Non-Taxable Allowances: How Employers Can Increase Employee Earnings Without Raises

Per diems, bonuses, transportation costs, meal allowances, Christmas bonuses, Easter bonuses, severance pay… All of these are non-taxable allowances that employers pay alongside net salaries to increase employees’ total earnings while avoiding large contributions. This practice is becoming increasingly common in Croatia. In addition to the pressure for wage growth in the private sector, partially driven by the government’s salary increases in the public sector and inflation, employers resort to such solutions to attract, retain, and motivate the best talents in a scarce labor market.

But how much do employers actually save on expenses with non-taxable income, and what does this ultimately mean for employees, aside from lower contributions for health and pension insurance? Marija Zuber, a tax advisor and a regular contributor to Lider, explains that the savings come from the amount of income tax and mandatory contributions.

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Marija Zuber

—– For example, if 100 euros is paid to an employee non-taxably, the employer’s cost is 100 euros. However, if that 100 euros is paid as a net salary in a city where the lower income tax rate is 20 percent, it must be converted to a gross amount of 156.25 euros, pay 31.25 euros in pension insurance contributions, 25 euros in income tax, and 25.57 euros in health insurance contributions, making the total cost 182.03 euros. The calculation is simple and clearly shows the motives. Employers behave rationally, and regulations allow them to do so – explains Zuber.

There are more than 40 different non-taxable allowances, and Zuber cites cases where some employees receive higher amounts of non-taxable income monthly than their net salary. For instance, field workers in construction often receive a higher field allowance than their net salary, or employees in public services who receive a higher transportation allowance than their net salary. Non-taxable allowances can also be received by individuals outside of employment. These are most often non-taxable and sports scholarships and allowances for amateur athletes.

Employee and State Problem

Given that no contributions or taxes are paid to the state for non-taxable income, employees consequently have lower pensions and lower social rights, e.g., maternity benefits, sick leave benefits, or unemployment benefits. Additionally, banks consider the taxable part of income when approving loans, notes Josipa Englman, head of the finance department at Selectio.

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Josipa Englman

photo Humski Jan

—– If an employee receives part of their income through non-taxable allowances, their creditworthiness may be reduced, making it more difficult to obtain housing and other loans. If employees become accustomed to non-taxable allowances as part of their regular income, but the long-term implications are not clearly communicated to them, dissatisfaction may arise when they realize that this income does not count towards the calculation of rights such as severance pay or bonuses related to gross salary – explains Englman.

The problem arises precisely in those situations when employees need to take out a loan or go on maternity leave.

– At those moments, there is a sudden increase in awareness that non-taxable allowances do not count towards the calculation for those rights, which can cause dissatisfaction and frustration – says Englman.

However, this is only a problem for the individual worker at first glance. Zuber believes that in the long term, it is ‘primarily a problem for the state’.

– Many Croatian workers aim to work for at least a few years in Germany, Austria, or Sweden, not only for the earnings but also because they will receive their pension from that country for the years worked, often for a few years of work in those countries more than for the rest of their working life in Croatia – adds Zuber.

Younger More Aware Than Older

Many employees are still not sufficiently familiar with the differences between taxable income and non-taxable allowances that employers can pay as additional benefits, but Englman says that younger generations are ‘more inclined to explore their rights and thoroughly examine the financial aspects of their earnings’.

– On the other hand, older generations often stick to a traditional understanding of salary, where the key focus is on gross and net amounts, without a deeper understanding of additional benefits – testifies Englman, noting that recently more and more candidates expect potential employers to offer non-taxable allowances, especially if they had them with their previous employer.

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Aleksandar Zemunić

—Thus, companies that do not pay non-taxable income lose an advantage over potential candidates who are already difficult to find in Croatia lately. As for managerial positions, Selectio director Aleksandar Zemunić adds that ‘candidates primarily negotiate their fixed salary along with performance-related bonuses and a company car’.

– In such packages, non-taxable payments do not constitute a significant part and are not a subject of discussion – says Zemunić.

Managers, therefore, prefer performance-related bonuses, while employers provide other employees with non-taxable allowances as a way to increase earnings without additional tax burdens.

Regulatory Changes

There are many good and bad social and economic characteristics of paying non-taxable income, but Zuber notes that there is always the possibility that the state will change the regulations governing mandatory public contributions based on employment.

– How this will affect workers and employers depends on the direction of the changes. If some non-taxable allowances were to be abolished or reduced, there is no guarantee that employers would immediately continue to pay them in the same amount as salaries – believes Zuber.

This could, therefore, mean lower earnings for workers or additional costs for employers, raising the question of how sustainable this model is in the long term.

– In any case, employers who clearly communicate their benefits system and continuously adjust packages in accordance with legislative changes have an advantage in the labor market – believes Zemunić.

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