What this means for your taxes
Salary packaging is a popular business incentive offered to employees, especially when it comes to motor vehicles. When done correctly, it can be a huge financial benefit for employees, but the tax implications can be confusing.
The typical way to package a car’s salary is with a renewed lease, which is a way for an employee to buy a new or used car and arrange for their employer to cover the cost of rental reimbursements to an agreed financial provider.
With a novated lease, the employer would pay the reimbursements and then deduct the amount from the employee’s pre-tax salary using a salary sacrifice arrangement.
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This means that a novation lease is a three-party agreement: between the employee, the employer and the financier.
The employee owns the car, and the employer agrees to make rental reimbursements to the financier for this car as a condition of employment.
The catch is that the agreement only stays in place while the employee is working for the employer. If the employment ends, the obligations go at least to the (former) employee and owner of the car.
Here’s where things can get tricky.
During the term of the novated lease, the employer is entitled to a deduction for rental costs when the car is provided under a wage sacrifice agreement.
Unfortunately, the arrangements also give rise to a car benefit under the Employee Benefits Tax (FBT) rules.
Here’s what you need to know.
How Nové Auto Leasing Works for Employers
1. The employer will be required to agree to the wage sacrifice arrangement that allows a member of staff to obtain a vehicle through a novation lease.
2. The employer makes lease repayments to the finance provider on behalf of the employee from their pre-tax salary.
3. Being a social benefit, the arrangement gives rise to an FBT liability, which the employer pays.
4. The amount of FBT obligation should be of zero dollar consequence to the employer when after-tax contributions are made.
5. Expenses incurred to arrange and maintain the lease (not lease reimbursements) are tax deductible to the employer for the period the lease is active.
6. Termination of the employment relationship also terminates the repayment commitment, as the obligations of the lease revert to the (former) employee.
7. When the vehicle is leased from the finance company, the employer can often claim a GST credit for the GST included in the lease charge.
How nové employee car leasing works
1. Salary sacrifice reduces the employee’s taxable income, as the amount is allocated from the pre-tax salary (it may even move the employee to the next lower tax bracket).
2. The vehicle is the employee’s choice and the employee has exclusive use and ownership.
3. Since the car is a social benefit, the FBT must be paid, although the employer is liable for this payment (which is however balanced under the arrangement)
4. Generally, as FBT is based on the purchase price of the vehicle, the legal formula is the most commonly used method. The operating cost method applies to operating costs with a percentage generally determined by logbook.
5. Making after-tax contributions to vehicle ownership costs may reduce FBT liability by the same amount contributed.
6. Usually the vehicle is obtained more profitably, because there is:
No GST on purchase (claimed by the employer)
Leasing companies usually get discounts on their fleet
The employer can also obtain a company discount.
Employee benefits tax: how it applies to the novated lease and how much you have to pay
Benefits that fall under the FBT scheme may be provided directly by the employer, by an “associate” of the employer, or by a third party who has entered into an agreement with the employer (in this case, the finance provider).
A car provided by lease novation is considered a social benefit for an employee, which means that it gives the employer an FBT responsibility.
A basic principle of wage sacrifice agreements is that an employer should not be better off or worse off for having offered an employee some form of compensation other than cash wages.
But, because the leased car potentially gives rise to FBT liability (which is an obligation of the employer), any FBT amount resulting from the novation of the lease is charged to the employee’s after-tax salary.
The employer then pays the FBT to the Australian Tax Office (ATO).
The car benefit value (on which the FBT amount is based) is based on the actual purchase price of the car. Calculating its “taxable value” for FBT can be done using two methods – the “legal formula” method (the most commonly used) or the “operating cost” method (OCM).
The CMO method: The employee must keep a logbook of the vehicle for 12 weeks to determine the percentage of professional use of the car. The private percentage is then applied to the operating costs for the year to determine the FBT liability.
This method can be quite complex, so it is rarely used except in cases where commercial use is very high.
The legal formula method: With the “legal formula” method, the taxable value is based on a percentage of the total number of kilometers traveled during the year (both professionally and privately). This is calculated at a flat rate of 20% of the total mileage.
An employee can reduce the FBT liability with post-tax contributions
The FBT liability that arises from wage conditioning a car through a novated lease can be reduced by the employee contributing, for example, to the running costs of the car from after-tax dollars.
It is important that these contributions come from the after-tax salary, because each dollar contributed then reduces the taxable value dollar for dollar to the total.
If an employee does this, rather than the employer paying the FBT tax rate (47% for the year 2022-23) and passing it on to the employee, they will be paying their own marginal tax rate which for many , would be less than 47 percent.
The difference between the taxable value and the total cost of the benefit will not be subject to FBT or income tax.
Very often the result of a novation lease, even with a salary contribution to reduce the FBT, is a higher net salary due to pre-tax deductions reducing the overall taxable income for the year.
Mark Chapman is Director of Tax Communications at H&R block.