Sections

Services

Information

UK United Kingdom

The truth about FBT on cars: meaningful tax reform is hard

If we needed another example of just how difficult meaningful and principled tax reform is in Australia, we got it recently in the reaction to the Government’s announcement that it would abolish the “statutory…

The fringe benefits tax (FBT) statutory formula method was a tax concession. AAP

If we needed another example of just how difficult meaningful and principled tax reform is in Australia, we got it recently in the reaction to the Government’s announcement that it would abolish the “statutory formula” method for valuing fringe benefits representing employer-provided cars. The reaction at times was hysterical.

Some of the claims were extreme and they are obviously calculated to put as much pressure on the Government to back down fully, or at least in part. These are the facts in regard to the relevant tax law.

Cost method versus statutory formula method

Where an employer provides a car for the use of an employee, a fringe benefits tax liability might arise. There are two methods of valuing this type of car usage benefit. One is the “cost method” and the other is the“statutory formula” method.

The cost method works out the cost of operating the car for the year (for example, petrol, servicing, insurance). From there, the employer (with the employees help) establishes the percentage of private use (such as a weekend drive to country) and percentage of income producing use (travelling from work premises to clients) of the car by the employee.

This is done on the basis of kilometres travelled on each activity by the employee. This is ascertained by the employee, for the employer, by keeping a log book of income producing trips for 12 weeks in the first year in which the employee had use of the car.

Once the percentage of private use is established, it is applied to the cost of the car to establish the taxable value of the benefit (for instance, the operating cost of $8,000 with 40% private use would mean a taxable value of $3,200).

Putting aside some transitional rules, the statutory formula method applies a flat 20% to the cost of purchase of the car. (If the car is more than four years old, the cost of the car is reduced to 66.6% of the cost of purchase). Under the statutory formula method, there is no requirement on the employer to establish the percentage of private use of the car by the employee.

That is, the statutory formula is not valuing the car fringe benefit by reference to the employee’s private use of the car. For example, if the car has a purchase cost of $32,000, the taxable value of the car benefit is $6,400 under the statutory formula method (that is, $32,000 x 20%).

The employer can choose whichever method suits them, including the one that gives the lowest taxable value. It is clear that the statutory formula method, like other presumptive tax mechanisms, is a simplification measure; it means an employer (or employee) can avoid the tax compliance obligations associated with keeping a log book under the cost method.

Generally, the statutory formula method will give a lower taxable value than the cost method when the car has a high percentage of private use, and the cost method will give a lower taxable value when there is a low percentage of private use. One could question the costs that are included in calculating costs(and therefore, taxable value) under the cost method (e.g. deemed interest, deemed depreciation). However, it is only the cost method that accurately ascertains the private use element of the car benefit.

This is what a principled, equitable and efficient income tax system should be taxing. Fringe benefits tax (FBT) is a surrogate income tax on employees who receive benefits for private consumption, but one unfair aspect of the FBT regime is that it taxes all benefits at the top marginal rate of tax applicable to natural persons (currently 46.5%) even though the recipient of the benefit may be on a lower tax rate than 46.5%).

Removing a tax concession

This means that where the statutory formula method gives a lower taxable value than the cost method, the taxpayer is getting a tax concession.

This is recognised in the annual Tax Expenditure Statements issued by Treasury. The Tax Expenditure Statements contain a list of items where taxpayers are getting a tax concession, along with an estimate of the aggregate of the tax concession.

The statutory formula method is listed as a significant tax expenditure. On the other hand, where the statutory formula method gives a higher taxable value than the cost method and the employer fails to elect into the lower cost method (this will rarely happen), the employer is being (unfairly) overtaxed. This would be a negative tax expenditure.

The removal of the statutory formula method simply moves this part of the tax system back to a principled position by removing a tax concession. These facts have been completely lost in the “debate”.

Start date could have been more prospective

In spite of the above, there is a legitimate issue about the start date of the new rules. The removal of the statutory formula method only applies to all new contracts entered into after 16 July 2013, but even then, the statutory formula can be used for the rest of the current FBT year (that is, until 31 March, 2014). After that year, only the cost method will be available.

All existing employee car usage arrangements can continue to use the statutory formula until the car is changed over. In this sense, these new rules are not retrospective. But, many employers and employees would have been in the process of arranging a new car on the announcement date but that arrangement may fall short of having a concluded contract.

In this sense, it is arguable that the Government measure does operate retrospectively for these employers and employees. To deal with the “immediate start date” issue and “retrospective” issue, the Government could have provided for a more generous deferred phase out of the statutory formula method (for instance, until March 2015).

In 2011, when the Government amended the multiple rates under the statutory formula method to move towards one rate (i.e. 20%), which increased the taxable value on most cars, the Government provided a transitional period whereby tax increases were progressively introduced over three years.

