 457 work visa.

Despite the Government populist rhetoric in the 29 November 2011 announcement, rich foreign nationals are not “rorting the Australian tax system through tax-free LAFHA, at the expense of the Australian taxpayer”.

Where any foreign executive currently has excessive LAFHA, their employer has always had to pay FBT to the Australian Taxation Office at an effective rate of around 87% on the net excessive LAFHA. (We always remind our clients that FBT is an effective rate of around 87%. If the excessive LAFHA is say $100,000, the company will have to pay around $87,000 in FBT. This has always been the case and is a very effective remedy against excessive LAFHA.)

There is therefore no need at all for this cancellation of LAFHA for 457 visa workers in Australia. However, tax-free LAFHA for foreign nationals will be cancelled from 1 July 2012 onwards.

2. The Tax Implications for Expatriates in Australia

Your expats working in Australia on a 457 visa will have a substantially higher tax burden from 1 July 2012 onwards.

Particularly those on a lower remuneration (for example $100,000 pa or less) may struggle to pay their bills. Australia is an extremely high-cost country. Many lower-paid expats will leave Australia as a result as they will not be able to afford to live here any longer. Or they will be forced to look for a higher-paying job elsewhere in Australia.

Remember that most foreign nationals working in Australia on a 457 visa still have to pay much higher private health insurance premiums than the equivalent Australian pays (often double or triple the premium) and much higher Australian school fees and University fees for their children (often double the cost). Most foreigners are also ineligible to use the Medicare public health system and those who are eligible (e.g. most UK nationals) don’t get the same level of access as Australians do. So, despite the Government’s announcement that this cancellation of tax-free LAFHA for 457 visa employees is to “ensure that a level playing field exists between temporary residents and permanent residents”, this is clearly not the case or the reason for this Australian Government attack on foreign nationals working in Australia.

As an example, let’s consider a UK national on a 457 visa is working in Western Australia. Her remuneration is $100,000 pa, which is currently structured efficiently into $60,000 pa taxable salary plus $40,000 pa tax-free LAFHA for her rent and food. Currently, she will pay $12,500 pa in income tax (2011-12 rates, including Medicare Levy and Flood Levy). However, with her tax-free LAFHA changing back into taxable salary, she will now pay $26,700 pa in tax (2011-12 rates for comparison, including Medicare Levy and Flood Levy). Her Australian income tax burden has just doubled, costing her an extra $1,183 per month in tax. At her relatively low level of income of $100,000 pa, the cancellation of tax-free LAFHA will be a disaster for her and her family.

3. The Implications for Employer Companies

Firstly, the employer company with 457 expats in Australia will now face additional State Payroll Tax costs. Where an assignee has a tax-free LAFHA of say $50,000 pa, and this becomes taxable from 1 July 2012, the company will have to pay a further $2,750 pa in State Payroll Tax for this assignee (using WA 5.5% rate as an example).

Payroll Tax is a state tax on the company’s total “wages” amount but tax-free LAFHA is not included as “wages”. If the company has 100 expat employees working in Australia and their LAFHA will all become taxable in July 2012, its Payroll Tax liability would increase as a result by around $275,000 per year. Over the next four years, that company will have around $1 million of additional, unbudgeted Payroll Tax costs because of the cancellation of 457 employees’ LAFHA.

Many assignees have an even higher LAFHA amount so the increased Payroll Tax costs will be even higher. You will need to update your corporate budgets for this increased cost from 1 July 2012.

Secondly, if the company has not been paying the 9% Super Guarantee (employer pension contribution) on its employees’ LAFHA, it may need to do so from 1 July 2012 when the LAFHA reverts to taxable salary (subject to contractual and statutory SG limits).

Thirdly, there are HR and contractual implications. Each company will have to decide how to deal with its assignees’ huge increase in Australian tax costs. If an employee’s assignment contract states that he or she will receive tax-free LAFHA, the contract will need to be changed. This will require HR participation, as well as discussion and agreement with the assignee. Some employers will increase their assignees’ remuneration to compensate for some of their extra tax costs, sharing some of the additional tax burden. Many employers will not be able to afford the extra cost – and paying a foreign national more money to do the same job will have negative implications for the Australians in the company doing the same job alongside the foreigner. How will a company justify giving a significant pay rise to its foreign workers but not to its Australian workers in the same role? Of course, many 457 employees in Australia may decide to end their Australian assignments and work elsewhere in the world or go home where the tax and the costs of living are much lower (e.g. USA, Singapore, Europe and Africa).

Even if your only employees receiving LAFHA are Australian nationals, this Government announcement will still affect you. You will need to revise your LAFHA policies before July 2012. Companies that set a rental LAFHA based on salary bands will need to change this practice or face additional FBT costs. And all employees with LAFHA will need to keep receipts to prove their actual expenses beyond a statutory amount.

However, it appears that the valuable children’s schooling and university costs tax exemption has not been targeted and remains open for use. This valuable tax-free benefit is technically not part of LAFHA, but applies to international assignees coming to Australia or going overseas where it is “customary” in the industry to provide this benefit. Given the impending cancellation of LAFHA for 457 visa employees, we foresee that this valuable tax-free benefit will become much more “customary”.

If you would like further information, to discuss this LAFHA issue or your other expatriate tax needs please contact us with our Global Tax Specialists, we are here to help you: