Private ruling: Lease Residual Values - Lease Shortfall payments - General deductions
Published: September 2017
Ruling period: Year ended 30 June 2017 | Year ended 30 June 2019
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the Commissioner treat the residual value determined in this ruling for the motor vehicle under the taxpayer's Novated Lease Arrangement (motor vehicle number 2) as the notional value for the purposes of subsection 43(c) of the FBTAA 1986? | A1: Yes Issue 2 | Q2: Will the lease shortfall payment made at termination of the lease for your former motor vehicle (motor vehicle number 1) constitute deductible expenditure pursuant to section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No

Relevant facts and circumstances: From 20XX to 20XX, your employment was based in the Sydney CBD. In 20XX, your employer relocated your position to a regional area. Due to family circumstances, it was not appropriate for you to relocate to a residence closer to the employer's office in the NSW regional area. You previously entered into a novated lease arrangement via a Salary Sacrifice Agreement (SSA) with your employer, in relation to motor vehicle number 1. Under this arrangement, the lease payment obligations are transferred to your employer but the residual payment obligations remain with you. You applied the minimum residual value (as percentage of cost) published in ATO Interpretive Decision (ATO ID) 2002/1004 (ATO ID 2002/1004) to this vehicle. In accordance with ATO ID 2002/1004, the agreed residual value for this vehicle at the end of the lease is $X. You advise that at the termination of the lease, you purchased this vehicle from a finance company (by paying out the residual value). You sold this vehicle for $X. Therefore, you incurred a net 'lease shortfall' amount of $Y. You forwarded documentation to the ATO, evidencing that you have entered into a new Novated Lease Arrangement for a new motor vehicle - motor vehicle number 2. This lease is for a term, and is also the subject of a SSA with your employer where the lease payment obligations are transferred to your employer but the residual payment obligations remain with you. You state that both of your motor vehicles are, while leased, used in the course of your employment and also for private purposes. You provided a written response which indicates that the percentage of private use is X%, and the percentage of business use is Y%. You have also stated that each of these motor vehicles either travels or is estimated to travel a distance in excess of 50,000 kilometres per annum.

Relevant legislative provisions: Fringe Benefits Tax Assessment Act 1986 subsection 43(c) | Income Tax Assessment Act 1997 section 8-1 Reasons for the Decision | Issue 1 | Minimum Residual Values | The concept of providing minimum residual values for leased cars as per ATO ID 2002/1004 is two-fold, in that: (i) It ensures that employers in a Novated Lease Arrangement are able to deduct lease payments (as this is one indicia supporting why the lease is considered to be a bona fide lease); and (ii) it provides certainty on the Fringe Benefits Tax implications arising on termination of the lease, where it is a bona fide lease. | The principles contained in Taxation Ruling IT 28 (IT 28), Taxation Determination TD 93/142 (TD 93/142), and Taxation Determination TD 95/63 (TD 95/63) all provide guidance to the effect that the residual value of a leased item should reflect its market value at the end of the lease, and not its written down value. | Paragraph 7 of IT 28 provides that it is necessary to decide whether the payments really are lease rentals or whether they are, in substance, consideration for the sale of the goods purported to be leased. In the latter case, the payments would be outgoings of a capital nature which would not be deductible for income tax purposes. | Paragraph 4 of TD 95/63 makes reference to IT 28, and further provides that 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, the lease agreement will generally be accepted as a bona fide lease. | TD 93/142 provides at paragraph 4 that a residual value lower than those outlined in the table may be used where a well-considered and fair estimate of the likely market value of the item at the end of the lease would result in a lower value. | Taxable value of external property fringe Benefits | Section 43 of the FBTAA specifies the rules for calculating the taxable value of external property fringe benefits. | External property fringe benefits are defined in subsection 136(1) FBTAA to mean a property fringe benefit other than an in house property fringe benefit. | Section 43 of the FBTAA sets out three methods of calculating the taxable value of external property fringe benefits - each applies to a particular set of circumstances. | Section 43 of the FBTAA provides: | 'Subject to this Part, the taxable value of an external property fringe benefit in relation to an employer in relation to a year of tax is: | a) Where the provider was the employer or an associate of the employer and the recipients property was purchased by the provider under an arm's length transaction at or about the provision time - the cost price of the recipients property to the provider; | b) where the provider was not the employer or an associate of the employer and the employer, or an associate of the employer, incurred expenditure to the provider under an arm's length transaction in respect of the provision of the property - the amount of that expenditure; or | c) in any other case - the notional value of the recipients property at the provision time; reduced by the amount of the recipients contribution.' | Notional value method | As the first two methods of ascertaining the taxable value of an external property fringe benefit do not apply in your case, subsection 43(c) of the FBTAA is to be applied. | The notional value, in relation to the provision of property or another benefit to a person, is defined in subsection 136(1) of the FBTAA as the amount that the person could reasonably be expected to have been required to pay to obtain the property or other benefit from the provider under an arm's length transaction. | An arm's length transaction is defined in subsection 136(1) of the FBTAA as a transaction where the parties to the transaction are dealing with each other at arm's length in relation to the transaction | In other words, the notional value would be equivalent to the market value, where the parties are dealing with each other at arm's length. | Paragraph 9 of TD 95/63 