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Current treatment
The valuation basis - cost or book value
Proposal
Availability for private use
Leased vehicles
Availability on a daily basis

5.1     The valuation of motor vehicles for FBT purposes was the issue most frequently raised as an area of concern in the comments made in submissions. Submissions considered that the review should reconsider the FBT treatment of motor vehicles in a range of areas.

Current treatment

5.2     As noted in chapter 2, motor vehicles are valued for FBT purposes on the basis of their availability for private use rather than actual use, to reflect the full range of fixed and variable costs the employee is saved from incurring by having the use of a vehicle that is owned by someone else, who bears those costs. The FBT value to an employee of a car provided by an employer is, therefore, the sum of the fixed (or standing) costs and variable (running) costs related to private use that the employee would have to bear if he or she owned the car.

5.3     Like other fringe benefits, the actual value of an employer-provided vehicle will vary according to individual employees' vehicle preferences and use. However, taking all such factors into account for each relevant employee would significantly increase compliance costs for employers. To avoid this complexity, a set rate is applied (currently 24% a year^[4]). That rate is based on the combined average fixed and variable costs for a vehicle that has an average amount of private use, expressed as a percentage of the cost of an average vehicle. The data source for these costs is the Automobile Association annual survey of motoring costs.^[5] This rate is then applied to the actual price of the vehicle to establish the value of the fringe benefit.

5.4     What constitutes the vehicle's actual price depends on whether the employer owns or leases the vehicle. In the case of a vehicle that is owned by the employer, the 24% rate is applied to the original cost of the vehicle. For example, if the cost of the car provided to an employee for unlimited private use is $30,000, the value of the fringe benefit is $7,200.

5.5     If the vehicle is leased and the lessor and lessee are not associated persons, the 24% rate is applied to the market value of the motor vehicle at the time the lease began. If, however, the leasing parties are associated, the vehicle's cost is used.

5.6     In any of these cases, however, the objective should be that the same amount of FBT is payable irrespective of the type of arrangement under which the vehicle is provided. To achieve this objective, the valuation basis for the cost of the car must be either consistent across all arrangements, or the statutory formula must vary to arrive at the same amount of liability.

5.7     The relevant formula and rules are contained in sections CI 3 and schedule 2 of the Income Tax Act 1994. Binding ruling (Binding ruling Pub 00/10) sets out what is considered by Inland Revenue to be the "cost price" of a vehicle for FBT purposes.

5.8     The formula establishes the maximum taxable benefit. Because it is an average, it will in individual cases result in the actual benefit being either undertaxed or overtaxed, but this is the trade-off for lower compliance costs.

5.9     The legislation also provides for the maximum taxable benefit to be reduced by any amounts paid by the employee for the receipt or enjoyment of the fringe benefit (see section CI 4(1)) and any days that the vehicle is not available for private use. The employee, for example, may pay for the petrol or the vehicle may not be available on weekends.

The valuation basis - cost or book value

5.10     Writers of submissions perceived the current valuation formula's use of the original cost of the vehicle to be unfair as the FBT liability remains constant while the vehicle declines in value over time. Although some appeared not to be aware that the valuation formula includes a depreciation allowance,^[6] others considered that aligning the FBT valuation with the depreciated value used for other tax purposes would result in a compliance cost saving.

5.11     The government agrees that there is a perception problem associated with using a vehicle's cost price as the base for calculating the benefit. Also, because the formula assumes vehicles are held for an average of five years, it results in overtaxation if the vehicle is kept beyond five years.

5.12     In 1982 the Task Force on Tax Reform (the McCaw Task Force),^[7] which recommended introducing FBT, considered the alternative option of using a vehicle's tax book value as the base, but noted a higher rate would be required to produce the same overall result as using cost price as the base. (As the example below illustrates, the equivalent percentage to 24% of the cost price would be 44% of the book value.)

5.13     Because the rate would be higher, the FBT liability using book value would initially be higher than when using the cost price. Also, because the annual tax depreciation rate on cars is, at over 20%,^[8] higher relative to that used by the Automobile Association, using it in the calculation is likely to exacerbate the rate increase. Consequently, changing the base alone may not address concerns expressed in submissions, although it would align the taxable value of the motor vehicle for fringe benefit purposes with the value of the vehicle for other tax purposes.

