What is a novated lease?
A novated lease is similar to a finance lease - but is primarily designed to be of benefit to employees who want to salary package a car and its related operating expenditure.
To novate is defined in the dictionary as “replace with something new, especially an old obligation by a new one”.
The car may be used for work purposes, or entirely privately, or a combination of the two. For practical purposes, a novated lease vehicle is ‘your’ car - it’s not a company or fleet car.
Because of the way in which the benefits to employees accrue, novated leases are also one of the easiest and most cost-effective ways for employers to incentivise and reward their valuable employees.
In other words, novated leases are a ‘win-win’ for both employees and employers.
Summary of Novated Lease Benefits
We will go through all the benefits in greater detail below, but here’s a quick summary for employees.
No GST payable on the car
No GST payable on running costs
Discounted price (many novated lease companies pass on their bulk buying discounts)
Income Tax savings (your costs are paid from your pre- tax salary)
Fully maintained (fuel, insurance, servicing, repairs, roadside assist and registration & CTP can be included)
Discounted fuel (many novated lease companies have discount arrangements with fuel outlets across Australia)
The car is yours to use 100% of the time
Portable (take your novated lease with you if you change jobs)
A novated lease is essentially a three-way agreement between you, your employer, and a specialist lender. Each party to the agreement plays a specific role.
The employer agrees to make regular, automated payroll deductions from the employee’s pre-tax salary (which is why these are also routinely referred to as ‘salary sacrifice’ or ‘salary packaging’ agreements).
The finance company procures the vehicle, establishes the lease and manages the administrative, contractual and compliance aspects of the transaction.
The novated lease payments are made direct to the financier by automatic payroll deduction. They are paid before the PAYG income tax is deducted from your salary.
The employee agrees to have those pre-tax salary deductions taken out, in exchange for the use of the chosen vehicle. (This is the so-called ‘salary sacrifice’ - sacrificing the pre-tax salary in exchange for the use of the vehicle.)
As with other leases there are typically a number of payments over a fixed term, with a residual (or balloon) payment due at the end of the lease. Essentially, the cost of the vehicle and the cost of the finance, minus the residual, is spread over those fixed repayments.
Technically, the lender owns the vehicle and leases it to you, the employee. (But for practical purposes it is 100 percent your vehicle.)
1. You don’t pay GST
Owning the vehicle in this way allows the lender to claim the GST (10% goods and services tax) on the purchase of the vehicle as an input tax credit (because the purchase is an operating expense in relation to the lender’s business) and therefore the vehicle can be acquired by you at ex-GST pricing.
In other words, if you engage in a novated lease, you get the vehicle without paying the GST on it. This is one of the few ways for an employee to acquire a new vehicle without being obliged to pay the GST.
The saving here can be considerable.
For example, a car with a $44,000 retail price can be procured in a novated lease for $40,000 (assuming, simplistically, that there is a $4000 GST component in the retail price). This represents a significant saving up front over the retail price typically available to employees under other financing methods - including paying cash.2. Pre-tax Payments
Repayments are made from your pre-tax (or gross) salary. This increases your buying power - because some funds that would otherwise be deducted as pay-as- you-go income tax (PAYG) may now be used to make the finance payments.
In this sense, a novated lease is a way of getting some of your tax dollars to work directly for you. In other words, some of your pre-tax salary that you would have paid as income tax is now helping you pay for the ownership cost of your new vehicle.
Novated leases can be a great way to boost purchasing power. Mobilising your pre-tax salary in this way means you can generally buy a better car for any given take-home pay amount, compared with engaging in an alternative finance type.
Conversely, any given car may be acquired with less impact on your take-home pay, under a novated lease.
And many lease companies pass their bulk buying discounts on, meaning you will also get a discount off the regular car price.
Salary sacrifice also reduces your taxable income - which can effectively increase your net disposable income. You might like to look at it like this: Your taxable income is reduced by the amount of the repayments.
5. Fringe Benefits Tax
The Federal Government also gives employees with novated leases generous Fringe Benefits Tax (FBT) concessions - even if the vehicle is only ever used for your own personal purposes (ie - not for business use).
Under a novated lease, by default, the Federal Government imposes some FBT obligations on the employee - because the vehicle does, in a sense, represent a fringe benefit to the employee.
