Rethinking 'In respect of employment': SEPL shakes up FBT landscape

Subsection 137(1) of the FBTAA sets out a statutory test for determining whether an individual is an “employee” for FBT purposes. Under this provision, a person is deemed to be an employee if they receive a non-cash benefit that, if paid in cash, would have been treated as salary or wages under the PAYG withholding provisions in Schedule 1 to the Taxation Administration Act 1953 (TAA).

This statutory test operates in addition to the common law definition of ‘employee’, effectively broadening the scope of FBT to include individuals who may not fall within the traditional employer–employee relationship but would be captured under the PAYG framework if the hypothetical held true. 

Importantly, this extended definition was considered in the recent SEPL case, where the court distinguished it from the earlier Knowles case, which had focused solely on the common law meaning of ‘employee’.

In Knowles, a company acting as trustee of a unit trust advanced funds to its directors and their spouses. These advances were later recorded as loans to the directors’ family trusts. Relevantly, The trust’s units were held by four family trusts, each linked to one of the company’s directors and their respective families.

All financial activities were managed through a single company bank account. Directors and their spouses withdrew funds from this account for private use, often without formal approval. For larger amounts, they would check with the financial controller to confirm availability. These withdrawals were recorded as loans to the respective family trusts and later cleared through capital distributions from the trust.

The Commissioner assessed FBT on advances made to directors as loan fringe benefits under section 16 of the FBTAA. The company argued these were not provided “in respect of employment,” but rather reflected the directors’ beliefs that, through their family trusts, they were the ultimate beneficial owners of the business and were simply drawing capital.

At first instance, the former Administrative Appeals Tribunal (AAT) found a “discernible and rational link” between the advances and the directors’ employment, concluding they were able to make drawings due to their roles as directors. The Federal Court agreed with this proposition but opted to refine the test, holding that:

• A causal link is not enough to trigger FBT;
• There must be a “sufficient or material” connection between the benefit and the employment; and
• Authorisation by a director alone does not establish the benefit was provided “in respect of” employment.

After the matter was remitted to the AAT for its reconsideration in accordance with the law,,  the AAT found no sufficient connection existed between the loans and the directors’ employment. It instead concluded that the loans were advanced in respect of their capacity as perceived owners or beneficiaries of the trust, not as employees or directors. Therefore, the loans did not constitute loan fringe benefits for FBT purposes.

The more recent SEPL case involved three brothers (who were directors and beneficiaries of a family trust), along with numerous other family members, were also eligible beneficiaries of the family trust. The directors decided to share the trust's profits equally among themselves and also received luxury motor vehicles for private use. The Commissioner assessed FBT on these non-cash benefits.

The taxpayer in SEPL relied on Knowles, arguing the benefits were provided to them as directors, owners, or beneficiaries, not as employees. The Commissioner, however, distinguished Knowles by pointing out while the directors in Knowles were collectively the beneficial owners, in SEPL there were "many other eligible beneficiaries" apart from the three brothers.

The Federal Court found the three directors to be employees for FBTAA purposes by applying two key principles:

• The definition of ‘employee’ under the FBTAA: The AAT at first instance in SEPL had incorrectly relied on common law concepts of employment, stating there was no employment relationship. In contrast, the Court applied the hypothetical test where if a non-cash benefit, paid in cash, would be considered “salary or wages” under the TAA.
• Clarification of "in respect of employment: The Federal Court in SEPL found the personal and exclusive use of luxury vehicles by the directors was linked to their employment. Specifically, the benefits arose “by reason of, by virtue of, or in relation directly or indirectly to” their roles as employees in the trust’s business. 

A key distinction from Knowles was ownership. In Knowles, the directors were effectively the sole beneficial owners, justifying their access to trust assets. In SEPL, however, there were many other eligible beneficiaries. The brothers’ access to the vehicles was not based on ownership, but on their position as directors. Therefore, the benefits were employment-related under the FBTAA’s definition of “employee”.  The brothers were also significantly entwined in the business’ operations.  In other words, holding an office and exercising control over the company’s affairs was treated as “employment” in the relevant sense. The court noted that FBT law looks to the substance of the relationship – a person who effectively runs the business and enjoys its perks can be an “employee” even if not on an official payroll.  The absence of cash wages was not exculpatory, in fact, it suggested the cars were part of how the individuals derived economic benefit from the trust (substituting for salary).

The interpretation of “in respect of employment” continues to evolve, with SEPL reinforcing the importance of understanding the nature and purpose of benefits provided. Employers must now take a more nuanced approach when assessing FBT obligations, especially in complex structures involving closely held trusts, directors, and discretionary beneficiaries.  The following matters should be considered:

• Directors and Proprietors as Employees: Company directors and active trust controllers may well be treated as employees for FBT purposes when they receive benefits. Even if an owner-manager doesn’t draw a wage, any personal benefits taken from the business – use of cars, payment of personal expenses, etc. – may be fringe benefits.  The common misconception that no salary means no FBT applies was definitively rejected.
• Broad reach of “in respect of employment: The case highlights how broadly the employment connection can be interpreted. Benefits provided “by virtue of” one’s position will attract FBT even if they are not labelled as compensation. For example, if a family trust allows a director’s spouse to use a holiday home or pays school fees for a child, those too could be fringe benefits if the privilege is extended because of the individual’s role or services. Businesses must therefore be vigilant in identifying any informal or non-cash perks flowing to those who work in or manage the business.
• Need for Proper Documentation and Treatment: To avoid hefty FBT assessments (and penalties), private businesses should document the capacity in which benefits are provided. If a genuine distribution of trust income is made, record it as such in minutes and consider its tax treatment carefully (noting a distribution in kind could still trigger other tax issues). Conversely, if an individual enjoys a business asset (car, property, etc.), it is safest to treat the use as an employer-provided benefit, calculate the taxable value, and include it in an FBT return or have the individual compensate the business accordingly.
• Overlap with Division 7A (Shareholder/Director Loans): It is worth noting arrangements like this might also attract scrutiny under Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) (which deals with loans or payments to shareholders of private companies). In this case, had FBT not applied, the interest-free use of a company/trust asset by an associate could have been treated as a deemed dividend to the individual. The Federal Court’s ruling effectively funnels such scenarios into FBT (since the individuals were employees in addition to being beneficiaries). Practically, companies should be aware that either FBT or Division 7A (or both) will apply when owners extract value informally – one cannot simply leave such benefits untaxed. Additionally, depending on the nature of the benefit provided, other sections of the ITAA 1936 may need to be considered.

In summary, this decision puts directors on notice that they must either pay themselves via salaries/dividends or properly account for benefits – “sweeping it under the rug” will lead to tax liabilities and considerable penalties, particularly if reasonable care is not taken.

We recommend engaging tax advisors early when designing or reviewing benefit arrangements involving directors, trust beneficiaries, or hybrid roles. Moreover, we recommend implementing a position paper to consider whether any updates to positions are warranted considering the SEPL decision. This can help strengthen compliance and ensure that benefit arrangements are aligned with both legislative requirements and ATO expectations.