David Lilja - Principal, Tax
As anticipated, as part of the last Budget announcement the Treasurer, Mr Wayne Swan, announced changes to the Fringe Benefits Tax (FBT) rules governing the taxing of company provided cars.
This change has followed on from debate, lead by the Greens who believe the historical four-tiered approach encourages employees to drive more in order to reduce FBT, conflicting with the promotion of a more environmentally conscious society. As such, a phasing in approach to a flat 20% statutory rate, as recommended by the Henry Review, will be adopted.
As a consequence, many will be asking the question - is salary packaging a car still worth it?
What are the proposed new rules?
It is important to note that the new rates only apply to "new commitments" entered into after 7.30pm (AEST) on 10 May 2011 phased in over four years based on the table below. As such, any arrangement considered to be an existing commitment will continue to be taxed under the old rules.
When do the new rules apply?
The draft legislation and the corresponding Explanatory Memorandum (EM) provide some guidance as to when the new rules apply. In the EM, it provides that the new rules will cover all cars unless an agreement was in place prior to budget night committing to the transaction, being one that is financially binding on one or more of the parties.
History certainly supports this. Following changes made a few years ago in relation to laptop computers, the former blanket exemption continued to apply to those contracts which were entered into to buy a laptop, notwithstanding if it may not have been delivered, being reimbursed by the employer or even salary packaged before the relevant cut off date.
The EM goes on to say that re-financing a car, altering the duration of an existing contract or changing employers will trigger a new commitment for which the new rules apply.
There is therefore some ambiguity in determining which rules to apply. As such, both employers and employees need to take care in all issues pertaining to cars that on face value are existing commitments prior to the cut off date (i.e. 10 May 2011) to avoid unknowingly triggering a change in the FBT treatment (which may be adverse to both). More importantly both parties should consider whether a particular action will change the arrangement from an existing commitment to a new commitment before committing to that action.
The future of salary packaging cars
In considering the impact of the changes, using an example of a car with an FBT base value of $40,000, the impact of the new rates from one extreme to the other is that:
1. a shift from the 26% band to the 20% band (the car travels less than 15,000km p.a.) will reduce FBT by approximately $2,304 compared to;
2. a shift from the 7% band to the 20% band (the car travels more than 40,000km p.a.) will increase FBT by approximately $4,992.
When looking at the above example and looking at the two extremes, the question arises as to how much this will impact the proposed clawback on FBT by the government? There is likely to be an increase in people who were traditionally deterred from salary packaging due to not driving sufficient kilometres, who are now considering its viability going forward.
Those that are higher kilometre drivers, who under the old regime would have fallen into the 11% or 7% statutory fraction, will need to reassess the economic benefits of salary packaging a car a little more closely.
For these drivers an opportunity may present itself to consider an alternate method to determine FBT liability- the operating cost method. Most employers prefer to use the statutory formula method rather than the operating cost method because the latter method requires employees to maintain log books, a compliance nightmare. However, the winding back of the benefit of salary packaging cars for those travelling more than 25,000 per annum, employers may allow employees to use the operating cost method in an attempt to equalise their position to the old rates. However, employers will need to ensure employees understand the difference between ‘business' and ‘private' travel, and the onerous requirements of maintaining a logbook, as this is a potential FBT risk.
Old statutory rates vs the flat 20%
To demonstrate the affect of the changes more specifically, below are two salary packaging examples based on an employee on the 38.5% tax rate and an employee on the top marginal tax rate.
Assumptions: The example demonstrates the impact of the rates pre budget night to the flat 20% rate scheduled to be effective from 1 April 2014 (assuming status quo in relation to marginal tax rates) where the employee travels between 25,000-40,000 km a year; and over 40,000 km a year. The examples are based on a $35,000 car with lease and running costs of $12,500 including GST using the tax rates for the current financial year (i.e. year ending 30 June 2012). The examples also disregard the flood levy and assume FBT is payable (i.e. no after tax employee contributions are made).
Conclusion
As evidenced by the examples, there will certainly be an increase in the FBT levied on cars under the new rates for those that historically travel more than 25,000km per year. Having said that, for those that would not exceed 15,000km per year, a tremendous opportunity is opened up to consider salary packaging a car where previously this was a no go zone. In summary, it shouldn't be lost that there will still be benefits for all to consider due to the concessional valuation rules relating to determining the FBT liability of cars, notwithstanding the flat rate.
Care needs to be taken in relation to existing cars by both employees and employers, as certain actions may unknowingly change the arrangement to a "new commitment" which may inadvertently trigger a higher FBT charge. As such a review of existing car arrangement is recommended to ensure the correct FBT rules are applied. Also, consideration of a proposed action in relation to an existing commitment should be taken to ensure no adverse impact on the intended outcome.