Novated Lease – Make your package Pay
Used astutely, taking part of your salary in benefits can bring excellent savings on tax, writes Barbara Drury.
Adrian Lister is a deputy principal of a government high school. These school holidays the Lister family is touring a remote region of Western Australia in the four-wheel-drive he packages as part of his salary.
Sales manager Miles Williams recently moved from Perth to Sydney for work. Because he is living away from home, he is able to salary package his rent payments for up to two years tax-free. He also packages income protection insurance and his airport lounge membership.
There’s a common belief that salary packaging is a tax perk for high flyers but the reality is more down to earth. A director of packaging specialists McMillan Shakespeare, Anthony Podesta, says more than 50 per cent of people who lease a car through their employer earn less than $75,000 a year.
Salary packaging allows you to take a portion of your total remuneration in the form of benefits such as superannuation or a car. This in effect reduces your pre-tax salary; you pay tax on the reduced amount and, provided you’ve chosen your benefits wisely and structured your package correctly, you should end up with more money in your pocket after tax.
A senior tax adviser with packaging specialist SmartSalary, Simon Ellis, says administrative costs tend to limit salary packaging to medium to larger companies and the public service. “Some of the best salary-packaging benefits are only available to people who work for public hospitals and charities,” he says.
Employees of public hospitals can package up to $9000 of their everyday costs – from mortgage repayments to groceries – from their pre-tax salary without incurring fringe benefits tax (FBT). This enables hospitals to better compete with salaries in the private sector on an after-tax basis.
Employees of charities fare even better – they can salary package up to $15,000 of their everyday costs tax-free.
For everyone else, salary packaging is limited to a defined menu of benefits. Super and cars are the most popular items, followed by a range of industry and job-specific items. Mining companies might offer remote-area housing benefits while Queensland Government workers receive electricity concessions.
“Understand the industry you work for, what you’re eligible for and what your employer offers,” Podesta says.
Where salary packaging is available, it’s important to select only those benefits that you would ordinarily pay for out of after-tax income.
And even then, make sure the numbers stack up for your individual circumstances. “There’s no point packaging a car if you don’t need it,” says a tax partner at Ernst & Young, Paul Ellis.
He says people need to pay careful attention to the administration of their salary package. “ATO auditors are looking at whether salary packaging is properly documented and implemented. Sometimes the documentation is too loose,” he says.
Cars are the most popular packaged benefit, even though the substantial reduction in marginal tax rates in recent years has reduced the financial rewards. Even so, Podesta says employees on salaries of about $45,000 and above still have the potential to benefit.
Podesta estimates that someone on a modest salary driving a modest Australian or imported vehicle 20,000 kilometres a year would be better off by about $3000 a year after tax.
The Tax Office formula for working out the packaging value of a vehicle depends on the cost of the vehicle multiplied by the annual kilometres driven. The further you drive, the less FBT you pay.
Podesta says an expensive car driving low kilometres would end up costing a fortune in fringe benefits tax.
While the employer pays the FBT, they generally deduct a similar amount from the employees after tax.
Ironically, the runaway popularity of this tax perk could throw a spanner in the works. The Henry Tax Review is checking under the bonnet and industry insiders believe there could be some tinkering with the tax formula in future.
“There has been a lot of pressure from green groups to amend the concession because [under the current system] the more kilometres you do, the more you save,” Simon Ellis says.
The most common method of packaging a car is a novated lease, where you choose your car and your employer pays the monthly lease rentals on your behalf. The lease, running costs and FBT are deducted from your pre-tax salary, leaving you with less taxable income, a lower tax bill and more take-home pay (see table above).
Under the employee contribution method you pay an amount from your after-tax income towards the cost of the car. “This allows you to pay FBT at your marginal tax rate [rather than the standard FBT rate of 46.5 per cent],” Paul Ellis says.
If you earn less than $180,000 and hence pay less than the top marginal rate of tax then Paul Ellis says it often makes sense to make after-tax contributions for a salary-packaged car and car parking because they are taxed at concessional rates.
The key to gaining the most benefit from packaging is to choose the car you would buy if you were paying for it yourself. That might be a station wagon, a 4WD or a second-hand car. You can even package a car you already own.
“You can sell your car back to your employer through a novated lease, get $20,000 back [for example] and pay off your mortgage then lease the vehicle back. It frees up cash flow and it’s tax effective,” Podesta says.
A tax partner with Deloitte Touche Tohmatsu, Elizma Bolt, says there is growing interest in packaging a car owned by the employee’s spouse. Called an associated lease, this allows a portion of the employee’s income to be redirected to the spouse, reducing the employee’s tax bill and saving the spouse car-related costs.
Despite the benefits of salary packaging a vehicle, there are potential pitfalls. Because it locks you into a medium- to long-term contract it can create problems if your circumstances change. If you lose your job or break the lease for any reason you must pay out the residual on the lease.
