Why do we have to pay luxury car tax?

Like any other tax, the luxury car tax (LCT) is a means of topping up government coffers. And if you incur the tax, you are legally obligated to pay it.

That's the simple answer to the question in the headline, but it's a question that begs a more detailed response.

When does the LCT apply, for instance? Why does it apply to some models of car and not others? And how much do I pay in tax when I buy a luxury car?

Let's start with the basics...

As the name indicates, the Luxury Car Tax is an additional levy for vehicles meeting criteria that match the government's definition of a luxury car.

The tax is payable on a car's retail price once it exceeds a certain amount (the LCT threshold). This amount varies from year to year in accordance with the consumer price index – the country's annual rate of inflation.

For the 2018-19 financial year, the threshold is $66,331. Many cars retailing at a price higher than that will incur the LCT, charged at a rate of 33 per cent for the component of the price exceeding the threshold.

In other words, a car costing $70,000 retail would incur tax payable for the excess (the difference between the price and the threshold). That excess ($70,000-$66,331) is $3669.

But the Goods & Services Tax (GST) charged for that difference has to be deducted from the GST-inclusive price before calculating the Luxury Car Tax. Otherwise the consumer will be paying tax on a tax.

Deducting the 10 per cent GST from the excess leaves a taxable sum of $3335. Dividing by three (or multiplying by 33 per cent – it's the same thing) results in a charge of $1100.70.

That takes the total price of the car to $71,100.70, which the buyer pays. The dealer receives the money from the customer in exchange for the car and forwards the tax amount payable on the car to the federal government.

That doesn't seem too punitive, but in another example, the tax on a car costing $200,000 or more will set you back an extra $40,000 or so – money flowing straight out of your pocket to the Treasury.

Calculating the tax for a car like the Jaguar I-PACE – an electric vehicle that is exempt up to the $75,526 green-car dispensation ceiling – is complicated by the higher threshold. The LCT charged for the I-PACE at entry level ($119,000) is around $2800 less than for a conventional car at the same price.

The tax doesn't necessarily apply to all vehicles sold in Australia. According to the ATO (Australian Taxation Office), cars manufactured or imported more than two years ago, for example, and emergency vehicles are exempt.

Motorhomes, campervans and other goods-carrying vehicles that carry more passengers than goods are also exempt.

Cars that are 'green' – using fuel at a rate of 7.0L/100km or less – are free of LCT up to a ceiling figure.

In 2008, when the Rudd Labor government proposed raising the LCT rate from the 25 per cent to 33 per cent, the Greens opposed the legislation, and successfully negotiated for an amendment that would encourage the purchase of eco-friendly cars. This dispensation is capped at $75,526 for the 2018-19 financial year.

In essence, any car consuming fuel at 7.0L/100km or lower and priced (currently) above $66,331 and below $75,526 will not incur the tax at all. This dispensation has left the way open for prestige brands to introduce new models that skirt around the legislated tax.

Often these models are electric vehicles, plug-in hybrids and even conventional small cars with four-cylinder engines claimed to consume 7.0L/100km or less in combined-cycle testing.

When the Howard government introduced the new 'Goods & Services Tax' in 2000, the broad-based consumption tax replaced a range of other taxes and levies, leading to price reductions for new cars right across the board.

But the problem confronting the government at the time was that the new tax system promised to reduce the prices of luxury cars far more in dollar terms than the price reductions for cars priced below the 'luxury' level.

The 10 per cent GST retail levy replaced a 22 per cent stamp duty payable on all new cars at the time, but initially there were no plans to replace the special wholesale tax that applied solely to luxury cars.

With a homegrown manufacturing industry to protect, the government couldn't allow the prices of luxury imports to fall so far that they were suddenly price-competitive with locally-built volume-selling models like Holden's Calais and Caprice or Ford's Fairlane and Fairmont Ghia.

The new tax on high-priced cars was introduced to ensure luxury imports remained less affordable than the locally-built high-end cars. Few locally-built cars were affected by the new tax. An extra revenue stream from taxing expensive imports was the cherry on top for the government.

Many in the industry, and a lot of customers as well, of course, would like to see the tax abolished. They argue, correctly, that since there's no longer a local manufacturing industry at risk from well equipped imports at affordable prices, the tax has passed its use-by date.

And with the prestige brands now offering any number of high-priced cars that also take advantage of the sub-7.0L/100km loophole, government revenue from the tax has dwindled rapidly in recent years, despite the increase in the LCT rate from 25 to 33 per cent a decade ago.

Some have argued too that rather than applying a discriminatory 'non-tariff barrier' like the LCT, the government should be taxing the whole spectrum of the automotive market, penalising cars that emit too much carbon-dioxide, as an example.

But the impetus for the LCT to be rescinded will most likely come from an external pressure point – the European Union. Australia is committed to a free-trade agreement with the EU, but the LCT has been one of the sticking points.

Australia is expected to call it quits for the LCT in order to accommodate European prestige brands, particularly from Germany, who insist that the tax actively deters buyers from purchasing their products.

So it's the projected free-trade agreement with Europe that will pave the way to cheaper upmarket cars in this country.