All About car financing.......

Source: The Economic Times

Arun Seth, a salaried employee is about to purchase a car of Rs 350,000 under a margin money scheme. He has to pay margin money of Rs 35,000 and pay an EMI of Rs 10,000 for the next three years. He is also expected to incur monthly car running costs of around Rs 5,000. Arun would meet the margin money, EMI and car running costs from his take home pay. Is this the right step?

What should Arun do to optimise his tax benefits? There are broadly two types of conventional auto financing schemes which are typically chosen by buyers - margin money scheme and finance lease. Another variant of a lease is an operating lease, which perhaps is the most beneficial for a salaried employee. However, it is the employer who has to enter into this lease arrangement and not the employee. All the above three Car Financing mechanism are explained below in detail:

1. Margin money scheme: Typically, under the margin money scheme, the ownership of the car lies with the buyer but the car is hypothecated with the financier as security. The financier finances up to 90% of the cost of the car and the buyer has to pay the balance amount as down payment. The financed amount is repaid in equated monthly installments (EMI) during the tenure of the loan, which generally ranges from three to seven years.
2. Finance lease: Under the scheme, the ownership of the car lies with the financier. The car is leased out to the customer for a specified tenure and the customer pays monthly lease rentals for use of the car. At the end of the lease term, the customer has the right to purchase the car at an agreed residual value. The scheme is so structured that the monthly lease rentals together with the residual value equal the cost of the car and the interest calculated thereon for the lease term at a certain rate. A finance lease is preferred by individuals who do not have enough funds to pay the upfront down payment. The interest rates charged are dependent on various factors like the economic profile of the customer and his credit rating. In certain cases, finance companies and banks also have tie-ups with car manufacturers and offer competitive rates on specific car models.
3. Operating lease: Under operating lease, the car is merely provided on rent to the customer against monthly hire charges. Running costs like repairs, insurance, etc., may be borne by either the leasing company or the customer and the monthly hire charges reflect the same. At the end of the lease term, the car is repossessed by the leasing company. Operating leases are not offered by banks and are generally offered by non-banking financial companies and leasing companies to corporate employers.

Tax planning for salaried employees

Unlike self-employed individuals who can claim the interest payments and car depreciation as a deduction and lower their tax bill, salaried employees do not enjoy any tax benefits under conventional auto financing options. Ideally, Arun should approach his employer who should then get into an operating lease arrangement with the finance company. This car can then be provided to Arun for official and personal use.

Process through which it is done

Here, as against the employee entering into a conventional financing arrangement with the financier, the corporate employer enters into an operating lease in respect of the car with the leasing company and provides the car to its employee, who then uses it for both official and personal purposes. On the tax front, the corporate employer incurs a Fringe Benefit Tax (FBT) cost. Thus, there is no tax liability on the benefit provided: - usage of the car, in the hands of the employee. It is essential that the lease is in the nature of an operating lease since the FBT provisions apply only in respect of operating lease payments. The lease rentals would be paid directly by the corporate employer ti the leasing company and the employee's take home pay would be lower to that extent. The running costs of the car upto a certain limit could be reimbursed by the employer on production of necessary evidence. As mentioned above, at the end of the lease term, the leasing company would repossess the car. The employee could if required, enter into a separate arrangement with the leasing company to purchase the car at an agreed residual value.

The tax advantage: How it works

The tax planning opportunity is presented by certain provisions of newly introduced FBT regime which seeks to tax certain fringe benifits provided by employer to their employees at the hand of employer. Under the FBT provisions, rent payable for an operating lease of a motor car is liable to FBT. The value of fringe benefit provided to the employee is laid down at 20% of the lease rentals. The employer is required to pay FBT @ 33.66% of such value (the effective FBT rate working out to be 6.73%). Reimbursements of car running costs like fuel, maintenence, driver's salary, etc., are also liable to FBT at an effective rate of 6.73% of such reimbursements. Once an employer has paid FBT on ceratin benefits provided to employees, such benefits are not taxed as perquisites in the hand of the employees. The above provisions present a useful tool to leverage the lower FBT rates and reduce the overall tax costs suffered by employees.

In Arun's case, his employes would be liable for an annual FBT in respect of the lease rentals and the reimbursements of the car running expenses. His annual taxable salary would be lower to the extent of the lease rentals and reimbursements, resulting in substaintial tax savings. However, even though the car is used by him, he would not have to pay any tax on the benefits (perquistes) available to him. Further, at the end of lease period, if the car is sold by the leassing company to the employee after having reposed the car, the perquisite rule would not be triggered since the transferror is not the employer and accordingly, the employee would not be taxed on such transfer. On the other hand, in the absence of an operating lease arrangement by the employer, he would have to pay income tax on the lease rentals and car running costs, which would be a taxable perquisite.

Other Factors

However, before implementing the above option, one should also consider other factors like registration cost (since the car would require a corporate registration which costs substantially more than an individual registration- the car would be registered in the name of leasing company) and the residual value at which car is sold to the employee at the end of the lease period. An informed desicion after considering the above factors, could enable the employee to reduce his yearly tax bill in an efficiant manner.

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