Edited version of private advice

Authorisation Number: 1012625944023

Ruling

Subject: Prepayment of novated lease expenses

Question 1

Will a fringe benefit arise if an employer makes a prepayment of an employee's car lease payments twelve months in advance?

No. However a car fringe benefit will arise when the car is either applied to a private use by the employee (or an associate) or the car is taken to be available for the private use of the employee (or an associate).

Question 2

Will an expense payment benefit arise from the prepayment of a novated lease where an employee terminates employment during the period to which the prepayment relates and the lease obligations revert to the employee?

Yes.

Question 3

Will an expense payment benefit arise from the prepayment of a novated lease where an employee purchases the car during the period that the prepayments relate to?

Yes.

Question 4

Will a property fringe benefit arise from the prepayment of a novated lease where an employee subsequently purchases a car for the minimum residual value for leased cars, as published by the Commissioner?

No.

Question 5

Is the employer entitled to claim a deduction if it makes a prepayment of an employee's car lease payments twelve months in advance?

Yes.

This ruling applies for the following period:

1 July 2014 to 30 June 2016

Relevant facts and circumstances

An employer intends to allow an employee to enter into a salary sacrifice arrangement involving a novated lease on a car. The novated lease will be for 24 months. The car will be below the luxury car limit. The residual will be set up in accordance with ATO minimum residual guidelines of approximately 56.25%.

The relevant terms and conditions from the proposed Novation Agreement are set out below:

NOVATION TO EMPLOYER OF LEASE RIGHTS AND OBLIGATIONS

1.1 On the Effective Date the Employee novates to the Employer the Lease Agreement to the extent of the Lease Rights and Obligations. The Employer accepts the novation.

1.2 On the novation referred to in clause 1.1

(1) The Employer undertakes the rights and obligations under the Lease to the extent of the then subsisting Lease Rights and Obligations; and

(2) The Employee has no further obligation to the Financier under the Lease in respect of the Lease Rights and Obligations and will obtain no further benefit from them.

NOVATION TO EMPLOYEE OF EXCEPTED OBLIGATIONS

2.1 On the Effective Date the Lease Agreement, to the extent of the Excepted Obligations, is novated to the Employee.

2.2 From the time of the novation mentioned in clause 2.1 the Employee's obligations to the Financier in respect of the Lease Agreement, to the extent of the Excepted Obligations, arise under and as a result of this novation.

NOVATION BACK TO EMPLOYEE ON SPECIFIED EVENTS

3.1 On the Termination Date the Employer novates to the Employee the Employer's Novated Lease Agreement to the extent of the then subsisting rights and obligations.

USE OF MOTOR VEHICLE BY THE EMPLOYEE

4.1 The Employer will until the Termination Date make the Motor Vehicle available for the use of the Employee and the Employee's associates (as defined in the Fringe Benefits Tax Assessment Act 1986) as part of the Employee's remuneration package.

4.2 The Financier consents to the Employer making the Motor Vehicle available to the Employee provided that the Employer:

(1) Consents to the Motor Vehicle being registered in the name of the Employee; and

(2) Ensures that the Motor Vehicle is registered in the name of the Employee.

INTERPRETATION

10.1 In this Agreement:

(5) "Excepted Obligations" means the Residual Value Obligations and the obligations specified in Item 8 of the Schedule;

(12) "Termination Date" means the earliest of:

(b) the date upon which the Financier received notification that the Employee's employment with the Employer has been terminated

It is proposed that the employer will make 12 months' worth of payments on 1 July 2014 to cover the first year's rental, followed by the remaining 12 months of payments on 1 July 2015.

The lease has not yet been entered into.

If the employee terminates employment during the period of prepayment, they will not be required to pay back the prepaid lease payments.

If the employee purchases the car from the lease company, prior to expiry date but during the period that the prepayments relate to, the employee would not be required to pay back the employer for the prepaid lease payments. The employer would not have the leasing company refund any lease payments. The employee would purchase the car for the payout figure on the lease, with the prepayment amount reducing the amount required to be paid to the leasing company.

It is anticipated that the lease will commence on 1 July 2014.

The employer is not a small business entity.

