Novated leases and FBT explained–Sept 2014

Wrapping a car into a salary package is a very popular choice, and doing so as part of a salary sacrifice arrangement often raises the topic of novated leases.

Explained simply, a novated lease is a way for an employee to buy a new or used car and have their employer assist in the organised repayment for that car to an agreed financial supplier. (To “novate”, by the way, is defined by the dictionary as “to replace by something new”, especially an old obligation by a new one.)

The way this is done is by the employer agreeing to make the repayments out of the employee’s pre-tax salary in a salary sacrifice arrangement which, like any such arrangement, reduces the employee’s taxable income. The terms of the lease repayments are calculated according to the employee’s earnings and the amount salary sacrificed.

A novated lease is therefore a three-way deal – between an employee, a financier, and the employer. The employee owns the car, and the employer agrees to make the lease repayments to the financier for that car as a condition of employment.

One obvious such condition is to remain an employee. In the event that employment ceases, the obligations and rights under the lease revert to the (former) employee. This can suit the person involved, as they keep the car (and there are no tax consequences), but can also suit the employer as they are not saddled with an extra vehicle or a financial commitment for it.

During the period of the novated lease, the employer is entitled to a deduction for lease expenses where the car is provided as part of a salary sacrifice arrangement (up to the luxury car limit). But it does give rise to a car benefit under fringe benefits tax (FBT) rules.

Fringe benefits tax

Fringe benefits that fall under the FBT regime can be provided directly by the employer, by an “associate” of the employer, or by a third party who has an arrangement with the employer (in this case, the finance supplier). A car provided by novated lease is considered a fringe benefit to an employee, and gives rise to an FBT liability for the employer.

A basic principle of salary sacrifice arrangements is that an employer is no better or worse off from having offered an employee a form of remuneration other than straight cash salary.

However as the leased car potentially gives rise to an FBT liability, and as FBT is an employer’s obligation, it is generally the case that any FBT amount arising as a result of the novated lease is charged to the employee’s salary package post-tax (which effectively balances each other out to end up with a zero outcome).

Generally, the value of the car benefit (on which the amount of FBT is based) is taken on the actual purchase price of the car. Working out its “taxable value” for FBT can be done using two methods – the “statutory formula” method (the most commonly used), or the “operating cost” method.

The latter requires working out the total operating costs of the car (fuel, oil, servicing, etc) and reducing that total amount by the portion of private kilometres travelled (which attracts FBT) as compared to the total kilometres. It is most often used where business kilometres travelled are high, but is more complicated and requires more records (logbooks) to be kept and calculations to be made.

With the “statutory formula” method, the taxable value is based on a percentage rate of the total number of kilometres travelled during the year (both business and private), which the Tax Office used to divide into different “bands” of kilometres recorded. However, with effect from July 1, 2014, this is now calculated at a flat rate of 20% of total kilometres for all post-May 11, 2011, contracts (the date from which amendments were made to the legislated methodology for valuing such benefits  — between then and July 1, 2014, a transitional scale applied, but this has now ended).

Leases that still exist and that started before 7.30pm, May 11, 2011 and that have no material change still operate under the rates that applied before the change to the statutory percentage rules, as per the following.

Total kilometres travelled                                 Statutory
during the FBT year                                          percentage

Less than 14,999km                                                      26%

15,000 to 24,999km                                                      20%

25,000 to 39,999km                                                      11%

Over 40,000km                                                                7%

As you can see, the more kilometres travelled, the less tax applies. This produced an unfortunate incentive to clock up enough distance to move into the next band of kilometres and gain a reduced FBT liability.

For example, where an employee uses a car valued at $34,000, a taxable value of $6,800 would arise if they drove 24,000km, but that taxable value would drop to only $3,740 if they drove more than 25,000km. This anomaly in valuation methods was the reason behind the government making the change to how calculations were made.

But beware: If a change is made to the pre-existing contract or lease terms of a pre-May 2011 contract, and the change qualifies as a “material variation”, this may push the arrangement into the new rate.

Post-tax contributions to reduce FBT

The tax liability that arises from the fringe benefit of salary packaging a car through a novated lease can be reduced by the employee making contributions towards, say, the running costs of the car from after-tax dollars. It is important that these contributions come from after-tax salary, as every dollar so contributed reduces the taxable value dollar-for-dollar up to the total.

By an employee doing this, rather than the employer paying the FBT tax rate, which is 47% for the 2014-15 year, and passing it on to the employee, they will be paying their own marginal rate which for many would be much less than that. The difference between the taxable value and the total cost of the benefit will not be subject to FBT or income tax.

Novated car lease employer outcomes:

• An employer will need to agree to the salary sacrifice arrangement that allows a staff member to obtain a vehicle through a novated lease
• The employer makes lease repayments to the finance supplier on behalf of the employee from their pre-tax salary
• Being a fringe benefit, the arrangement gives rise to an FBT liability, which the employer pays
• Expenses incurred in arranging and maintaining the lease (not the lease repayments) are tax deductible for the employer for the period the lease is active
• The amount of the FBT liability should have a nil dollar consequence for the employer where post-tax contributions are made
• The end of the employment relationship also ends the repayment commitment, as lease obligations revert to the (former) employee

• When you lease the vehicle from the finance company, you can claim a GST credit for the GST included in the lease charges. However you generally can’t claim GST credits if you make input taxed supplies.

Employee outcomes:

• The vehicle is of the employee’s choice, and the employee has exclusive use and ownership
• Salary sacrificing reduces one’s taxable income, as the amount is assigned from pre-tax salary (you may even find yourself in the next lower tax bracket)
• As the car is a fringe benefit, FBT must be paid, although the employer is liable for this payment (which is however balanced-out within the arrangement)
• Generally, FBT is based on the purchase price of the vehicle, as the statutory formula is the most commonly utilised method. The operating cost method applies to running costs with a percentage usually determined by logbook
• Making post-tax contributions to the costs of owning the vehicle can reduce the FBT liability by the same amount contributed
• Usually the vehicle is obtained more cost effectively, as there is:

o    No GST on purchase (claimed by employer)

o    Leasing companies usually get fleet discounts

• The employer may also get a corporate discount.

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