Responsibility for the collection and payment of tax due on benefits in kindmoves from the employee to the employer, writes Anne Bolster of PricewaterhouseCoopers.

At first glance it would appear that the only tax change for employees from January 1st is the increased employee (PAYE) tax credit announced last week by the Minister for Finance in his Budget speech and worth €240 per year to each employee.

In his Budget 2003 speech in December 2002, however, the Minister announced a fundamental change in the tax system for employees and employers from January 1st, 2004, by extending PAYE and PRSI to employee benefits. The 2003 Finance and Social Welfare Acts introduced the legislation to facilitate the introduction of the changes from next year.

From January 1st, 2004, the employer will have responsibility, under new valuation rules, to estimate the sum of all taxable benefits provided to employees and include this amount as "notional pay" within the PAYE/PRSI system.

As a result employers are not just facing additional PRSI costs but also additional administrative and human resources headaches, as the responsibility for collection and payment of the tax due on benefits in kind moves from the employee to the employer.

From 2004, employees earning less than the employee PRSI earnings ceiling of €42,160 (which is being increased from €40,420 in 2003) will suffer an additional 6 per cent deduction on the taxable value of all benefits provided by their employer.

By contrast, higher earning employees will generally suffer only an additional 2 per cent deduction on benefits provided by their employer.

For employees earning less than €42,160, if the taxable value of their benefit in kind exceeds €4,000, they will actually see a reduction in their net salary from the start of next year even after taking account of the increased employee (PAYE) tax credit.

The impact for a single individual earning €35,000 a year and provided with a company car, which has an original market value of €19,000, is demonstrated in Example 1. This employee's take-home pay will actually drop from €24,550 in 2003 to €24,228 in 2004 (down €26.83 per month).

As demonstrated in Example 2, higher earning employees will continue to receive some protection from full PRSI costs on benefits in kind because of the retention of the employee earnings ceiling. They will however suffer the additional health contribution levy of 2 per cent on all earnings including taxable benefits which exceed €42,160.

Example 2 assumes that the individual earns €65,000 and drives a company car with an original market value of €25,000.

Employees earning more than €42,160 will only see a reduction in their net salary from the start of 2004, as a result of these new rules, if the total of their non-cash benefits exceeds €12,000 per annum.

The Finance Act 2003 also includes new rules for valuing benefits for tax purposes. The valuation rules for calculating the taxable benefit on a company car were simplified, mainly to assist employers in calculating the benefit in kind where business mileage exceeds 15,000 per annum.

Where an employee's business mileage exceeds 15,000 in a year, a tapering relief applies to calculate the taxable benefit. From January 1st next there is a reduction in the number of tapering relief mileage bands to simplify the calculation. But the employer will be required to monitor the employee's mileage in order to calculate the correct notional pay amount.

Arising from this simplification in valuation rules, where the employer does not meet all the running costs of the car - such as servicing or certain fuel bills for example - a significant increased benefit in kind charge can arise. In these circumstances not only does the employee face an increased tax and PRSI cost but the employer's PRSI costs can also increase substantially.

The impact for an individual provided with a company car, with an original market value of €20,000, where the employee meets all the running costs is demonstrated in Example 3.

For this individual the change in the valuation rules means almost a 2 per cent increase in tax even allowing for the increase in the PAYE tax credit announced last week, while the employer is facing a 15 per cent increase in PRSI costs over the current year.

Even where employers meet all running costs of a company car, in order to provide such a car to an employee they will bear an additional annual cost of up to 3.2 per cent of the original value of the car.

In light of the tax changes, many employers are considering re-designing their car schemes or indeed replacing the company car with a car allowance in an attempt to reduce costs for both themselves and their employees.

Replacing existing benefits with cash allowances is not as straightforward as it might seem, as employers will need to consider the implications for any buy-out payment as well as the potential impact of increased cash remuneration on pension schemes.

While the new valuation rules applicable to cars may not represent good news for many employees or employers, the Revenue guide to operating PAYE and PRSI on benefits, issued recently, takes a common sense approach to valuing certain other benefits.

For example, Revenue accepts that where an employer provides a mobile phone to an employee, a benefit in kind charge will not arise where the private use of the phone is incidental to business use.

Revenue also accepts that where membership of a professional body is relevant to the employment no benefit in kind charge will arise where the employer pays the subscription.

The guide also clarifies the benefits that Revenue regards as falling outside the charge to PAYE/PRSI, subject to certain conditions. These include car parking, provision of newspapers and once-off benefits with a value of less than €100 per annum.

These changes represent one of the most significant changes in recent years to the PAYE and PRSI system. The result leaves many employees facing additional costs despite the proposed increase in the employee tax credit.

Employers face extra PRSI costs which will add approximately 1 per cent to their payroll costs for every 10 per cent of employees' remuneration packages which are made up of taxable benefits.

On top of the additional PRSI costs, employers face the "hidden costs" which will arise from the administration of the new system whether or not their payroll is outsourced.

In light of the more aggressive Revenue approach to imposing interest, penalties and publication for tax defaulters, getting it wrong will prove even more costly.

Employers who are considering eliminating benefits or changing benefit packages as a result of the new rules may need to decide whether the benefits are part of the terms and condition of the employment or genuine discretionary benefits. Employers will also need to consider the potential human resources and industrial relations implications of the changes.

But it is not all bad news as employers can continue to provide a range of "exempt" benefits to employees without operating Employee Benefits Withholding Tax.

Budget 2004 may have been insignificant in terms of changes to employee and employer tax but the application of PAYE and PRSI to benefits from January 1st promises some interesting times ahead and the implications should not be underestimated.

Anne Bolster is with the HR services group in PricewaterhouseCoopers.