Relevant legislative provisions

Division 2 of the Fringe Benefits Tax Assessment Act 1986

Subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986

Section 20 of the Fringe Benefits Tax Assessment Act 1986

Paragraph 20(a) of the Fringe Benefits Tax Assessment Act 1986

Section 40 of the Fringe Benefits Tax Assessment Act 1986

Paragraph 43(c) of the Fringe Benefits Tax Assessment Act 1986

Subdivision H of the Income Tax Assessment Act 1936

Paragraph 82KZL(2)(b) of the Income Tax Assessment Act 1936

Paragraph 82KZMA(1)(a) of the Income Tax Assessment Act 1936

Paragraph 82KZMA(1)(b) of the Income Tax Assessment Act 1936

Subsection 82KZMA(2) of the Income Tax Assessment Act 1936

Subsection 82KZMA(3) of the Income Tax Assessment Act 1936

Subparagraph 82KZMA(3)(a)(i) of the Income Tax Assessment Act 1936

Paragraph 82KZMA(3)(b) of the Income Tax Assessment Act 1936

Paragraph 82KZMA(3)(c) of the Income Tax Assessment Act 1936

Subsection 82KZMA(4) of the Income Tax Assessment Act 1936

Subsection 82KZMA(5) of the Income Tax Assessment Act 1936

Section 82KZMD of the Income Tax Assessment Act 1936

Section 8-1 of the Income Tax Assessment Act 1997

Reasons for decision

Question 1

In general terms the definition of fringe benefit in subsection 136(1) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA) requires a benefit to be provided to an employee, or associate of an employee.

 Taxation Ruling TR 1999/15 Income tax and fringe benefits tax: taxation consequences of certain motor vehicle lease novation arrangements (TR 1999/15) provides guidelines on lease novation arrangements. Paragraph 4 of TR 1999/15 states: 

A novation is a tripartite arrangement whereby the three parties (lessor, lessee and employer) agree to change or transfer all or some of the rights and obligations in a motor vehicle lease entered into between two of the parties.

Full novation is a novation (transfer) of all the rights and obligations in a finance lease or in a finance lease and sub-lease arrangement. As a result of a full novation the employer takes over all the rights and responsibilities contained in the original lease.

A variation on the full novation is an arrangement known as a split full novation whereby the lessee's rights and obligations under a finance lease (except the residual payment obligation) are transferred to an employer.

 In this case a proposed arrangement will exist between the employer and an employee, whereby a Novation Agreement transfers the obligation to make lease payments on a car, to the employer (clause 1.1). During the term of the novated lease the obligation to make lease payments will no longer be the employee's. The residual payment obligation still rests with the employee (clause 2.1). The result is that the Novation Agreement is a split full novation.

As the obligation to make the lease payments will be transferred to the employer under the terms of the Novation Agreement, a fringe benefit will not arise from the lease payments, prepaid or otherwise. The payments simply involve the employer discharging an obligation that it has under the terms of the Novation Agreement. This does not involve a benefit being provided to an employee, or associate, by the employer.

The prepayment of these obligations does not effect this view.

The employer, in accordance with clause 4.1 of the proposed Novation Agreement, makes the car available to an employee for private use. Paragraph 29 of TR 1999/15 explains the effect of this:

29. A car benefit arises under Division 2 of the FBTAA in these novations where the employer provides the car for the private use of the employee or associate of the employee.

As per paragraph 29 of TR 1999/15, since the employer makes the car available to an employee for private use, the employer is providing a car benefit under Division 2 of the FBTAA.

Consequently a car fringe benefit arises when the car is either applied to a private use by the employee (or an associate) or the car is taken to be available for the private use of the employee (or an associate).

Question 2

In accordance with clause 3.1 of the Novation Agreement, the subsisting rights and obligations revert to the employee on the "Termination Date".

The termination date is defined in section 10.1 paragraph (12)(b) of the Novation Agreement as, among other occasions:

The date upon which the Financier received notification that the Employee's employment with the Employer has been terminated

Therefore, all remaining obligations under the novated lease revert to the employee on termination of their employment.

It has also been advised that the employee has no obligation to repay the employer any lease payments upon termination of employment. Therefore, where the lease has been prepaid the employee will not be required to make payments for a period of the lease for which they would otherwise have had an obligation.

For example, if the employer prepays the lease obligations for the period from 1 July to 30 June the following year, and the employee terminates their employment on 31 December, the employee will not be required to pay the lease obligations that relate to the period from 1 January to 30 June. The payments for this period will already have been paid by the employer, who do not require repayment of these amounts.

Section 20 of the FBTAA, dealing with expense payment benefits, states:

 Where a person (in this section referred to as the provider):

 

(a) makes a payment in discharge, in whole or in part, of an obligation of another person (in this section referred to as the recipient) to pay an amount to a third person in respect of expenditure incurred by the recipient;  

the making of the payment referred to in paragraph (a) shall be taken to constitute the provision of a benefit by the provider to the recipient.

