Edited version of private advice

Authorisation Number: 1052179760815

Date of advice: 6 November 2023

Ruling

Subject: Work related expense - vehicle hire purchase

Question

Are you required to use the market value of a luxury car, for depreciation purposes, as at the date the novated lease agreement terminated?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

On XX XX 20XX, your spouse signed and accepted a finance lease for a motor vehicle (the Vehicle).

The Vehicle is a 20XX XX and is a car for the purposes of the tax act.

The Vehicle is a luxury car.

Your spouse entered a novated lease arrangement.

The parties involved with the novated lease were:

•         Your spouse

•         Your spouse's previous employer, and

•         The finance provider.

The novated lease was managed by a novated lease specialist.

The purchase price of the vehicle in 20XX was $XXX,XXX.XX.

In XX 20XX, you commenced employment in a new role.

You are required to use the vehicle for your work.

In XX 20XX, your spouse ended the employment relationship with their previous employer.

The previous employer notified the novated lease specialist that your spouse had ceased their employment.

On XX XX 20XX, the novated lease specialist advised your spouse, that the novated lease termination and reconciliation was to take effect.

At the termination of the novated lease, all rights and obligations of the Vehicle transferred to you and your spouse.

You bear all running costs associated with the vehicle, including insurance, registration, servicing, repairs, and fuel.

You did not make any balloon payments; nor were there any payout amounts due when the lease transferred to you.

The principal outstanding on the loan, when the lease transferred to your spouse and yourself, was $XX,XXX.XX.

Relevant legislative provisions

Income Tax Assessment Act 1936 Schedule 2E, Division 42A

Income Tax Assessment Act 1997 Section 40-25

Income Tax Assessment Act 1997 Section 40-40

Income Tax Assessment Act 1997 Section 40-185

Income Tax Assessment Act 1997 Section 240-25

Income Tax Assessment Act 1997 Section 242-75

Income Tax Assessment Act 1997 Section 242-90

Income Tax Assessment Act 1997 Section 955-1

Reasons for decision

Question

Are you required to use the market value of a luxury car, for depreciation purposes, as at the date the novated lease agreement terminated?

Summary

Yes. On the cessation of employment, novated lease arrangements are unwound, the (now ex) employee resumes the role as lessee and the employer has no further responsibility for the vehicle. Subsection 242-90(3) of the Income Tax Assessment Act 1997 (ITAA 1997) explains that the consideration for the sale of the car by the lessee, and the first element of the cost of the car to the lessor, is the market value of the car at the time the novation arrangement is terminated.

Detailed Reasoning

Termination amount

Subsection 955-1(1) of the ITAA 1997 explains that a termination amount means an amount payable because an arrangement in relation to the property ends and includes:

(a)  if, at the end of the arrangement, one party to the arrangement acquires the property from the other party - an amount payable for the acquisition, or

(b)  if, at the end of the arrangement, the property is lost or destroyed - any amounts paid to the owner of the property as a result of the loss or destruction; or

(c)   otherwise - the market value of the property at the end of the arrangement.

Division 242 of the ITAA 1997 discusses the lease of luxury cars. For income tax purposes, a leased luxury car is treated as if it had been sold by the lessor to the lessee for the car's market value.

Section 242-75 of the ITAA 1997 details that when a luxury car lease ends (whether it expires or is terminated before its expiry date), one of 3 things will happen:

(a)  If the lease is extended or renewed-the original notional loan is treated has having been repaid and the lessor is treated as having made a new loan to the lessee; or

(b)  If the lessee acquires the car from the lessor-the lessee continues to own the car for tax purposes, and the actual transfer and the termination payment to acquire the car are ignored for tax purposes; or

(c)   If the lessee's right to use the car ends-the lessee is treated as having sole the car back to the lessor.

In your circumstances, your scenario fits subsection 242-75(b), therefore you continue to own the car for tax purposes.

Cessation of novated lease and balancing adjustment event

Taxation Ruling TR 1999/15 Income tax and fringe benefits: taxation consequences of certain motor vehicle lease novation arrangements explains that when a novation involves a luxury car, the employee is the notional owner as sub-lessor in the sub-lease between the employee and the employer for the purpose of Schedule 2E, Division 42A of the Income Tax Assessment Act 1936 (ITAA 1936).

