Should reimbursements be paid through payroll?

Let’s start with the basics. What are reimbursements? In simple terms, reimbursements are money that an employer pays to employees for any business-related expenses that they have already paid out of their own pocket.

The Australia Taxation Office (ATO) defines reimbursements as payments made to workers for actual expenses already incurred. Remember: these expenses must be directly related to the business and necessary for employees to carry out their jobs.

Common types of reimbursed expenses

Reimbursements come in all shapes and sizes but there are four main types of expenses that companies often reimburse:

• Travel expenses, e.g. flights, accommodation and transportation for business purposes.
• Work-related expenses, e.g. for equipment, uniforms and professional memberships.
• Vehicle expenses, e.g. fuel, maintenance and parking fees when using a personal vehicle for business purposes.
• Home office costs, e.g. computers, telephone and internet expenses.

Distinction between reimbursements and income

Reimbursements are generally not considered taxable income for employees. However, they have to meet three main criteria if they’re to be considered legitimate business-related reimbursements:

• They must have a direct connection to the business
• They must be properly documented (receipts, invoices, etc)
• They must be for the exact amount of the expense

Legal framework in Australia

As you might expect, reimbursements are tightly regulated in Australia. What’s more, the goalposts are always changing, which is why businesses need to be on their toes to ensure compliance. Let’s cover some of the legal basics relating to reimbursements.

Payroll and taxation laws relevant to reimbursements

Australian payroll legislation stipulates that all businesses must comply with the Fair Work Act 2009 (Fair Work Act), which states that reimbursements must not be treated as wages but as compensation for out-of-pocket expenses. This is important to keep in mind because it means reimbursements are generally not subject to the same tax as salary or wages.

The Australian Taxation Office (ATO) and reimbursements

The ATO provides specific guidelines on how to handle allowances and reimbursements. The main thing to remember is that reimbursements have to be substantiated with receipts or other forms of proof to be exempt from taxes. This simple requirement ultimately helps prevent misuse and ensures that reimbursements are made only for business-related expenses.

Fringe Benefits Tax (FBT) and reimbursements

Some reimbursements may be subject to Fringe Benefits Tax (FBT) if they provide a personal benefit to an employee beyond the business necessity. Understanding FBT not only helps you comply with Australian law but can also help you reduce your tax burden.

Overview of Fringe Benefits Tax (FBT)

As an employer, you’re required to pay FBT on certain benefits you provide your employees. FBT is separate from income tax and calculated based on the taxable value of the fringe benefits you provide.

Examples of benefits subject to FBT include:

• Using a company car for private purposes
• Private health insurance paid for by the employer
• Entertainment expenses that also provide a personal benefit

It’s important to stress that employers are responsible for paying FBT, not employees. The FBT year runs from April 1 to March 31, and it’s your responsibility to self-assess your FBT liability and submit an FBT return.

Top tip: The taxable value of a fringe benefit is usually how much it cost you to provide the benefit. However, you have to use statutory formulas for some benefits, e.g. car benefits.

Reimbursements and FBT exemptions

If an employee pays for an expense that benefits them and you reimburse them for it (or pay a third party directly), this can create an expense payment fringe benefit.

However, FBT doesn’t apply to all reimbursements. For example, you’re not required to pay FBT if the reimbursement is for an exempt benefit, such as minor benefits, portable electronic devices, protective clothing and tools.

Top tip: You can sometimes reduce the taxable value of an expense payment fringe benefit, e.g. if your employee could have claimed the expense as an income tax deduction (known as the ‘otherwise deductible rule’).

Reimbursements through payroll: pros and cons

Reimbursing your employees through payroll sounds like common sense. Of course, using the same system for both expenses and payroll has advantages — but also a few drawbacks. Let’s go over some of the main pros and cons.

Pros	Cons
Streamlined process for both employer and employee Integrating reimbursements with payroll makes it easier to track and report business expenses. All payments are handled in one system, which also makes life easier for your finance team — saving both time and money.	Possible confusion between income and non-taxable reimbursements Mixing reimbursements with payroll can complicate accounting processes. This can lead to confusion between salary and expense payments, especially if business expenses aren’t classified correctly.
Easier record-keeping and reporting for tax purposes Keeping payroll and reimbursements together makes it easier to maintain and review accurate financial records. Plus, payroll software can automatically update business expense forms.	Challenge in keeping accurate records for audit purposes Tracking and classifying business expenses takes an expert eye and mistakes can prove costly. Failing to handle reimbursements correctly or keep accurate records can cause compliance issues and result in hefty fines.
Potential for automatic processing with modern payroll systems Payroll solutions can process reimbursements automatically, which saves time and improves transparency. Reimbursements are processed on a regular payroll cycle and paid directly into employees’ accounts.	Potential for increased complexity in payroll processing Smaller businesses may find it easier to manage expenses separately in batches rather than regular payroll cycles. Employees also have to wait until the next payroll cycle to receive their reimbursements.

Alternatives to payroll reimbursements

Despite the benefits of paying reimbursements using payroll software, it may not be the best option for every company — especially small businesses. So, here are three great alternatives to payroll reimbursements.

Direct bank transfers separate from payroll

Direct bank transfers are perfect for quick payments, which can reduce the financial strain on your employees. This option also simplifies your accounting by keeping expense transactions separate from salary payments. However, your employees will have to provide receipts and reports for every reimbursement.

Corporate credit cards for business expenses

Using corporate credit cards can make it easier to manage costs by tracking and recording transactions using credit card statements. This means less manual data entry and fewer errors. Plus, employees avoid out-of-pocket costs and you can easily keep expenses in line with company policies.

Reimbursement through expense management software

Expense management software can do a lot of the heavy lifting when it comes to reimbursements thanks to powerful tracking and reporting features. Automation also helps reduce errors and simplify audits. Even better, many of these tools integrate seamlessly with other systems, including payroll software.

Best practices for managing reimbursements

Handling reimbursements well keeps your finances in check and your teams happy. After all, nobody likes paying out of pocket for business expenses. Here are some helpful tips to make managing reimbursements as simple and hassle-free as possible.

Establish clear policies and procedures

Your policies should outline the reimbursement process in detail, including what’s covered and what’s not. Clear guidelines ultimately make the process smoother for everyone involved — both employer and employees. Also, make sure that all employees can easily access any information on reimbursements.

Educate employees on the reimbursement process

Although policies and procedures are essential, communication is key. Let your employees know what types of expenses can be reimbursed, what documentation they need to provide and what steps they need to follow to submit a request. Getting this information across helps prevent misunderstandings and ensures everyone is on the same page.

Keep detailed records of all reimbursements

Keeping records of all reimbursements is not only a best practice but an ATO requirement. Your records should include evidence of expenses, e.g. receipts and invoices as well as what the expense was for, the amount and the date. What’s more, you have to keep these records for at least five years and be ready to show them if requested by the ATO.

Top tip: Tools like the ATO’s myDeductions service make record-keeping easier by storing information electronically and keeping your records both secure and backed up.

Conclusion

So, let’s bring it full circle. Should you pay reimbursements through payroll? Ultimately that depends on your company. Many larger companies can benefit from integrating these processes while smaller businesses may find it easier to handle reimbursements separately. The most important thing is to find a solution that aligns with your needs, goals and legal requirements.

ADP payroll software makes payroll a breeze. Our cloud-based payroll systems make in-house manual payroll a thing of the past — all while ensuring compliance with Australian tax laws and maintaining clear and accurate records. Find the perfect payroll solution for your business today.

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