Many employers these days are offering car allowances as opposed to company cars, as then the employee is required to go and take out a form of car loan for themselves and if their employment ceased with their current employer, the car loan carries on with them and there is no ongoing commitment to the employer.

There are a few things to consider when using up your car allowance to assist with your vehicle purchase.

How to spend your car allowance

When being provided a car allowance, it’s not just the car loan repayment that needs to be factored in. You need to estimate how much you need to put aside for running costs, which could include fuel, insurance, registration, ongoing servicing, and maintenance. Your car allowance is designed to cover all of this, so you’ll need to keep that in mind when budgeting and looking at various vehicles.

Does my current car meet the requirements?

You could use your car allowance to simply run and maintain your current car. You’ll have the flexibility to spend the funds how you want but the allowance will be treated as taxable income. However, you’ll need to consider whether the vehicle is suitable for the job you’re required to do.

You may need a towbar and a certain level of torque to pull a trailer with the equipment you need for a job. You may need a large amount of space in the vehicle to fit tools. If you’re travelling long distances, you’ll need a reliable car and may want one with good fuel efficiency.

If your car doesn’t fit the bill, you may have to look at other finance options.

What are my finance options?

There are four main options when considering a car allowance:

Commercial Hire Purchase

The most common form of a car loan for a car allowance in the past was a “Commercial Hire Purchase”. This form of loan is being used less now due to new taxation rulings in regards to GST implications. Unless you are registered for GST and have the ability to claim the GST, this form of loan may be the most costly, which is why a commercial hire purchase is being used less and less.

Consumer loan or chattel mortgage

Chattel mortgages and consumer loans are quite commonly used with car allowances. Both have the same outcome as to the ownership of the car, yet the chattel mortgage is declaring that the usage of the vehicle will be wholly or predominantly for business use. A chattel mortgage may have less favourable terms if the loan were to be terminated early though, so ensure that this is factored in when weighing up your decision. Because you own the vehicle, the available tax deductions may be the same with either structure, but speak with a tax professional first.

Novated lease

A novated lease is an agreement between you, your employer, and a finance provider. You enter into a car lease which your employer then takes over and pays for out of your pre-tax salary. This can provide significant tax savings while also giving you the opportunity to upgrade cars every year if you wish.

Finance lease

A finance lease is another option that can be used for a car allowance. The main point of difference with this structure is the financier owns the vehicle, which you lease from them. This could result in the repayments being subject to GST. There is less flexibility with lease agreements with this structure, due to the requirement of having a residual value at the end of the lease.

Whichever way you decide to go, it’s recommended you speak with a tax professional prior to entering into any contracts.

How do tax deductions and car allowances work?

A car allowance doesn’t save you on tax and is treated as taxable income. It doesn’t matter how little or how much you use the car for work, all of your allowance is treated as taxable income by the tax office. This is why novated leases are attractive for some people, as the allowance comes out of your pre-tax salary.

At tax time, you can claim a tax deduction for using your car for business purposes. The allowance isn’t a deductible expense, it just assists you with work expenses you may have incurred while using the car.

There is a range of costs you may be able to claim with regards to your vehicle, but that will come down to how you used the vehicle and the deduction method you choose. Consider visiting a tax specialist or the Australian Tax Office website.