Applying the ‘otherwise deductible’ rule to fringe benefits

Employers will soon (if not, already) be reviewing records and arrangements to identify taxable fringe benefits for the 2025 fringe benefits tax (FBT) year. Where taxable benefits are not otherwise exempt, any further FBT concessions should be explored – the ‘otherwise deductible’ rule being one of these. Employers will need to be mindful of some of the nuances involved when applying the ‘otherwise deductible’ rule, and this article focuses on some of the key considerations relevant to its application to expense payment fringe benefits. 

An expense payment fringe benefit occurs when an employer pays for, or reimburses, an expense incurred by an employee. This can include a wide range of costs which can be private or business-related. Common examples include expenditure relating to work-related travel, mobile phones, professional development courses, or amounts incurred for other personal purposes that are recoverable under employer policies.

The taxable value of an expense payment fringe benefit, which would capture most employee reimbursements (other than where an exemption applies), can be reduced to the extent the employee would have been entitled to a once-off income tax deduction for the expense if they had paid for it themselves. Section 24 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) outlines the following conditions that must be satisfied for an employer to be able to reduce the taxable value of an expense payment fringe benefit under the otherwise deductible rule:

1. Provided to employees - The recipient of the expense payment fringe benefit must be an employee.
2. Once-only income tax deduction - The employee must be entitled to a once-only income tax deduction for the expense. 
3. Substantiation - The employee must give the employer certain documentation to be able to substantiate the deduction, other than in limited circumstances (i.e. where the expense meets one of the exceptions set out in section 24(e) of the FBTAA).  

Employers should ensure the breadth of section 24 is considered, as it highlights criteria which may apply in certain circumstances. Some of the traps that we commonly see when trying to meet these criteria is outlined below. 

Provided to employees

An employer can only apply a reduction to the taxable value of an expense payment fringe benefit where the recipient of the benefit is an employee. However, no reduction is available if the benefit is provided to an associate of an employee, even if it was incurred in earning assessable income. 

An example would be an employer reimbursing an employee for home office expenses where the underlying expense had been incurred by an employee’s spouse. While the expense is related to income earning activities for both individuals, the ‘otherwise deductible’ rule only applies to expenditure incurred by the employee. 

In circumstances where the benefit is ‘joint’, a specific formula (as set out in section 24) must be followed to ensure the reduction is correct.

Once-only income tax deduction 

A reduction in taxable value only applies where the employee would have been entitled to a deduction in one year of income and not any other year of income if they had incurred the expense themselves. Therefore, expenses that give rise to depreciation deductions or prepayments and borrowing expenses that are spread over more than one year are excluded.

It is therefore necessary that employers are familiar with the general and specific deduction rules contained in the Income Tax Assessment Act 1997 (ITAA 1997) to ensure appropriate reductions are applied. Common examples of expenses that have specific deduction rules include payments for subscriptions to trade, business and professional associations (section 25-55 of the ITAA 1997), travel between workplaces (section 25-100 of the ITAA 1997) and the costs of managing tax affairs (section 25-5 of the ITAA 1997).

As a guide, if an employee incurs an expense solely in performing employment related duties, then the expense is more likely to be work related and therefore deductible. On the other hand, if an employee is reimbursed for expenses that are private and domestic in nature, then they would not be deductible (and by extension, not otherwise deductible for FBT purposes). 

Of course, care needs to be taken where employers provide a benefit for work-related reasons, but where the reason is unlikely to be deductible for a particular reason – such as where a benefit has an inherently private nature (which would not be deductible). Examples include reimbursements for childcare or pet boarding for an employee, even if it is incurred so that an employee can undertake a work-related trip.  

Substantiation

When an employer uses the otherwise deductible rule, they must have certain documentation to substantiate the extent to which the benefit would have been ‘otherwise deductible’ to the employee, prior to the date of lodgment of the FBT return. 

Employers must generally obtain either a signed employee expense payment declaration or travel diary (if applicable) to apply the ‘otherwise deductible’ rule. This is in addition to the general documentation required to be maintained to substantiate expense amounts such as receipts, tax invoices and any relevant explanations that justify the business purpose of the expense.

Adequate alternative records

From 1 April 2024, an employer may accept adequate alternative records instead of an employee declaration for an expense payment fringe benefit (Legislative instrument LI 2024/6). The records can only be accepted as an alternative to the declaration if they are obtained and held by the employer prior to the lodgment of the FBT return each year. 

LI 2024/6 provides that generally, the Australian Taxation Office (ATO) will accept any type of written record and any number of records (e.g. employer polices, written emails, or text messages, payroll records) which include the same level of detail typically included within an FBT declaration. 

If you are looking to apply the alternative record keeping measures when utilising the ‘otherwise deductible’ rule, particular care will need to be taken with expenditure where only a partial income tax deduction would have been available to the employee (for example, the reimbursement of home internet expenses that are partially attributed to private use).  

By understanding and applying the ‘otherwise deductible’ rule appropriately, employers can ensure concessions are appropriately claimed, however as may be evident, there are a series of rules that make this concession easy to get wrong. 

If you have any questions about your FBT obligations or specifically about the application of the ‘otherwise deductible’ rule for your fringe benefits, please reach out to your PwC specialist.