COVID-19 represents unique opportunity for businesses to reconsider their options when it comes to motor vehicles
Tax Alert - September 2020
By Aaron Mitchell, Andrea Scatchard
It is commonplace amongst New Zealand businesses for motor vehicles to be used for both private and business travel. Businesses are often faced with the question of deciding whether they would be better off financially by buying or leasing motor vehicles through their business and making them available to employees, or to reimburse their employees for any business use of their own personal motor vehicles.
Due to the current COVID-19 environment and economic outlook, it is now more important than ever that businesses identify opportunities where they can reduce expenditure and maintain cash flow. The shift towards a work from home (“WFH”) culture in many businesses raises the opportunity for them reconsider and potentially reduce their overall motor vehicle expenditure by ensuring they utilise a tax efficient option to suit their circumstances.
There is no magic formula though, it is very much a case of analysing each individual situation to determine which option may give the best outcome. We have outlined some of the key tax considerations below.
Buying a motor vehicle through the business
The approach of many businesses is to purchase or lease company motor vehicles and provide them to their employees for business use. A fringe benefit tax (“FBT”) liability will arise where employers make motor vehicles owned by the employer available to employees for their own private use.
The general principle and starting point is that if a vehicle is available for private use at any point during the day, the entire day is subject to FBT and included in the FBT calculation. “Private use” of a vehicle ordinarily includes travel between home and work (unless home is a workplace) and any other travel that confers a private benefit on the employee.
Pool vehicles stored at the office are not usually subject to FBT as there is no private use (unless employees take them home).
Businesses should also be aware that employees taking vehicles home purely for security reasons will not in itself make the journey from work to the employee’s home work-related, and therefore FBT is likely to still apply in such cases.
There are some specific motor vehicle exemptions which, if satisfied on a particular day, mean there is no fringe benefit provided on that day in relation to the vehicle. These include exemptions for work related vehicles, business travel and emergency callouts. These can result in significant FBT savings provided they are correctly applied and the appropriate supporting records are maintained.
Once businesses have determined the days in the quarter which give rise to a fringe benefit, the next step is to calculate the value of the fringe benefit provided. The most common approach is to use a formula which takes 5% of the GST inclusive motor vehicle cost each quarter, adjust for any days on which the vehicle is not available. The resulting amount is then adjusted for any employee contributions. FBT is payable on this amount.
The other approach is to base the quarterly calculation on 9% of the tax book value of the vehicle, calculated on a GST inclusive basis. Generally this method is only recommended if a vehicle has been held for at least 5 years.
Inherent business use portion
It has long been recognised that the FBT rules are inflexible and can result in over taxation where there is a high level of business use of a company vehicle. The quarterly FBT calculations have been designed by Inland Revenue assuming that the proportion of motor vehicle use is 25% business and 75% private, and take into account the average expenditure typically incurred in running a vehicle for 14,000km per annum.
As such, where the business use of a company car is determined to be more than 25% and full private use is allowed, it may be more tax efficient to reimburse the employee for work related use of their personal vehicle rather than providing a company car. Obviously the impact on the employee’s remuneration package also needs to be factored into any decision here.
Motor vehicle expenditure deductions
Sole traders, partnerships and certain closely-held companies (where the only fringe benefits are vehicles provided to shareholder employees) are able to claim tax deductions for the business proportion of the running costs of a motor vehicle. The allowable deduction for motor vehicle expenditure is calculated using either a cost or kilometre rate method.
The cost method is the total of expenditure incurred for use of a motor vehicle (e.g. registration, WOF, petrol, repairs, insurance etc.) plus an amount for depreciation, multiplied by the business use proportion of the motor vehicle.
Kilometre rate method
The kilometre rate method is less compliance heavy and allows taxpayers to deduct a fixed amount per kilometre based on rates published by IR. The deduction is calculated as follows:
IR kilometre rate x total number of kilometres travelled x the business proportion.
For an overview of the current kilometre rates, see our Tax Alert article here.
The business proportion must be calculated by either reference to actual records or by keeping a logbook for a test period to establish the proportion of business use.
The more common approach is to keep a logbook for a test period. The test period has to be at least 90 consecutive days and must represent the usual pattern of travel for the vehicle. This calculation can then be used for a period of up to 3 years (provided business use does not change by more than 20 percentage points). Once this 3-year period has expired, another logbook will need to be completed. Many businesses find it easier to follow this approach rather than keeping actual records for every trip.
If no actual records or logbook are maintained and the kilometre rate has not been used, then the business use proportion will be the lesser of the proportion of actual business use or 25% of total vehicle use.
As such, where the business use of the vehicle is greater than 25% of the total use, there is an incentive for businesses to keep a logbook in order to claim a greater deduction for motor vehicle expenditure. Inherent in applying the logbook approach is the need to take an odometer reading each 1 April to determine the total distanced travelled in a tax year.
Mileage allowances or reimbursements
A mileage allowance or reimbursement can be paid to employees to cover the cost of using their own vehicle for work-related purposes. The amount paid is often calculated by reference to the Inland Revenue kilometre rates for employee mileage reimbursements. Alternatively actual employee costs can be used to determine the amount paid to the employee as can other reputable sources such as the published AA rates.
Where the amount paid is no more than the amount allowed under Inland Revenue guidelines the payment will be tax free. However, if the amount paid to the employee exceeds the guidelines, the excess will be taxable.
In April 2018 Inland Revenue introduced a two tier rate structure for working out the allowable tax free reimbursement to employees. The per kilometre rate that can be reimbursed tax free reduces significantly after the first 3,500km per annum, or after the employee has driven a total of 14,000km for both business and private travel in a tax year (depending on what records are kept). Where employees travel greater distances, the amount that they can be reimbursed tax free, using the IR rates, has reduced compared with what could be reimbursed tax-free before 2018.
Employers with employees that do a lot of business travel have struggled to apply these rules in a cost efficient manner, and with managing employee expectations regarding the amount that can be reimbursed tax free. But despite these difficulties, where an employee undertakes more than 25% work related travel, reimbursing them for the cost should in principle be more tax efficient than providing a company car (where full FBT is paid on the company car).
The travel patterns and the business use proportions of a motor vehicle are important considerations businesses should take into account when determining whether to purchase a vehicle through the company or not. This however is only one of the large variety of factors businesses should look to consider.
The current COVID-19 environment and the long term impact it may have on the way business is conducted raises the opportunity for businesses to review the way they pay for work related travel. If businesses choose to shift to WFH arrangements on a more permanent basis, and to conducting more business virtually and reducing the amount of travel undertaken, this could result in a shift in the amount of work related vehicle travel in the foreseeable future. Motor vehicle ownership decisions that have been made in the past based on expected travel patterns may now need to be reviewed as they may no longer be fit for purpose. Similarly, employees that have maintained logbooks to support mileage reimbursement claims may find that new logbooks need to be kept if there has been a material change in the amount of work related travel undertaken.
With the importance of reducing excess expenditure and maintaining cash flow in the current economy, now is a good time to consider the tax implications of your current motor vehicle arrangements. Please contact your usual Deloitte adviser if you would like any assistance or guidance in this process.
September 2020 Tax Alert contents
- COVID-19 represents unique opportunity for businesses to reconsider their options when it comes to motor vehicles