On termination of employment, there will be an amount of prepayment that relates to a period for which the lease reverts to the employee and which the employee is not required to reimburse the employer. The employer has therefore met the employee's obligation to the financier to make lease payments for so much of the prepayment as relates to the period commencing at the time of termination and ceasing at the end of the prepayment period. That is, on a pro-rata basis.

In terms of section 20 of the FBTAA, the prepayment that relates to the period commencing on the date of termination of employment is a discharge of the employee's obligation to a third person, being the financier. This constitutes the provision of an expense payment benefit by the employer (as the provider) to the employee (as the recipient) and is not altered by virtue of the lease payments having been prepaid.

As the employer is providing this benefit to the employee in respect of their employment the advance lease prepayment at the time of termination will be a fringe benefit as defined in subsection 136(1) of the FBTAA.

Question 3

Where the employer makes a prepayment and the employee subsequently purchases the car prior to the time that the Novated Agreement would otherwise have expired (i.e. during the prepayment period), an expense payment fringe benefit arises. This is the case whether the employer makes all of the prepayments and effectively finalises its obligations under the Novated Agreement, or whether only one of the two prepayments has been made.

Similar to the previous question, where the lease has been prepaid the employee will not be required to repay the employer for so much of these payments as relates to the timeframe after which they purchase the vehicle. Further, the leasing company would not refund these payments.

Revisiting the earlier example, if the employer has an obligation to make lease payments from 1 July to 30 June the following year, and prepays the lease obligations for this entire period, and the employee purchases the vehicle on 31 December, the employee will not be required to repay the lease obligations that relate to the period from 1 January to 30 June. That is, the payments for this period (which we shall term 'advance payments') will already have been paid by the employer, who have stated that they do not require repayment of these amounts.

In these circumstances the advance payments would reduce the payout figure required to be paid to the financier to finalise the lease. At that point in time, the novation is expired since the lease is broken. The advance lease payments are in effect applied to the purchase price. That is, they reduce the payout figure.

The employer has argued that the obligation to make lease payments does not revert to the employee at the time of purchase of the vehicle. Regardless, the advance payment amounts are considered to be a contribution towards the purchase price of the vehicle, paid by the employer. Since the lease would expire at the time of the employee's purchase of the car, the employer's obligations under the Novated Agreement would cease at this time. The employer would have had no obligation to contribute the remaining lease payments towards the payout figure of the car. The fact that the lease payments have been prepaid has the effect of the employer making a contribution towards the payout figure, on behalf of the employee.

Similar to the reasoning in the previous question, an expense payment benefit has arisen under paragraph 20(a) of the FBTAA. That is, to the extent of the lease payments that relate to the period commencing from the purchase date of the vehicle, the employer has made a payment in discharge, in part, of an obligation of its employee to pay an amount to a third person (the financier), being the payout figure of the car.

Consequently the employer is providing this benefit to the employee in respect of their employment resulting in the provision of a fringe benefit as defined in subsection 136(1) of the FBTAA.

Question 4

Section 40 of the FBTAA provides that where a provider provides property to a recipient, the provision of the property shall constitute a property benefit.

Taxation Ruling IT 2509 Income tax : income tax and fringe benefits tax consequences of an employee leasing a car to an employer which is subsequently provided back to the employee explains the fringe benefits tax consequences arising from a leasing arrangement for an employer where the employee purchases a car for less than its market value:

15. The employer will have to pay fringe benefits tax on the car fringe benefit provided to an employee and on the benefit the employee obtains from purchasing the car for less than its market value at the expiration of the finance lease. This latter benefit would be a property fringe benefit or alternatively a residual fringe benefit.

18. The provision of the car to the employee at the expiration of the lease is the provision of a benefit by the finance company under an arrangement to which the finance company and the employer are parties. The arrangement is properly attributable to the employment relationship and the benefit is therefore a fringe benefit. As the provision of a car is the provision of property the benefit is an "external property fringe benefit".

19. The taxable value of an external property fringe benefit valued under paragraph 43(c) of the Fringe Benefits Tax Assessment Act is the notional value of the car at the time the employee acquires it less the amount contributed by the employee. "Notional value" is defined in subsection 136(1) and means the amount the employee could reasonably be expected to have been required to pay to obtain the car from the owner under an arm's length transaction.

