Companies should base their car selection policies on the wholelife cost of the vehicle. Deloitte business car consultant Dan Rees explains why.
When organisations do not base their car selection policies on the true, post-tax whole life cost (WLC) of cars to the business, this can result in cost uncertainty, lower potential for cost savings, reduced incentive for employees to choose “greener” cars, and less flexibility in choice.
Employers implementing salary sacrifice schemes for cars without considering the WLC are open to unexpected costs or the risk of providing a less attractive benefit, reducing take-up.
What is WLC?
The design and operation of a fleet of company cars based on their WLC is now widely accepted as best practice within the fleet industry for cost control purposes.
The WLC equation is specific to the business acquiring the cars and must incorporate all incurred commercial costs, such as funding, fuel, maintenance and insurance, which are then adjusted for the implications of corporation tax relief (and restrictions), employer’s National Insurance (NI) and VAT, as appropriate.
These costs and taxation implications must be considered for the full retention period of the vehicle, incorporating any known legislative changes that occur during that period. All cash flows can then be discounted at a specific rate to calculate the true cost, or net present value (NPV), of the contract to the business.
These calculations are not straight forward, particularly when considering complex fuel reimbursement arrangements, or the quantum and timing of cash flows, such as tax relief and NI payment for discounting purposes.
Why use WLC?
Many businesses still base their car selection policies on upfront cost bands, such as list price or monthly lease rental. The issue with this approach is that there can be a huge variation in WLC terms of cars with the same upfront cost, often many thousands of pounds, which is directly related to the emissions level (tax cost) and depreciation rate of each individual car.
It is difficult for policies structured in this way to create cost savings or certainty, without applying heavy restrictions to the types of car available for selection by employees.
Greater cost certainty is achieved by selecting cars according to WLC band, rather than upfront cost band where this variation in WLC arises. However, this approach in isolation does not necessarily improve choice or incentivise the selection of “greener” cars because ultimately there is still a band; it is just defined using different parameters.
There could also be a distinct difference in the types of car that exist in any one WLC band. One could be a high depreciating car with high emissions and the other low depreciating with low emissions. Restrictions would still need to be applied to car choice, such as emissions caps, but for reasons other than simply cost.
Increasing choice and 'green' incentive
Deloitte’s methodology uses WLC, but it is designed to increase choice, flexibility and provide an incentive to choose 'greener' cars. Instead of a WLC band, a WLC figure is used as a benchmark for an employee car entitlement grade. Employees can choose cars either side of this level, with a financial adjustment made to ensure that the WLC of any car to the business is the same as the benchmark.
If an employee chooses a car above the benchmark, a tax efficient payment from net salary can be calculated to cover the WLC difference to the employer, taking into account the changes in tax charges to both parties.
Note that this is not the same as 'trading up' to a better car in the usual sense, but is simply making a contribution towards the private use of a car, within grade parameters.
A similar mechanism could apply in the reverse direction, where an employee chooses a car below the same benchmark to receive in return an additional, non-pensionable, payment of gross salary, which generally provides an excellent incentive for employees to choose “greener” cars.
It is worth bearing in mind that with greater flexibility and choice come reduced reallocation potential in the event of employees leaving. In practice reallocation can be a fairly unpredictable and difficult exercise, regardless of the car selection policy, but there is a balance that can be found.
Potential for cost savings
Our experience of implementing WLC policies with employers is that besides providing a valuable cost control framework for the company car fleet, there is also the potential for substantial cost savings by moving away from the existing upfront cost based policy.
Since the most influential factors are emissions and depreciation, we frequently find that, counter-intuitively, the total fleet WLC can be reduced by making more desirable cars with higher upfront costs and lower emissions available for selection.
In one example, a fleet comprised solely of cars from one manufacturer, a heavily restrictive policy traditionally used to drive down upfront costs, was restructured using the WLC basis to widen employee choice to several manufacturers.
The cost saving expected to be realised is 10% of the original fleet cost over one fleet cycle, building in a 10% year on year increase in fuel price. The business is pleased with the cost savings and structure provided by the new design and the employees are much happier with their greater choice, despite having to pay for it in some cases.
Evidence suggests that there are more employees receiving gross cash reimbursements than making net salary payments, an indication of employees making informed cost based decisions and selecting lower CO2 alternative cars.
Carbon footprint and duty of care implications
Road transport generates a huge percentage of the
Deloitte’s WLC methodology uses the tax system to provide a clear cost benefit for employees to choose 'greener' company cars. This only happens though, if the financial adjustments are calculated according to WLC, not upfront cost, and the employees are able to view the true cost of cars to them, rather than concentrating solely on the adjustment payments.
A concern for businesses which have decided in the past to move away from company cars to the provision of cash allowances in their stead is that there is no real incentive for employees who take cash to choose low emission cars.
In fact, the average emissions of these populations of drivers’ cars are substantially higher than equivalent company car fleets, due largely to the cars being older. Cash fleets can be more administratively problematic to ensure that all cars are roadworthy and within policy parameters, which introduces a duty of care issue.
The rise of salary sacrifice
Salary sacrifice is of rapidly growing interest to employers, in both the public and private sectors, that wish to reduce their environmental and duty of care exposure by providing a tax efficient alternative for employees who take cash, or reinvigorate their benefits package to offer a company car to their ineligible wider workforce.
An employee can elect to give up an amount of salary in return for a company car, which is taxed as a benefit in kind (BIK) as usual. It works because the tax regime is favourable to low emission company cars, when compared to salary.
In addition, the business can potentially reclaim VAT and can usually receive volume based discounts from the car manufacturers, both of which are unavailable to an individual.
All this means that an employee could get a car from the scheme at a substantial saving when compared to buying the same car privately.
Businesses can choose to share in this saving, whilst not overly decreasing the attractiveness to employees, but calculating the sacrifice amount is crucial to ensure that the WLC of the car to the business is fully covered and the level of savings the business requires to make is realised.
It is very important to look at the existing company car policy when examining whether salary sacrifice is the right option for cash takers.
The risk is that a properly designed salary sacrifice scheme using WLC as the basis for the calculations is more attractive than the existing company car scheme, which could lead to more employees taking the cash route only to move back into company cars via salary sacrifice.
If the cost of the cash to the business is higher than a company car, then that could dramatically increase the fleet cost, which is obviously not the desired intention. It would be a lot easier to simply restructure the existing company car fleet to use WLC, as it achieves the same result.
WLC is widely accepted as the most effective way to provide cost control and certainty in a company car fleet. Flexibility and choice are additional benefits, but the calculations required to achieve this accurately are complicated.
Salary sacrifice for company cars is a brand new benefit in the flexible benefits arena and our technology is helping to ensure that employers do not face unexpected costs through our application of the WLC methodology.
WLC, used correctly, allows for employer cost savings and greater certainty, opens up choice to employees, incentivises selection of lower CO2 cars and enhances the value of the benefit of a car.