Difficulties of bringing about meaningful tax reform

More important to the national interest, does this episode (which may not be over yet) say anything about the prospects for meaningful and principled tax reform? It is certainly not encouraging. It does send the message that those with tax concessions, and the industry serving those tax concession recipients, will not give up their concessions without a fight. It probably does not help where there is a lack of bipartisanship, which is the case with the removal of the statutory formula as the Coalition have indicated they will oppose this measure.

Similar to many areas of human conduct, the longer tax concessions remain in place aspart of the tax system, the higher the level of normality that isachieved. Normality and entrenchment can reach the point where usersof the tax concession start believing that the concession is a normalpart of a benchmark tax system.

Some of those complaining about the removal of the statutory formula method may genuinely believe that the government is imposing a tax increase on them over and above what a benchmark income tax would impose, rather than seeing the government’s announcement as the removal of a tax concession.

Many complainants though will be moved by pure self-interest and these people know full well they have been accessing a tax concession. Sadly, our tax system is riddled with many significant tax concessions that depart from a benchmark tax system - such as the 50% tax concession on capital gains of natural persons, 100% exemption on all the gain made on the family home, generous tax concessions on superannuation, failure to tax all land under state land tax regimes.

Some not-so-apparent concessions involve negative gearing, or the current generous treatment of discretionary trusts and the lack of death duties. The longer tax concessions remain in our tax system, the more normality they will achieve. In turn, the harder it will be for future politicians to remove or scale back the concessions.

In a future where Australians demand more services from Government and at the same time resist higher taxes, scaling back tax concessions may be the least displeasing option to meet desired revenue needs. One heartening thing for future governments is that there are still many tax concessions worth a lot of lost revenue that could be wound back.

Join the conversation

23 Comments sorted by

  1. David Coles

    logged in via Facebook

    The capacity to whinge that we have probably always have had has been assisted dramatically by both social media and an increasingly uncritical mainstream media.

    I received the benefit of this scheme for many years and enjoyed it but it was always going to end and so it should.

    report
    1. Fred Payne

      retired

      In reply to David Coles

      Hear, hear
      And while we are at it we probably should consider the future of negative gearing, which in turn is really another huge tax rort

      report
    2. William Raper

      Retired

      In reply to Fred Payne

      These comments are amazing - I have yet to see no comments disagreeing with a government proposal that I agree with!

      Where are the usual nay sayers?

      report
    3. Gerard Dean

      Managing Director

      In reply to William Raper

      Changing the FBT law in this way should have been publicly debated before a final decision was made. I am confident that if Rudd knew that a large percentage of those affected were not rich BMW drivers, rather middle income earners working for charity and public health systems, he may have toned down the change. He possibly may have left the public sector and charity workers allowance in place whilst tightening the luxury end of the market.

      The object of the original system was to provide an…

      Read more
  2. Elisabeth Marchant

    Retired school teacher

    The concept that 'tax rorts' ought to be eliminated is quite simple and easily understood. Just how much money was denied the public purse by this rort is astounding.

    Obviously its removal will require some other adjustments, and no doubt we will hear about those soon.

    report
  3. Greg Young

    Program Director

    "In a future where Australians demand more services from Government and at the same time resist higher taxes, scaling back tax concessions may be the least displeasing option to meet desired revenue needs."

    This is the heart of the problem with government in Australia. Australians expect perennial rolled-gold government services without increasing their contribution to the funding. At the same time they vote out any government that dares to go into deficit to fund our future, in the foolish delusion…

    Read more
  4. Henry Verberne

    Once in the fossil fuel industry but now free to speak up

    There were some whingers on this subject in a previous article, including a so-called chartered accountant. It is unfortunate that, once again, the Opposition has shamelessly and hysterically, sought to capitalise on the furore from the vehicle industry to decry a genuine attempt to wind back some unsubstantiated tax reduction claims. Particularly nauseating was Joe Hockey's aggressive championing of the rorting as shows the hypocrisy at heart of his previous pronouncements that the "age of entitlement" is over.
    Abbott and Hockey bang on about a "budget emergency" but refuse to support virtually all specific measures to assist the return of the budget to surplus-except maybe savage spending cuts which hurt the less well off disproportionately.

    report
    1. Peter Evans

      Retired

      In reply to Henry Verberne

      And of course we hear nothing of what they might change to achieve the savings they see as required in this "budget emergency'. Of course will be easy to pick and choose those announced by the Government but tweaked so they can be packaged as fairer. I benefit from the tax concessions on super and would be sad to see them go but realise they are in large part unsustainable. Most concessions have gone well past any justification such as to assist start up of an industry such as superannuation. Perhaps a future government could make it a policy to set firm time limits on any concessions with public reviews required before continuation.

      report
  5. Robin Bell

    Research Academic Public Health, at University of Newcastle

    The problem with novated leases on vehicles is just that too many of the middle lower class started using this tax haven. If we had saved it for the wealth then it would still be going on as usual, like family trusts etc.......
    Can't have everyone evading tax.

    report
  6. Ken Blackman

    activist

    "In a future where Australians demand more services from Government and at the same time resist higher taxes" Hang on, isn't that what's brought much of southern Europe low in recent times?