provides two examples where a motor vehicle is acquired at the residual value, and whether the purchase is considered to be at arm's length for the purposes of section 43 of the FBTAA. Part of example 1 involves a situation where the employee makes the purchase - as highlighted in bold text below: | 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. | You have advised that the resale value of your leased motor vehicles is always less than the minimum residual value calculated in accordance with the percentages of the original cost as set out in the table in ATO ID 2002/1004, due to your excessive mileage and your specific circumstances. Accordingly, you have asked the Commissioner to determine whether he will treat the minimum residual value for motor vehicle number 2 determined as X% of its cost for a lease period as the notional value of the vehicle for the purpose of subsection 43(c) of the FBTAA. | The Commissioner has released guidance in the form of an ATO publication on the process of conducting a market valuation for various taxation purposes. This publication indicates that a market valuation assessment should be based on reasonably objective and supportable data. It also indicates that a market value determined in advance may not be reliable because subsequent events may change the appropriate valuation. However, where the valuer's method takes these unknown future events into account, the ATO may be prepared to accept that method. | Your specific circumstances involve a prospective valuation of a motor vehicle. You have provided evidence that the estimated market value of your current motor vehicle (motor vehicle number 2) will be $X at the end of the lease, on the basis that your mileage is approximately 100,000 kilometres over a period of time (as evidenced by your historical pattern of vehicle usage and the distance from your residence to your place of employment). | This evidence is considered to constitute reliable and independent evidence provided by a person who possesses specific knowledge, experience and judgement in the field. It is therefore considered to be a well-considered and fair estimate of the prospective market value of the current vehicle - motor vehicle number 2 - at the end of the lease term. It is supported by your previous pattern of travel over X years which was Y kilometres. Accordingly, the estimate based on 100,000 kilometres being travelled over the next X years is reasonable, provided your circumstances are not reasonably expected to change in this time. | On the basis of the valuation you have provided and having regard to your specific circumstances, the percentage of cost that you are able to use to determine the minimum residual value in respect of the lease on motor vehicle number 2 will be X% at the end of the lease. This is provided that the residual value represents a bona fide estimate of the market value of this motor vehicle on termination of the lease, and your mileage continues to be at least 50,000 kilometres per annum over the next two years. If the residual value for motor vehicle number 2 at the end of its two-year lease term is X% of its cost, the Commissioner will treat that residual value as the notional value for the purposes of subsection 43(c) of the FBTAA, consistent with TD 95/63 | Issue 2 | Detailed reasoning | Section 8-1 of the 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. | Subsection 8-1(1) of the ITAA 1997 provides: | 'You can deduct from your assessable income any loss or outgoing to the extent that: | a) It is incurred in gaining or producing your assessable income; or | b) It is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income. | Note: Division 35 prevents losses from non-commercial business activities that may contribute to a tax loss being offset against other assessable income.' | Subsection 8-1(2) of the ITAA 1997 provides: | 'You cannot deduct a loss or outgoing under this section to the extent that: | a) It is a loss or outgoing of capital, or of a capital nature; or | b) It is a loss or outgoing of a private or domestic nature; or | c) It is incurred in relation to gaining or producing your *exempt income or your non-assessable non-exempt income; or | d) A provision of this Act prevents you from deducting it..... ' | Paragraph 8-1(2)(b) of the ITAA 1997 (the second negative limb of section 8-1) denies a deduction for a loss or outgoing that is of a "private or domestic nature". What constitutes "private" or "domestic" expenses is not defined in the Act. However, under ordinary concepts, expenditure that is "private" in nature is generally considered to relate to you in your personal or private capacity and expenditure that is "domestic" in nature is ordinarily associated your household or other domestic affairs. A loss or outgoing is not deductible to the extent that it is of a "private or domestic nature''. Private or domestic expenses are generally not deductible under section 8-1(1) in any event, since they are not normally "incidental and relevant" to earning assessable income and their "essential character" (being to live, rather than to generate assessable income) logically severs them from any income-producing activity: Federal Commissioner of Taxation v Hatchett (1971) 125 CLR 494, per Menzies J (at p498). That is, expenditure which is "essentially" of a private or domestic nature will not generally be deductible under subsection 8-1(1) of the ITAA 1997as it will not have been incurred by a taxpayer "in the course of" gaining or producing assessable income, even though the taxpayer may, as a matter of practicality, need to incur the expenditure to earn assessable income. | In the present case, your employer leased a motor vehicle (motor vehicle number 1) for you to use for both work and for private purposes under a Novated Lease Arrangement via a SSA. You did not own the motor vehicle because of the Novated Lease Arrangement between yourself and your employer. It was not until you paid the residual at the termination of the lease that you acquired the vehicle. However, simultaneously with terminating the lease you sold the vehicle and incurred a loss of $X. Therefore, the net lease shortfall payment which was made as a result of these transactions was not to any extent incurred in gaining or producing income, as the vehicle was never used to any extent, following its acquisition by you, in gaining or producing income, and it was a wholly private or domestic expenditure. The lease shortfall amount is not deductible under section 8-1 of the ITAA 1997.