Taxation Determination TD 95/63 Fringe benefits tax: where a car is acquired at the end of a lease, is the acquisition at the residual value an 'arm's length transaction' for the purposes of section 43 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)? (which prevails over IT 2509 where their views are inconsistent), explains that the taxable value equates to the residual value, less the employee contribution. However, this is based on the presumption that the residual value meets certain minimum guidelines (paragraph 4):

2. In Granby Pty Ltd v. FC of T (1995) 30 ATR 400; 95 ATC 4240, the Federal Court determined that where a lessor and lessee had dealt with each other at arm's length in the initial lease transaction, the acquisition by a lessee for the residual value at the completion of the lease was also a dealing at arm's length. Even though the Granby case concerned the capital gains provisions of the Income Tax Assessment Act 1936 (ITAA), we accept that the views of the Court regarding the arm's length dealing also apply to the FBTAA.

3. Where an employer acquires a car at the end of a lease and subsequently provides that car to an employee, the employer is taken to have provided a property fringe benefit. If the lease is a bona fide lease, the taxable value of the property fringe benefit will be the amount of the residual payment less any employee contribution.

4. The Granby case proceeded on the assumption that there was a bona fide lease in that case. Therefore, the first question to be considered in each case is whether a bona fide lease exists. As indicated in paragraph 7 of Taxation Ruling IT 28, it is necessary to decide whether payments really are lease rentals or whether they are, in substance, consideration for the sale of the goods purported to be leased. Where the residual value under a lease agreement is equal to or exceeds the minimum residual value calculated in accordance with the percentages of the original cost as set out in the table in IT 28, and where there is no express or implied agreement under which ownership would pass to the lessee at the end of the lease, we will generally accept the agreement as a bona fide lease. The table in IT 28 provides only an estimate of the future value of leased plant, and is not intended to reflect actual market value.

In short, where an employer purchases a car at the end of a lease for at least the minimum residual value and subsequently provides that car to an employee, a property fringe benefit arises. The taxable value to the employer will be the difference between the purchase price and the employee's contribution towards it.

In the employer's case, it has been stated that at the conclusion of the lease the residual value will meet the minimum residual value after two years of 56.25% (see ATO ID 2002/1004 Income Tax: car lease residual values, which was published after the Commissioner amended his determination for the effective life of cars from 6 2/3 years to 8 years). Unlike the scenario above, the employee will be making the purchase. TD 95/63 provides two examples, the first of which involves a situation where the employee makes the purchase (highlighted):

1. A car costing $30,000 is leased by an employer for 4 years with a 30% residual value that equals the minimum residual value set out in IT 28. The employer subsequently purchases the car for the residual value of $9,000 and on-sells it to an employee for the same amount.

The lease is a bona fide lease, so the purchase of the car at the residual value is accepted as an 'arm's length transaction' for the purposes of paragraph 43(a) of the FBTAA. The taxable value is nil, being the cost price to the employer of $9,000 less the employee contribution of $9,000.

Where the employee purchases the car directly from the lessor at the residual value, the taxable value is the same.

2. A car costing $30,000 is leased by an employer for 4 years with a 20% residual value, which is less than the minimum residual values set out in IT 28. The employer subsequently purchases the car for the residual value of $6,000 and on-sells it to an employee for the same amount. Similar cars have been sold at public auction for an average of $9,000.

The lease is not accepted as a bona fide lease, so the taxable value calculated under paragraph 43(c) of the FBTAA is $3,000, being the notional (or market) value of $9,000 at the time the car is provided to the employee less the employee contribution of $6,000.

Following example 1 above, where the employee purchases the car directly at the end of the lease for its residual value, the taxable value of the property fringe benefit will be nil, assuming the residual value meets the minimum value published in ATO ID 2002/1004 (which has effect for assets acquired on or after 1 July 2002). This is not altered by the employer making prepayments of the lease expenses, nor by the employee purchasing the car prior to the end of the period to which the prepayments relate.

Where a discount is provided for early payments, resulting in the residual value falling below the minimum residual value for leased assets with a lease term of two years (56.25% for assets with an effective life of 8 years), the taxable value is calculated under paragraph 43(c) of the FBTAA, being the notional (or market) value at the time the car is provided to the employee less the employee contribution.

Question 5

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

TR 1999/15 discusses deductions under full novated lease arrangements at paragraphs 7 and 27:

7. The employer in the novated lease is entitled to a deduction for lease expenses where the vehicle is used in the business or provided to an employee as part of a salary packaging arrangement.

27. The employer becomes the lessee under the novated lease and is entitled to a deduction for lease expenses where the vehicle is used in the business or provided to an employee as part of a salary packaging arrangement

In the employer's case it intends to become a lessee under a novated lease arrangement in which a car is provided to an employee under a salary sacrifice arrangement. As per TR 1999/15 it will be entitled to a deduction under section 8-1 of the ITAA 1997 for the lease payments.