    Dale doesn't mention a couple of major examples of rights, or permits, which, being of long standing have morphed into entrenched, assumed-permanent business-plan fundamentals: taxi licenses (in Victoria) and water rights (e.g. in the MD Basin). In NEITHER case did the recipients have any justification for assuming they OWNED the 'concession'. In both cases they have profited mightily at public expense - and in the water case, it's the environment that has borne the damage on the public's behalf.

    But tell that to a bunch of myopic self-interested irrigators in the Riverina, or fat-cat taxi-investors several removes from your driver. When the music stops, both should pay (as well as the public, whose governments in the past encouraged such schemes).

    report
  7. Robin Bell

    Research Academic Public Health, at University of Newcastle

    What about "salary sacrificing". I've never really understood why this works..... oh, why it should work.

    report
    1. Henry Verberne

      Once in the fossil fuel industry but now free to speak up

      In reply to Robin Bell

      I'm no Super expert but in the case of salary sacrificing it was introduced (with limits) by the government to encourage employees to provide for their own retirement and avoid huge and growing numbers of baby boomers having to rely on the pension.

      report
  8. Bruce Rossel

    Stakeholder Relations

    A well written and considered article. Thanks for contributing it, Dale.

    I am one of the people "in the barrel" for this measure (executive level public servant in Canberra). See article in today's Canberra Times for more details:
    http://www.canberratimes.com.au/federal-politics/political-news/canberra-to-be-hit-hard-by-fbt-changes-20130722-2qf41.html

    I have salary sacrificing a vehicle as part of my remuneration package for the last ten years. About two months ago I decided I would pay out my current leased vehicle and not enter into another novated lease agreement on a new car.

    Something to note though is there is no law or regulations yet to give effect to these changes. Not even draft ones to consider. Another case of policy on the run via media release.

    report
  9. Ian Rudd
    Ian Rudd is a Friend of The Conversation.

    Retired accountant & unapologetic dissident

    The problem with the cost method is it is a) a pain in the neck to comply with (the keeping of logbooks and collection of actual costs for each vehicle) and b) it relies on taxpayers keeping honest records which I'm pretty sure most will not do.

    Our tax system is far too complicated as it is and it should be simplified even if doing so might result in a little unfairness here and there.

    If the object is to increase tax revenue then I think it could be achieved by raising the proportion, currently 20%, applied to the cost of the car for the purpose of calculating the tax. Also the percentage deduction applied to older cars (now 66.6%) and/or the age at which the deduction applies could be changed.

    report
    1. George Burns

      logged in via email @incybr.com.au

      In reply to Ian Rudd

      Modern vehicles have very extensive computerised black box monitoring systems. Ostensibly for repair and fault monitoring there is no doubt that the authorities could transparently monitor vehicle usage. After all we are perfectly willing to allow corporates and government the ability to monitor our mobiles and internet connections. Might be a bit hard to get away with speeding or running that red light though. Another non tax revenue stream ?

      report
    2. Ian Rudd
      Ian Rudd is a Friend of The Conversation.

      Retired accountant & unapologetic dissident

      In reply to George Burns

      The last thing we want is government monitoring in our lives but you have a point. Certainly they presumably then could on specific, authorized occasions use the black boxes to uncover some dishonesty but that in itself would be costly and not help simplify our tax laws.

      report
    3. Richard Schmidt

      Programmer/Analyst at CSSP (construction industry software company)

      In reply to Ian Rudd

      Watch the sales of Log Book GPS systems explode!
      I'm sure this technology had a bearing on the tax change, as this makes it very easy to accurately measure where a car has been!

      report
  10. Geoff Taylor

    Consultant

    As someone who has had to fill in a logbook all year for fifteen years as part of operating a small business, three months out of five years for FBT seems to be a breeze.

    report
    1. Chris Briggs

      Logged in via facebook

      In reply to Geoff Taylor

      The Statutory Method has distinct compliance advantages for both business and the tax system because it is simple and virtually impossible to avoid. The flat rate should however (ideally) approximate the average of a "typical" fleet's private and business use mix. When the original Stat Method rates were introduced in 1986 they would have reasonably reflected fleet vehicle use at that time. The use of vehicles in businesses has changed a lot since then. With the resource available to Treasury, surely…

      Read more
  11. bruno spandonide

    research officer

    Great article! A bit lost by the end with the debate over tax concessions. What is really the difference between an additional tax and the removal of a tax concession? The simple fact that the concession benefits to a specific category of persons.
    Two points mentioned could be more developed to offer a broader perspective. First, taxation systems tend to be more sophisticated in order to match the complexity of the variety of industries that exists in the global economy but fails to adapt to the…

    Read more