5.14     An alternative would be to use market value rather than book value, but this would have higher compliance and administrative costs because of the need to verify each car's market value annually. Using some standard values may assist in this regard but could be quite inaccurate.

Minimum value

5.15     Because the depreciated tax value declines rapidly over five years, using book value could significantly understate the value of the benefit thereafter. Accordingly, a minimum fringe benefit value would be needed to reflect the benefits that the use of an employer-provided vehicle continues to provide to an employee regardless of the value of the vehicle on the employer's books. The minimum value should cover at least the average cost of warranting, registering, insuring and running private vehicles, assuming an annual distance of 14,000kms,^[9] which equates to around $3000.

Proposal

5.16     The government proposes that tax book value (subject to a minimum value) be used as a method of valuing vehicle fringe benefits, as an alternative to cost price. Having a choice would enable employers to better align the base they use for FBT purposes with the base they use for tax depreciation purposes. Employers would need to elect at the beginning which option they wished to use for each vehicle and that election would continue to apply for the period of ownership of the vehicle, or the first five years, whichever is shorter. If the book value option were adopted, a minimum value of $3000, reviewed periodically, would apply.

Availability for private use

5.17     Submissions considered that the concept of "availability for private use" also needed to be re-examined because a large FBT liability could be incurred if the employer did not prohibit private use, even in circumstances where actual private use was very small.

5.18     As noted earlier, under the current rules, an identification of private versus business use can be made based on a three-month test period in which a log of use is kept. This allocation is, however, on the basis of availability rather than actual use. For the reasons outlined earlier, the government considers availability to be the appropriate approach.

5.19     Actual private use of work-provided motor vehicles can be quite variable, ranging typically from occasional home-to-work travel only to regular use outside work. Unfettered use usually arises with vehicles provided to executives, whereas it is more likely that other staff will take home fleet vehicles, perhaps primarily for garaging. In the latter case employers will often place specific limits on private use and require that work use take priority during work time. This "tagging" of the benefit, it is argued, reduces its value. This is a reasonable argument, but by how much is the benefit reduced?

5.20     In some instances employees may find the limitations have little practical impact on their ability to use an employer-provided car when they want. For example, an employer may require that a vehicle is used solely for work purposes during work hours but this would not impede an employee from using the car to drive to and from work and on evenings and weekends, so he or she could still have a higher use of the vehicle than is assumed in the standard formula used to calculate the fringe benefit.

5.21     This example illustrates the difficulty of trying to identify the impact of particular limitations on the value of any benefit. The impact will depend on the extent of the limitation, the personal circumstances of the employee and how well the limitation is adhered to (which will depend on how sensibly it can be monitored).

The appropriate rate

5.22     In 1982 the McCaw Task Force used Automobile Association data to calculate both the fixed and variable costs of motoring, grouping cars according to three categories (small, medium, large) and assuming they travel an average of 16,000kms each year. The aggregate cost was then expressed as a percentage of the cost of the car. On this basis it calculated the percentage benefit to range from 35% for a large vehicle to 43% for a small vehicle. The Task Force considered, however, that a more conservative rate of 24% a year would be more appropriate, to reflect the following factors:

• Many taxpayers' private motoring travel is less than the benchmark distance of 16,000kms.
• Some operating costs (such as fuel) may be met by the employee.
• The vehicle may be superior to that which the employee would have purchased for his or her own use.
• Some restrictions may be placed on the use of a vehicle for private purposes so that it is not wholly available for private running.

5.23     These factors were partially reflected in the final 1985 legislation. Operating costs specifically met by employees reduce the benefit; the availability for private use test is applied to motor vehicles on a daily basis; and the rate calculation of 24% was the cost at that time for employees travelling an average of only 8,000kms per year.

5.24     Applying the methodology used by the McCaw Task Force to current motoring costs and car prices^[10] shows that, in real terms, the cost of motoring has declined significantly over the past 20 years, as shown in table 1. Based on 16,000kms, the annual motoring costs as a percentage of the cost price of the vehicles have declined by as much as 20%. The decline is mainly in the variable costs as there is no decline at the 8,000kms level. Arguably, however, 8,000kms per year is too low to reflect average actual travel. The Automobile Association assumes average annual motoring to be 14,000kms, which we consider to be a more reasonable basis for the calculations. It produces a decline in real motoring costs of around 18%.

