Let's talk about fringe benefits tax

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08 Sep 2016 by smartleasing

It's safe to say that no one is ever particularly excited about the prospect of paying taxes. This is one of the most significant reasons that fringe benefits tax (FBT) continues to be such a point of contention for anyone considering a salary packaged car in Australia. This is certainly the case at Smartleasing, where many customers have echoed these concerns.

Your FBT liability under a novated lease is actually far less scary than you'd think. At Smartleasing, we use the Employee Contribution Method (ECM) for FBT – payments are taken from both pre- and post-tax income, and the post-tax part is specifically calculated to offset your FBT liability.

The bottom line is that you're not likely to ever receive an FBT bill with Smartleasing. If you want to learn more about the ins and outs of this system, keep on reading!

Understanding fringe benefits tax

One of the most attractive features of a car under a novated lease is that you get one of the newest cars on offer while reducing your income tax burden. In order to make up for the lost revenue, the Australian Taxation Office (ATO) levies a smaller tax on this and other employment-related fringe benefits.

As of May 10, 2011, the taxable value of a car fringe benefit using the statutory formula method is 20%. For a $25,000 vehicle, that would be a payment of $5,000 on March 31 – the end of the FBT year – repeating annually during the period of the novated lease.

In the past, quite a bit of calculating was necessary to determine if a novated lease was the better financial option – especially as FBT liability was determined based on the amount of kilometres you drove each year. Now, however, your FBT liability is unaffected by how much or how little you drive in any given amount of time.

What is the employee contribution method?

Naturally, motorists want to lower their FBT liability. At Smartleasing, we manage that through the employee contribution method (ECM). Don't be fooled by the name – this is not a real out-of-pocket expense under a novated lease.

Whenever employees make contributions towards the running costs of a car, the ATO reduces their FBT liability by a matching amount. So, if the taxable value of a vehicle is $5,000, and an employee contributes $2,000 for included running costs – such as tyres, fuel and maintenance – his or her FBT liability is calculated on $3,000 instead.

It's thanks to the ECM that Smartleasing is able to work FBT into an easily managed expense, rather than the yearly lump payment it normally would be.

The pretax salary myth

To understand how Smartleasing handles the ECM, we must first look at one of the biggest misconceptions about novated leasing – pretax salary deductions.

Most people assume that all payments related to a salary packaged car come from an employee's salary before income tax is applied, thus reducing their tax burden for the year. While it's true that most payments are taken out of pretax salary, there are some that come out after tax salary.

According to the ATO, any employee contributions that are meant to lower your FBT liability must be taken from post-tax salary and reported as part of an employer's assessable income. As such, you must pay part of your running costs out of your salary after taxes are deducted – otherwise it would not reduce your FBT liability.

Knocking down the FBT liability

Now we know why some novated lease payments come from post-tax salary, so let's look at how the numbers actually add up.

Say that the vehicle and lease terms you want come down to $15,000 over the course of the year, and that car carries an FBT value of $5,000. Instead of taking $15,000  and a further $5,000 out of your pretax salary, we take $10,000 before taxes and $5,000 after. The post-tax payment forms your employee contribution.

Both of these payments, pre- and post-tax, are spread out evenly over your pay periods in the FBT year; you make them in smaller increments rather than all at once. This offsets the need to pay a lump FBT sum while still providing the benefits of lowering your income tax burden with pretax payments.

How do marginal tax rates come into play?

Of course, this method doesn't apply for all lessees. If you're in the higher income brackets, there's only a minimal difference between paying everything from your pretax salary or splitting the costs up.

This is because of how marginal tax affects your payments. Currently, at the highest marginal rate, FBT is assessed at 49 cents to the dollar. If you earn less than $180,000 for the year – which is true for most of our clients at Smartleasing – your marginal tax rate will likely be 34.5 or 39 cents on the dollar instead. As a result, below the $180,000 threshold, it makes more financial sense to handle employee contributions from your post-tax salary.

Over $180,000, it really doesn't make much of a difference whether these payments are taken out before or after taxes. These earners can chose either method.

We hope that's helped demystify FBT. But if you have questions about how FBT affects you and your lease, get in touch with us... we're here to help.