Novated leases – a Money Buddy guide

The novated lease has become increasingly popular over recent years, offering benefits to both employees and employers. So, what are novated leases and how do they work?

A novated lease is a three- way arrangement between an employer, their employee and a vehicle financier, offering an alternative to the standard company car. The employee leases a motor vehicle of their choice from the financier who then novates the agreement to their employer. It is now the employer's responsibility to ensure the monthly lease payments are paid to the financier out of the employee’s gross salary.

The car is now available for the employee's unrestricted use, including private use. Other running costs can also be deducted directly from the employee's gross salary by the employer, offering significant benefits to both.

Employer benefits

As well as being able to offer employees the extra incentive of a car in their remuneration package, a novated lease also:

takes away the burden of managing a company car fleet;
takes away the necessity of recording the car as an asset or liability in the business;
offers an income tax deduction for all payments made under the agreement, including lease rental payments;
offers many employers, if registered for GST, the ability to claim an input tax credit on the GST paid on the lease, (t here are exceptions to this); and
takes the responsibility of making lease payments away from the employer as soon as the employee leaves their job.

Employee benefits

Novated leases offer employees:

tax savings through salary sacrifice arrangements as the lease payments are taken out of their pre-tax wages;
freedom to choose the vehicle they want;
the unconditional use of the vehicle for both work and private purposes; and
the option to own the vehicle outright at the end of the lease term.

If an employee leaves their present job before paying off the lease agreement, they have the option to take the vehicle with them to their new employer (if the new employer agrees to take over the novated lease), or they can arrange lease payments themselves.

Novated leases and Fringe Benefits Tax (FBT)

FBT is a Federal Government tax imposed on certain fringe benefits provided to employees by their employer and is paid by the employer. The amount of tax paid is determined by the 'grossed-up' value of the benefit. This is where the value of the benefit is increased to be comparable with the after-tax salary-sacrificed amount of the benefit, plus FBT. This is intended to cancel out the employee’s salary tax benefits.

The FBT liability is generally charged to the employee by the employer as a salary deduction.

Is a novated lease suitable for me?

The majority of employees that benefit from novated leases are those who have a portion of their salary in a higher tax bracket as deductions for the novated lease and associated costs are taken out of their pre-tax salary.

Others who can benefit are those who use their car a lot, since FBT is calculated not only on the value of the car, but also on the distance travelled each year. The greater the distance, the lower your pre-tax salary and the less tax you'll pay.

Case Studies

Ian is middle management in a large construction firm. His salary is over $75,000 and, consequently, for the potion of his salary over the $75,000 cut-off-point, Ian is paying 40c for every dollar earned.

Ian decides to take out a novated lease on a new Holden Astra. After lease rental payments and other running costs are taken from his pre-tax salary, Ian is pleased to discover that his annual salary has dropped to $74,200. As a result, Ian no longer pays 40c in the dollar for any portion of his salary.

On the other hand, Katherine earns $32,000 a year and pays 30c in the dollar. A novated lease is unlikely to bring her pre-tax salary down to below $25,001, the point where her tax rate would drop.

Novated leases aren't for everyone, but for those workers in the right situation it could be the ideal opportunity to reduce those tax bills substantially.