It is important to structure salary sacrificing arrangements to be beneficial to both the employer and employee. This often involves the employer passing on costs associated with providing the benefit. One of these costs is the luxury car adjustment. This article discusses whether this adjustment is relevant to income tax exempt employers and whether the cost should be passed on to employees.
Structuring salary packaging arrangements
Salary packaging (also known as salary sacrifice) is essentially a term used to describe the arrangement between an employee and their employer where the employee agrees to forego cash salary in exchange for the provision of non-cash benefits. These benefits are essentially paid (or provided) for through the employee’s pre-tax salary. Any agreement to salary package must be entered into before the employee earns the income in order for it to be acceptable to the ATO—it can never be retrospective.
In order for salary packaging to be beneficial to both parties, an employer will usually require the employee to salary package not only the GST exclusive cost of the benefit (since the employer will usually be entitled to claim an input tax credit) but also any other costs associated with the provision of the benefit (for example, any fringe benefits tax payable by way of provision of the benefit).
In essence, a properly structured salary packaging arrangement is a number crunching exercise ensuring the employer is not ‘out of pocket’ by providing fringe benefits to the employee rather than paying them cash salary. From the employee’s perspective, they should benefit from having an overall lower income tax bill and therefore more post-tax cash in their pocket each pay period.
Luxury car adjustment
We were recently asked the following question via the member Q&A tool:
One of our employees has taken on a novated lease of a luxury car through ABCXYZ Leasing Co, a finance company. This employee has elected the operating cost method. The finance company has advised us that there is a ‘luxury car adjustment of 30%’. Is this adjustment required to be passed on to the employee as part of the operating costs attached to the vehicle?
In general, the luxury car adjustment (LCA) is an amount added to novated lease salary packaging calculations due to the loss of income tax deductions for a taxable employer. Under the income tax rules, a leased luxury car is treated as a notional purchase with a loan, such that interest deductions are available but depreciation is limited to the luxury car depreciation limit (currently $57,581). No deduction is allowed for the lease payment.
Generally, where a luxury car is acquired by a financier then leases the vehicle to an individual (who then novates the lease to the employer), for tax purposes the employer is treated as having acquired the car at full value. The employer can only claim depreciation to the luxury car depreciation limit and then also claims deductions for interest expenses. This differs to the actual cost incurred by the employer (being the lease payments), and the difference is usually recouped as an LCA. The LCA is essentially the tax cost for the employer that relates to the loss of a full deduction for the lease payments.
However, the LCA is not an issue for tax-exempt employers because, put simply, such employers don’t pay company tax, but do pay and claim GST. This means that there is no trigger or need for a tax-exempt employer to adjust the company tax they pay and pass this ‘cost’ on to the employee as a salary sacrificed LCA amount.