Paragraph 30 of the TR 1999/15 further details that partial novated lease arrangements are specified to continue only for so long as the employee is employed, or the last lease payment is made. On the cessation of employment, the arrangements are unwound, and both the sub-lease and the novation are terminated. In that circumstance the (now ex) employee resumes the role as lessee and the employer has no further responsibility for the vehicle.

The ATO Interpretive Decision (ID) 2003/759 - Income Tax Capital Allowances: balancing adjustment event - early termination of novated luxury car lease arrangement explains that when a novation arrangement is terminated because an employee ceases to be employed, the employee is the holder of the car again under item 1 of the table in section 40-40 of the ITAA 1997. This results in the employee resuming the role of lessee, and accordingly, a balancing adjustment event occurs.

ATO ID 2005-197 - Income Tax Capital Allowances: cost - novation of luxury car lease immediately following termination of earlier novation supports the explanation that when a novation arrangement terminates because an employee ceases to be employed, the employee transfers from the role of lessor to lessee. On early termination of the novation arrangement, the car is taken to have been disposed of by the employer by way of sale to the employee and the car is acquired by the employee on the early termination of the lease.

Section 40-185 of the ITAA 1997 discusses the amount you are taken to have paid to hold a depreciating asset or to receive a benefit. Note 1 details that this section of the legislation discusses amounts you are taken to have received and includes a lessee's deemed consideration when a lease ends under subsection 242-90(3). Subsection 242-90(3) reads that the consideration for the sale of the car by the lessee, and the first element of the cost of the car to the lessor, are the market value of the car at the end time of an arrangement.

The cost of acquisition by the lessor is taken to have been the amount worked out using the formula in former subsection 42A-105(5) of former schedule 2E to the Income Tax Assessment Act 1936 (ITAA 1936) or the market value if it is impractical to use the formula. Note there is not a formula under subsection 242-90(3) of the ITAA 1997 (which replaced subsection 42A-105(5) of the ITAA 1936). The cost of acquisition by the lessor is the market value of the car at the time the lease ended. In addition, the employee also becomes the lessee of the luxury car at that time and starts to hold the luxury car under item 1 of the table in section 40-40 of the ITAA 1997.

With the cessation of the novation agreement, the standard agreement between the finance provider and the employee is re-established, such that the vehicle is leased by the finance company to the employee on the same terms as the original standard agreement. The standard agreement takes operative effect when the novation agreement is terminated.

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)? Further explains that where a lease is in effect, a contract for sale of the goods, then the taxable value is the notional (or market) value at the time of the acquisition of the car by the employee, less any employee contribution. The notional (or market) value will be the amount the employer would have been expected to pay to obtain the car in the marketplace, which will not necessarily equate to the residual value under the agreement.

Taxation Determination TD 93/231 Fringe benefits tax: what is an acceptable method for determining the 'notional value' of a property fringe benefit for the purpose of sections 42 and 43 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)? Reiterates that the 'notional value' is the amount that a person could reasonably be expected to have been required to pay to obtain the property under an arm's length transaction.

Subsection 240-25(5)(b) of the ITAA 1997 also considers the cost of the acquisition of the property by the notional buyer is taken to have been the amount that could reasonably have been expected to have been paid by the notional buyer for the purchase of the property if:

(i)    The notional seller had actually sold the property to the buyer at the start of the arrangement; and

(ii)   The notional seller and the notional buyer were dealing with each other at arm's length in connection with the sale.

Application to your circumstances

You took out a finance lease for a luxury car and entered into a partial novation arrangement in which the lease payment obligations were transferred to your previous employer, who in turn, provided the vehicle for your private use. This arrangement continued until your previous employment relationship ended and the employer had no further responsibility for the vehicle.

On XX XX 20XX, you were notified that your novated lease salary packaging arrangement will cease. This is considered a termination event that results in a balancing adjustment. You have agreed to continue the lease and have not entered into another novation arrangement. The 'termination amount' is the market value of the car at the time of the expiry of the novation arrangement.

The decline in value (depreciation) of an asset used to produce salary or wages is deductible under section 40-25 of the ITAA 1997, a condition for the deduction is use of the depreciating asset 'for the purpose of producing assessable income'.