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Brett Chulu: Clean pay and total cost to company

MANY organisations in Zimbabwe do not have formal human resources (HR) departments.

However, some of the strategic functions of HR are driven by the CEOs in such organisations. One of the aims of this column is to improve the quality of those strategic HR decisions by helping organisations move from the fatal “commonsense” HR approach to decisions based on solid HR theory, practice and research.

Last week we introduced the Total Cost To Company (TCTC) approach to remunerating employees in response to a reader’s request. TCTC means that a company tracks every cost associated with remunerating each employee and pool these into one figure. This instalment seeks to explain the concept of “clean pay” which one of the variations of the TCTC approach.

When an organisation provides a cash salary only and no benefits, it is said to be providing clean pay. Under clean pay, all benefits are converted to cash.

Under clean pay the employer does not provide any benefits and leaves it to the employee to purchase their own benefits, if they so desire.

By eliminating the administrative costs associated with employee-benefits, clean pay can boost company cash flows. The employee might still want to enjoy “benefits” such as medical aid and pension. Under clean pay, it is left to the employee to use their cash salary to purchase these. The burden and cost of administering benefits simply defaults to the employee.

Against the backdrop of the current depressed economic environment and its negative effect on company performance, Zimbabwean firms are beginning to move towards the TCTC model, ditching the traditional “salary plus benefits” approach. For organisations without formal strategic HR expertise clean pay may, at face value, appear very attractive.

Six points need to be considered before deciding to adopt the “clean pay” model as a form of TCTC.

First, like employment taxation systems in many countries Zimbabwe’s system is based on a “salary plus benefits” approach. Some benefits are either fully exempt from tax or part exempt. Medical aid contributions by the employer are exempt from tax, so are medical costs borne by the employer. For instance, the Finance Act of 2010 made provisions for pension contributions up to a maximum of US$450   per month exempt from tax.

A clean pay approach can “clean out” the employee as it can raise their taxable income. A clean pay package effectively forces them to surrender tax exemptions. Worse still, it might push them to a higher tax bracket. Clean pay, if not carefully considered, can leave the employee poorer.

Second, one of the most effective employee tax strategies used internationally is a salary sacrifice arrangement. This is when an employee voluntarily takes a lower pre-tax salary in exchange for a benefit that the employer provides. The advantage is that an employee’s taxable income is reduced while at the same time enjoying a benefit of their choice. Under clean pay this is not desirable as the prime reason for adopting clean pay is getting rid of the administrative costs of managing employee-benefit programs.

Third, converting some non-cash benefits brings serious administrative and policy challenges. The use of a company-provided car is associated with a non-cash benefit. An employee is deemed to use a company vehicle for non-business purposes thus extracting a private benefit. Likewise, free accommodation or cheap accommodation is a non-cash benefit. This is so as the employee is not paying the rentals at the open market rates. Clean pay is built on the premise that all benefits can be converted to cash.

Advocates of clean pay advise companies to get rid of the company car benefit and instead provide loans (cash).

 

What about housing? Clean pay would mean that the employees on free accommodation are asked to pay a cash rental contribution from their cash salary. This does not make sense if the company owns the house as the purpose for such houses is normally not to raise revenue from employees.

Should the company give the employee the cash equivalent of the non-cash benefit only to pay it back to the company? Non-cash benefits are a poser to clean pay strategists.  Clean pay brings problems where companies have already invested in immoveable assets originally designed for the benefit of employees. Under clean pay the organisation should be prepared to sell the houses to the current employees on favourable loan terms and set up housing purchase guarantee schemes for new employees. What happens when the employee leaves before the house is fully purchased?

 

  • Fourth, clean pay can seriously damage the company brand. In the global village human capital markets for critical skills are joined. Offering just a salary without company-provided benefits might cause the brand value of a company to depreciate in the minds and hearts of current and prospective employees. Clean pay risks the firm being labelled a “non-brand” and financially challenged company.

It is now recognised that the first 100 days or “honeymoon” period of a new employee are critical in retaining new hires. During this honeymoon phase they put to test the employer brand promise. The first 100 days determine whether an employee will decide to stay or leave. It has been estimated that the break-even point of a new hire, that is, the time a new hire stops costing the employer and begins contributing to the profit, is three to four months. The chances of a new hire with critical skills staying after the “honeymoon” period in a company with a salary-only approach are very low. A good employee brand lowers employment costs.

  • Fifth, for those organisations in Zimbabwe negotiating the terms and conditions of service through collective bargaining clean pay may be fiercely resisted. Collective bargaining agreements may specify that the organisation should assist the employee to purchase medical aid and pension benefits. With the current low salaries employees are likely to divert the cash meant to purchase medical and pension benefits to stretch their budgets. Employee negotiators are likely to advance this argument against clean pay.
  • Last, research on clean pay warns firms not to take an impulsive plunge. Clean pay was found to be appropriate for small organisations without the financial wherewithal and administrative capacity to offer an array of add-on benefits. It was contended that where the scope for enjoying tax exemptions was limited clean pay would work well. It was further contended that employees would waste a lot of time and effort hunting for bargains in terms of benefits. By negotiating as individuals employees lose out on the collective bargaining power when dealing with say pension and medical insurance benefit providers. Strangely enough research on clean pay points that employees may still expect the company to provide some form of benefit.

Firms considering migrating to a TCTC model (including clean pay) need to do an in-depth analysis of taxation implications, employee brand value depreciation risk and competitor analysis. Realistically, HR should work with finance and tax experts when migrating to a TCTC model. Firms also need to be clear which TCTC variant they want to adopt. TCTC variants such as the Total Package, Hybrid Package can be adopted.

  • Let’s discuss at brettchulu@consultant.com.

 

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