Where expenditure qualifies for deduction under section 8-1 of the ITAA 1997, the deduction is generally allowable in full in the year the expenditure is incurred. In Wentworth's case, where a 12-month prepayment of lease expenses is made on 1 July the amount will be deductible in that income year.

However, where the prepayment takes place in one income year and covers a period running into another income year, the timing of deductions will be subject to the advance payment rules in Subdivision H of the Income Tax Assessment Act 1936 (ITAA 1936), in particular sections 82KZL to 82KZO.

Subsection 82KZMA(1) of the ITAA 1936 provides:

Section 82KZMD sets the amount and timing of deductions for expenditure that a taxpayer incurs in a year of income (the expenditure year), if:

(a) apart from those sections, the taxpayer could deduct the expenditure under section 73B, 73BA, 73BH, 73QA, 73QB or former section 73Y of this Act or section 8-1 of the Income Tax Assessment Act 1997 for the expenditure year; and

(b) the requirements in subsections (2), (3), (4) and (5) are met.

Paragraph 82KZMA(1)(a) of the ITAA 1936 is satisfied, being an expenditure that could otherwise be deducted in the relevant expenditure year under section 8-1 of the ITAA 1997.

The conditions in paragraph 82KZMA(1)(b) of the ITAA 1936 are also satisfied, as follows:

Subsection 82KZMA(2)

The employer carries on a business and is not a small business entity taxpayer for the year of income (paragraphs 82KZMA(2)(a) and (b) of the ITAA 1936).

Subsection 82KZMA(3)

The prepayment will be incurred in carrying on a business and incurred under an agreement being the Novated Agreement (subparagraph 82 KZMA(3)(a)(i) and paragraph 82KZMA(3)(b) of the ITAA 1936).

The prepayment will be incurred in return for the 'doing of a thing' under the agreement that, for the purposes of this discussion, is not to be wholly done within the expenditure year (paragraph 82KZMA(3)(c) of the ITAA 1936). The lease payments resulting in the provision of a car will continue to be granted over more than one income year, and beyond the income year in which the prepayment is paid.

Paragraph 82KZL(2)(b) of the ITAA 1936 incorporates lease payments into the 'doing of a thing'. It provides that where expenditure incurred under an agreement consists of a lease payment or a 'payment of a similar kind' the expenditure shall be taken to be incurred in return for the making available, or the continued availability of the thing leased or otherwise of a similar kind under the agreement during the period to which the payment relates. In the employer's case, any prepaid lease payment is made under the Novated Agreement, which is incurred in return for the use of the car, thereby meeting paragraph 82KZL(2)(b) of the ITAA 1936 and consequently paragraph 82KZMA(3)(c) of the ITAA 1936.

Subsection 82KZMA(4)

The prepayment will not be 'excluded expenditure' (subsection 82KZMA(4) of the ITAA 1936), as that term is defined in subsection 82KZL(1) of the ITAA 1936, as the amount of the payment will not be less than $1000, it is not required to be paid by law, or by an order of a court, of the Commonwealth, a State or a Territory. It will not be a payment under a contract of service, it is not a payment of a capital, private or domestic nature and nor does it come within paragraphs (e) or (f) of 'excluded expenditure' as defined in subsection 82KZL(1) of the ITAA 1936.

Subsection 82KZMA(5)

The prepayment will not be to meet a 'pre-RBT obligation' (subsection 82KZMA(5) of the ITAA 1936) as that term is defined in subsection 82KZL(1) of the ITAA 1936.

The requirements of subsection 82KZMA(1) of the ITAA 1936 have all been met. As a result, section 82KZMD of the ITAA 1936 operates to set the amount and timing of deductions that the employer incurs for lease prepayments.

The portion of prepayments deductible in each year of income that contains all or part of the 'eligible service period' (as defined in subsection 82KZL(1) of the ITAA 1936) is calculated using the formula contained in subsection 82KZMD(2) of the ITAA 1936, as follows:

Expenditure x Number of days of eligible service period in the year of income

Total number of days of eligible service period

Example: If the employer makes a prepayment of lease payments on 21 July 2014 covering the period from that date until 20 July 2015, the deductible expenditure for the income years ended 30 June 2015 and 30 June 2016 is calculated, respectively, as follows:

2015 year: Expenditure x 345

365

2016 year: Expenditure x 20 .

365

In short, where the employer prepays an amount under the Novated Agreement relating to a period contained within one income year, it will be entitled to deduct the full amount under section 8-1 of the ITAA 1997. Where a prepayment is applicable to a period that encompasses more than one income year, an apportionment of the deduction must be made in accordance with Subdivision H of the ITAA 1936.