Tax Break: Perk quirk

(December 2006) A new job is often accompanied with a number of decisions relating to the benefits package. And not surprisingly it’s the flashy ones, like company cars and club memberships that get the most attention. So when your clients ask for guidance, bring them down to earth. First, point out the value of employment perks is often taxable, so in the case of an individual who is taxed at a 46% marginal rate, the benefit will cost that person 46 cents on the dollar. That’s fine, so long as it’s a perk that person needs.

Consider Miranda Drake, who’s negotiating a compensation package with her soon-to-be employer. As a 30-something upwardly mobile executive, she loves the idea of having the company provide her a brand new BMW. Although she does expect to drive for business, the car will primarily be used for personal trips. Her best guess is that she’ll put on 10,000 kilometres a year for out-of-office appointments, 7,000 kilometres annually to and from the office (which is not classified as business use under the tax code), and an additional 8,000 klicks for personal travel.

The car costs about $49,000 but the company will likely lease it for about $770 per month (including tax) and pay annual insurance of $1,400. Miranda will pay fuel costs but the company will provide an allowance of 40 cents per kilometre for business travel. Miranda’s annual taxable benefit relating to this car will be comprised of the standby charge for having a car available for personal use and an operating benefit relating to the company’s payment of expenses. The allowance provided by the company for business driving will be tax-free, since it’s deemed a reasonable allowance by the CRA.

Now for some math. The standby charge benefit for a leased car, computed as 2/3 of the lease cost, is $6,160 per year. Interestingly, this is almost one-half of what the benefit would be if the same vehicle was purchased (in that case the standby charge would be 2% per month of the cost, or $11,760).

That’s why it’s almost always better to have an employer provide a leased car. The standby charge applies no matter how much or how little the car is used for business. However, if more than 50% of travel is related to business and personal travel is below 20,000 kilometres annually, the basic standby charge can be reduced by applying the fraction of personal kilometres driven/20,000.

Miranda won’t benefit from the standby charge reduction because driving to and from the office is not counted as business travel. The operating benefit is 22 cents per kilometre of personal travel when an employer pays any portion of operating costs. Since Miranda’s employer only pays $1,400 for insurance, she still winds up with a taxable benefit of $3,300.

All totalled, this perk translates to a $9,460 taxable benefit which will cost her $4,350 in tax. Miranda may be better off negotiating a higher base pay and leasing a more modest car or using her own car for business travel.

But if she’s really set on the company car, she should agree to pay her own insurance in exchange for a $1,400 increase in salary. Doing that would push her net income inclusion down to $7,560.

This doesn’t mean a company car is always a bad deal. Someone who uses one for 20,000 annual business kilometres and 5,000 personal kilometres is a great candidate for the perk. The standby charge benefit in that case is only $1,540 and net income inclusion, in respect of the insurance supplement, is only $770 (if business usage exceeds 50%, the operating benefit can be 1/2 of the standby charge); a total taxable amount of $2,310 and related tax of only $1,060.

This is the first of a two-part series on workplace benefits.

Gena Katz, FCA, CFP, is an executive director with Ernst & Young’s national tax practice in Toronto. “Tax Break” appears monthly. This is the first of a two-part series on workplace benefits.

(12/06/06)