Salary packaging is a popular business incentive offered to employees, particularly when it comes to motor vehicles. When done properly it can be a huge financial benefit to employees, but the tax implications can be confusing.
The typical way to salary package a car is with a novated lease, which is a way for an employee to buy a new or used car and have their employer cover the cost of lease repayments to an agreed financial supplier.
With a novated lease, the employer would pay the repayments then deducting the amount from the employee's pre-tax salary using a salary sacrifice arrangement.
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That means a novated lease is a three-way agreement: between the employee, the employer and the financier.
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.
The catch is that the agreement only sits in place while the employee works for the employer. If the employment ends, the obligations for the least revert back to the (former) employee and owner of the car.
Here's where things can get tricky.
During the period of the novated lease, the employer is entitled to a deduction for the lease expenses where the car is provided as part of a salary sacrifice arrangement.
Unfortunately, the arrangements also give rise to a car benefit under the fringe benefits tax (FBT) rules.
Here's what you need to know.
How novated car leasing works for employers
1. The employer will need to agree to the salary sacrifice arrangement that allows a staff member to obtain a vehicle through a novated lease.
2. The employer makes lease repayments to the finance supplier on behalf of the employee from their pre-tax salary.
3. Being a fringe benefit, the arrangement gives rise to an FBT liability, which the employer pays.
4. The amount of the FBT liability should have a nil dollar consequence for the employer where post-tax contributions are made.
5. 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.
6. The end of the employment relationship also ends the repayment commitment, as lease obligations 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 charges.
How novated car leasing works for employees
1. Salary sacrificing reduces the employee’s taxable income, as the amount is assigned from pre-tax salary (it can even move the employee into the next lower tax bracket).
2. The vehicle is of the employee's choice, and the employee has exclusive use and ownership.
3. 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)
4. Generally, as FBT is based on the purchase price of the vehicle, the statutory formula is the most commonly utilised method. The operating cost method applies to running costs with a percentage usually determined by logbook.
5. Making post-tax contributions to the costs of owning the vehicle can reduce the FBT liability by the same amount contributed.
6. Usually the vehicle is obtained more cost effectively, as there is:
No GST on purchase (claimed by employer)
Leasing companies usually get fleet discounts
The employer may also get a corporate discount.
Fringe benefits tax: How it applies to the novated lease and how much you need to pay
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 to be a fringe benefit to an employee, which means it gives the employer a FBT liability.
A basic principle of salary sacrifice arrangements is that an employer should be no better or worse off from having offered an employee a form of remuneration other than straight cash salary.
But, as the leased car potentially gives rise to an FBT liability (which is an employer's obligation) any FBT amount arising as a result of the novated lease is charged to the employee's salary package post-tax.
The employer then remits the FBT to the Australian Tax Office (ATO).
The value of the car benefit (on which the amount of FBT is based) is based 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 (OCM).
The OCM method: The employee needs to maintain a vehicle log book for 12 weeks to determine the car's percentage business usage. The private percentage is then applied to the operating costs for the year to determine the FBT liability.
This method can be pretty complex so it's rarely used, except in cases where business usage is very high.
The statutory formula method: 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). This is calculated at a flat rate of 20 per cent of total kilometres.
An employee can reduce the FBT liability with post-tax contributions
The FBT liability that arises from 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 contributed then 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 (47 per cent for the 2022-23 year) and passing it on to the employee, they will be paying their own marginal tax rate which for many would be lower than 47 per cent.
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 novated lease arrangement, even with an employee contribution to reduce the FBT, is a higher net salary due to the pre-tax deductions reducing overall taxable income for the financial year.
Mark Chapman is director of tax communications at H&R Block.