Podesta says employees without job security should consider redundancy insurance to cover their vehicle.
Ellis, from Ernst & Young, says younger people generally don’t pay as much attention to super, especially now that the amount that can be effectively salary sacrificed has been reduced. Miles Williams, at 31, admits he has other priorities. “I use salary packaging to get tax benefits now, not for retirement purposes. At the moment there are other things I’d rather be saving for, such as buying investment property,” he says.
Employees aged 50 and over can contribute up to $50,000 a year to super from their gross salary and pay tax at the concessional rate of 15 per cent rather than their marginal tax rate. Younger employees can contribute a maximum of $25,000 at the concessional rate.
Hence, a 45-year-old on a salary of $100,000, whose employer pays super guarantee payments of $9000 a year, can only contribute an additional $16,000 a year ($25,000 minus $9000). If you inadvertently contribute more than your concessional limit you will be taxed at the top marginal rate of 46.5 per cent, including the Medicare levy, for any excess instead of the 15 per cent concessional tax rate.
“Sometimes people are not cognisant of changes to the super rules so they are sacrificing above their limits,” Paul Ellis says. “[This oversight] won’t crystallise ’til they put in their tax return at the end of the tax year and they will end up with a higher tax bill.”
GADGETS, LEISURE AND LOANS
Paul Ellis says the ability to package a laptop has reduced significantly since the rules were tightened last year. Now you can only package one laptop a year and it must be primarily for work-related purposes.
However, there is still a wide range of items available for professional employees. Mobiles, airport lounge membership, BlackBerries and other communication devices, taxis to and from work, in-house childcare and in-house gym memberships are still popular. “For generation Y there is not as much emphasis on owning vehicles – they are more inclined to use taxis,” Paul Ellis says.
Employees can also package shares in the company that employs them. The Federal Government has tightened up the rules and legislation is still pending but Paul Ellis says up to $1000 of shares is tax exempt, plus a further $5000 worth can be taken on a tax-deferred basis
This has effectively ended the once-common practice of salary sacrificing an annual bonus into a deferred share plan.
Employees can also package up to $1000 worth of in-house benefits exempt from FBT.
For example, if you work for a manufacturer of electrical goods you can package $1000 of their products tax-free.
One benefit that has been gaining traction recently is salary sacrifice of leisure facilities, such as apartments, where you lease the accommodation for your annual holidays. “The ATO seems to accept only half the value of that [leisure facility] is subject to FBT,” Paul Ellis says. The remaining half is taxed at the corporate rate of 30 per cent. That means an executive on the top marginal tax rate comes out ahead by packaging the cost of the apartment. “It’s an evolving area and there’s some testing of the borders,” he says.
Preferred vehicle for savings
When Robert Tarabay’s employer, State Transit Authority NSW, introduced salary packaging for its employees, he grabbed the chance to upgrade his car.
At that time he was driving a second-hand sedan and found it impossible to take his three daughters — plus luggage, prams and other items — on holiday.
Six years later, he is on to his second three-year car lease and is driving a seven-seat four-wheel-drive with plenty of room for his growing family (pictured above).
“We do more than 25,000 kilometres a year to reduce the fringe benefits tax and we’ve got the freedom to travel. There are consistent deductions from my salary — fuel, rego, tyres and maintenance are all covered — so there are no unexpected expenses,” he says.
Now they drive to Queensland most Christmas holidays to visit family and are about to head off to the Hunter Valley.
Tarabay says he isn’t financially better (or worse) off after packaging his car — he’s used the opportunity to upgrade to a better vehicle than he could otherwise afford, at no extra cost.
While his employer offers salary sacrifice into super, at this stage of life he has other priorities.
“We’re focused on taking the kids out, sightseeing … having a good time while they’re learning,” he says.
Salary packaging nuts and bolts
Under salary packaging, or salary sacrifice, employees receive part of their salary in the form of benefits, such as the use of a car for private purposes.
You receive a reduced salary plus benefits but only pay income tax on your reduced salary. Your employer may be liable for fringe benefits tax (FBT) — at a rate of 46.5 per cent — on the benefits you receive and reduce your salary by an equivalent amount.
Portable electronic devices, computer software, protective clothing, a briefcase and tools of trade are exempt from FBT provided you use them primarily for work and you only claim one of a certain type of item a year.
If the total value of your fringe benefits is more than $2000 a year, the full taxable value — referred to as reportable fringe benefits — will be recorded on your group certificate. You won’t be taxed on these but they will be used to work out the Medicare levy surcharge, superannuation rebates and deductions, the mature-age worker tax offset, child support obligations, higher education loan program (HELP) repayments and income-tested government benefits.
You can make employee contributions out of your after-tax income towards the cost of benefits and reduce any reportable fringe benefits.
So now you are an expert on Salary Packagine, lets talk about how it can benefit you. Simply fill out our online application form or give us a call on 1300 547 226 to discuss your options.