Issue
Is the first element of cost of a luxury car reduced to the car limit under section 40-230 of the Income Tax Assessment Act 1997 (ITAA 1997) if, following the early termination of a novation arrangement with one employer, the employee immediately novated the car lease to a new employer?
Decision
Yes. If the car is a luxury car at the time the car lease is novated to the new employer the first element of cost of the car for the new employer is reduced to the car limit under section 40-230 of the ITAA 1997.
Facts
A luxury car is provided to the employee via a novated lease. The car cost $100,000 when new. The first employer commenced the lease of the car on 1 July 2003. The employee terminated their employment with this employer on 30 June 2004. At this time, the amount taken to be the cost of acquisition of the car by the lessor from the first employer under former subsection 42A-105(3) of former Schedule 2E to the Income Tax Assessment Act 1936 (ITAA 1936), was $80,000 (being the market value on the termination of the lease as required by former paragraph 42A-105(3)(b) of former Schedule 2E to the ITAA 1936).
The employee commenced employment with the new employer on 1 July 2004, which is also the date the luxury car lease was novated to the new employer. The luxury car limit for the 2004-05 income year is $57,009.
The employee remains with the second employer until the remaining two years of the lease have expired.
Reasons for Decision
Balancing adjustment event - first employer
Former Division 42A of former Schedule 2E to the ITAA 1936 applies to the lease of a luxury car. Ordinarily the employee, as the lessee of a luxury car, is the holder of the car under item 1 of the table in section 40-40 of the ITAA 1997.
However, under a fully novated lease, the employer is the lessee of the car for the purposes of former Division 42A of former Schedule 2E to the ITAA 1936. In that case, the employer is the holder of the car under item 1 of the table in section 40-40 of the ITAA 1997.
When the novation arrangement was terminated because the employee ceased being employed by the first employer, the employer stopped being the lessee of the car for the purposes of former Division 42A of former Schedule 2E to the ITAA 1936. Consequently, the employer stopped holding the car because item 1 of the table in section 40-40 of the ITAA 1997 no longer applied.
At this time the lessor again becomes the holder of the car. This is because, on early termination of the novation arrangement the car is taken to have been disposed of by the lessee by way of sale to the lessor and to have been acquired by the lessor on the early termination of the lease.
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 ITAA 1936 or the market value, if it is impractical to use the formula. In this arrangement, this amount is $80,000. Note that there is not a formula under sub-section 242-90(3) of 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 became the lessee of the luxury car at that time and started to hold the car under item 1 of the table in section 40-40 of the ITAA 1997.
Result of novation to new employer and cost to that employer
Taxation Ruling TR 1999/15, at paragraphs 25 to 29, explains that the new novation is a new lease. The second employer becomes the lessee after entering into the lease and also becomes the holder of the car under item 1 of the table in section 40-40 of the ITAA 1997.
Where the new novated lease is a luxury car lease, the cost will be the base value that the second employer uses when working out its decline in value under section 40-70 of the ITAA 1997. The cost of a depreciating asset that is held consists of two elements. The first element is worked out as at the time when you began to hold the asset. In this case, it will be the amount that the employer is taken to have paid to hold the asset under section 40-185 of the ITAA 1997.
Under item 1 of the table in subsection 40-185(1) of the ITAA 1997, the cost is the amount you pay to hold a depreciating asset or to receive a benefit. The note accompanying subsection 40-185(1) of the ITAA 1997 makes it clear that the amount you pay under item 1 includes amounts taken to be the consideration for the acquisition of the car under former section 42A-20 of former Schedule 2E to the ITAA 1936 (or from 1 July 2010, subsection 242-90(3) of the ITAA 1997).
Because the new novation occurs immediately after the termination of the first novated lease the amount taken to be paid by the lessor when that luxury car lease was terminated under former subsection 42A-105(3) of former Schedule 2E to the ITAA 1936 will be the amount to be used for the purposes of former section 42A-20 of former Schedule 2E to the ITAA 1936. If the intervening period between the termination of the first novation and the new novation were longer, the taxation effects of the intervening transactions (e.g. the balancing adjustment event that occurs because of the employee's novation to the new employer) may have to be taken into account. The amount taken to have been received under former 42A-105(3) of former Schedule 2E to the ITAA 1936 for the purposes of this example was $80,000. This is the amount that the second employer is taken to have paid to hold the car from 1 July 2004.
The amount of $80,000 is the first element of cost of the car for the second employer. It exceeds the car limit for that year and is therefore reduced (by the operation of section 40-230 of the ITAA 1997) to that limit, namely $57,009.
Amendment History
Date of Amendment Part Comment 07 June 2019 Reasons for Decision Legislation repealed on 1 July 2010. Added 'former' to references to the repealed law where required and inserted New Legislative references Reasons for Decision Paragraph 5 Minor changes to existing content. Addition of a Note distinguishing the replacement provision from the repealed provision in relation to a cost formula
Date of Amendment | Part | Comment
07 June 2019 | Reasons for Decision | Legislation repealed on 1 July 2010. Added 'former' to references to the repealed law where required and inserted New Legislative references
Reasons for Decision Paragraph 5 | Minor changes to existing content. Addition of a Note distinguishing the replacement provision from the repealed provision in relation to a cost formula