5.25     This decline over the last 20 years suggests that the valuation of the fringe benefit at a rate of 24% of a vehicle's cost is now overstated, so the rate could be reduced. Continuing to apply a discount to the actual rate will also help reflect any reduction in the benefit's value from the limitations often placed on private use during the day.

Proposal

5.26     Applying an 18% reduction to the 24% discounted rate considered appropriate in the early 1980s and included in the legislation would reduce the rate to 20%. The equivalent percentage using book value as the base would be around 36%. The government proposes, therefore, to introduce revised valuation rates of 20% for cost and 36% for book value.

Leased vehicles

5.27     FBT on leased vehicles is assessed on the vehicle's market value at the beginning of the lease. This is intended to produce the same outcome as if the vehicle were owned but removes the need for the employer to ascertain the cost or book value from the owner.

5.28     In practice, however, as a number of submissions noted, leasing a vehicle can produce a lower FBT liability. This is because many leases are being structured so that they become renewable each year, resulting in a new market value annually and a commensurate reduction in FBT as the vehicle ages.^[11] The result is that, effectively, there is a double recognition of depreciation - one being through the market value of the vehicle and the other being incorporated into the rate calculation, as explained earlier.

5.29     This situation should be rectified to help ensure both that the FBT base is not undermined and that the choice between leasing and owning is not driven by the tax outcome.

Proposal

5.30     The suggested approach is to provide equality of treatment between leased and owned vehicles by allowing lessees the same options that owners have when valuing the fringe benefit. This means that lessees would be able to use either a rate of 20% on the cost price of the vehicle or a rate of 36% on the book value of the vehicle. If lessees cannot obtain the necessary cost price or book value information from the lessor, they would be able to use a market value rate (27%) that produces an equivalent FBT result.

5.31     This option would not increase compliance costs for employers who lease vehicles as they could continue the current practice of valuing vehicles each year, with the book value or cost price generally replacing the market valuation.

Availability on a daily basis

5.32     A related issue raised by submissions is whether the FBT liability should continue to be calculated on a daily basis. Currently, if a vehicle is available for private use at any time during the day, such as for home-to-work travel, the vehicle is considered to be available for the whole day. Calculating the benefit on, say, an hourly basis would involve a far higher compliance cost and would be more difficult to monitor. Some submissions considered that calculating on a daily basis leads to unfair outcomes when, for example, an employee takes a vehicle home at night because the employee is required to take it to another work site the following morning. In such cases the vehicle is considered to be used privately between the time it is driven home and the time it is driven to work and an FBT liability arises for both days.

5.33     We agree that when an employee has no choice but to take a vehicle home so as to get to another work site the following day, such as may occur with a district nurse, that this should be treated as a business use, provided the employee is prohibited from using the vehicle for private use over the period. The recently released exposure draft IS3448, from Inland Revenue's Adjudication and Rulings division, is likely to be helpful in clarifying the FBT treatment in such cases.

5.34     The government has also looked at the feasibility of a day being defined as any 24-hour period rather than a calendar day. A reference point would be needed, which could be achieved by employers electing when their day would begin. For example, an employer may elect to begin the day at 6.00pm, in which case any private travel between 6.00pm on a particular calendar day and 6.00pm the following calendar day would be treated as being all within the same day for FBT purposes.

5.35     The employer's election would apply for every day thereafter but could be reviewed after three years. The election would also only apply to motor vehicle fringe benefits. Employers should not generally need to maintain more records as a result of this option if the private use of a vehicle follows a regular pattern and can, therefore, be established through a logbook test period. Moreover, it is optional, so that if an employer makes no election, the current treatment of a calendar day would apply.

Proposal

5.36     Individual employers would have the option to elect the start time for their day for the purposes of calculating their motor vehicle fringe benefits, and that election would also apply for every day after the election. Employers could review their election after three years. If an employer did not make an election, a day would be a calendar day.

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