For business owners and employees who use personal vehicles for business purposes, a car allowance is a beneficial option provided by the Canada Revenue Agency (CRA). This allowance enables businesses to reimburse individuals for the business-related use of their personal vehicles. It’s essential to understand how to correctly implement and report a car allowance to ensure compliance with CRA regulations and to fully take advantage of the available tax benefits.
Defining the Car Allowance
A car allowance is essentially a reimbursement for using a personal vehicle for business purposes. This can apply to sales representatives visiting clients, employees making deliveries for their employer, or any situation where a vehicle is needed for business activities.
There are two main ways to receive a car allowance: a per-kilometer allowance or a fixed vehicle allowance. Each method comes with its own tax implications and benefits, affecting both the individual receiving the allowance and the business providing it.
Allowance Per-Kilometer
The per-kilometer allowance is calculated based on the number of kilometers driven for business purposes. For the 2024 tax year, the CRA mileage rates are $0.70 per kilometer for the first 5,000 kilometers, and $0.64 for any additional kilometers. In 2023, the rates were $0.68 for the first 5,000 kilometers and $0.62 for additional kilometers.
This allowance is fully tax-deductible for the business and does not need to be reported as income by the individual, making it a tax-free benefit. However, the individual receiving the allowance cannot claim any additional vehicle-related expenses on their personal tax return, except for parking fees.
Fixed Car Allowance
Alternatively, some businesses provide a fixed vehicle allowance, where the individual receives a set monthly amount to cover the business use of their personal vehicle. While this allowance is tax-deductible for the business, it is considered taxable income for the individual and must be reported on their T4 slip.
The advantage of this method is that the individual can claim actual vehicle expenses—such as maintenance, fuel, insurance, repairs, and lease payments—on their tax return. These expenses must be prorated based on the proportion of the vehicle’s use for business versus personal purposes.
Choosing the Right Approach
Choosing between a per-kilometer allowance and a fixed vehicle allowance depends on the vehicle’s usage and the individual’s financial situation. Let’s look at a couple of examples to illustrate this:
Scenario 1
Employee A drives 27,000 kilometers annually for business (90%) and 3,000 kilometers for personal use (10%). They incur $30,000 in annual vehicle expenses (maintenance, lease, etc.).
Under the per-kilometer method:
- 5,000 km x $0.70 = $3,500
- 22,000 km x $0.64 = $14,080
- $3,500 + $14,080 = $17,580
Employee A receives a $17,580 car allowance, which does not need to be reported as income on their personal tax return. The business can claim this $17,580 as a deductible expense.
Under the fixed allowance method:
Let’s assume the business pays Employee A $1,500 per month as a fixed allowance.
- The annual car allowance is $18,000, but since only 90% of the vehicle use is for business, Employee A can claim 90% of that:
90% x $18,000 = $16,200 - The difference of $1,800 is considered taxable income.
- With a 40% tax rate: 40% x $1,800 = $720
- Employee A’s after-tax amount: $18,000 – $720 = $17,280
Additionally, Employee A can claim 90% of their vehicle expenses:
- 90% x $30,000 = $27,000
So, while Employee A pays $720 in taxes, they keep $17,280 after tax and can claim $27,000 in vehicle expenses. The business can deduct $17,280 as a business expense.
Scenario 2
Employee B drives 9,000 kilometers annually for business (90%) and 1,000 kilometers for personal use (10%).
Under the per-kilometer method:
- 9,000 km x $0.70 = $6,300
Employee B receives a $6,300 car allowance, which is not reported as income on their personal tax return. The business can claim $6,300 as a deductible expense.
Under the fixed allowance method:
Employee B also receives $1,500 per month, totaling $18,000 annually.
- 90% x $18,000 = $16,200
- The remaining $1,800 is taxable income.
- With a 40% tax rate:
40% x $1,800 = $720 - Employee B’s after-tax amount:
$18,000 – $720 = $17,280
Employee B can also claim 90% of their vehicle expenses:
- 90% x $30,000 = $27,000
In this case, Employee B pays $720 in taxes, keeps $17,280 after tax, and can claim $27,000 in vehicle expenses. The business can deduct $17,280 as a business expense.
Best ways to Manage the Car Allowance
To ensure compliance and maximize tax benefits, it’s crucial to maintain accurate records. Keeping a vehicle log, whether manually or through an app or accounting software, will help track and differentiate between personal and business use of the vehicle. Accurate documentation is vital for supporting your claims, regardless of whether you’re using the per-kilometer or fixed allowance method.
Additionally, it’s important to retain all receipts, especially if you’re claiming actual vehicle expenses under the fixed allowance method. Credit card statements alone are not sufficient for CRA purposes.
Conclusion
Choosing between a per-kilometer allowance and a fixed vehicle allowance requires thoughtful evaluation of your driving habits and financial circumstances. Both options offer advantages, but understanding the tax implications and keeping thorough records is essential to maximize your car allowance benefits. Whether you’re a business owner establishing an allowance program or an employee exploring your options, careful planning and proper documentation of your expenses can result in substantial tax savings.