Using the ‘statutory formula’ method, FBT is calculated at a flat 20 per cent rate on the cost of the car. (It’s also possible to use an ‘operating cost’ method - but this imposes additional reporting obligations, such as a log book.)
In general, the income tax savings using a novated lease are greater than the FBT payable on the car.
Additionally, FBT can be reduced further using the ‘employee contribution method’ (ECM) to reduce your FBT liability.
Using the ECM, contributions to the vehicle made from your after-tax salary will reduce your FBT obligations. Paying some running costs on the car from your after-tax salary - for example, registration, insurance servicing, fuel, new tyres, etc. - reduces your FBT obligation. In many cases, it is possible to eliminate FBT liability completely.
(In general, if the after-tax contributions total 20 percent of the cost of the car over one year, FBT liability is eliminated.) Speak to your accountant for more detail in respect to your FBT position.
6. Fully Maintained Novated Lease
The maintenance and running cost expenses - for example, fuel, insurance, servicing, repairs, registration, roadside assistance and insurance may be included in a ‘fully maintained’ novated lease.
This means - effectively - that all these ancillary goods and services may also be purchased GST-free, and paid for with your pre-tax salary.
Your novated lease is also portable - meaning you may take it with you if you leave the business and take up employment elsewhere. All you need to do in these circumstances is enter into another novation agreement with your new employer and the finance company. (This is a benefit for your employer, too - see below.)
At the end of the term, you benefit from any equity you have built up in the vehicle. Should you sell the vehicle and repay the agreed residual amount, any profit left over is income tax exempt.
Speaking of residuals - these are flexible too, but it is important to be realistic about retained value over the lease term, and also keep in mind the Australian Tax Office’s guidelines on minimum residual values (see table below), as well as your lender’s stated maximum residual value amounts.
Minimum residue values for leased cars - percentage of cost
|Term of Lease||Effective Life - 8 Years|
If your employer agrees to a novated leasing programme, you can choose the kind of vehicle that suits you and your lifestyle - from a conventional car to a sports car or a 4WD or SUV.
In other words you are not restricted in vehicle choice in the manner of the limitations applied to a typical company car or fleet policy.
Even accessories you stipulate for the vehicle can be included in the novated lease agreement.
10. No Usage Restrictions
Finally, the vehicle is yours to use 100 percent of the time. There are no restrictions (for example, on who is permitted to drive the vehicle, or usage out of business hours) as there often are on company-owned fleet cars.
11. Cost Savings Comparison to Other Finance Options
The following example is based on the following assumptions:
- Retail vehicle cost: $37,293 (incl GST)
- Annual salary: $85,000
- Term: 5 years
- Travel: 15,000 kms per year
- Location: NSW 2000
|Novated Lease||Car Loan||Mortgage Loan||Cash|
|Cost of finance||$32,643||$47,520||$41,220||-|
|Savings compared to car loan||$12,360||-||$6,300||$10,360|
As you can see, in this example, a novated lease would save you $12,360 compared to a car loan, or $6,060 compared to a mortgage loan, or $2,000 compared to cash.
Smart employers know that a car is a major expense item for their employees. For many employees, the car is the second biggest item in the household budget, following the rent or mortgage repayments.
Employers wishing to reward and incentivise their employees with a novated leasing program offer their employees a significant saving on a car, with very little cost to the business.
1. Motivated Staff
Perhaps the biggest advantage to a novated leasing programme is: Happy, motivated employees. By offering your staff a considerable saving and the freedom to choose the right vehicle for them, staff motivation and productivity are typically maintained at high levels.
Employees with novated leases typically feel validated and rewarded and are more likely to stay with you as an employee.
Additionally, a novated leasing programme is typically far more time-efficient and cost-effective than administering a traditional company fleet (which can be a full- time job for one or more staff in its own right).
2. Low costs
Monetarily, the principal benefits to your staff offered by a novated leasing agreement are funded structurally, within a regulatory framework that allows the pricing and payment concessions. There’s no direct cost to the business - unlike most other reward and incentive programs.
In other words, you (the employer) is not the one funding the GST exemption on the acquisition price, etc. These discounts are built into the nature of the agreement itself.
The regular payroll deductions for novated leases are easily automated, and both administration and compliance are managed by the novated lease provider, not the employer.
After filling out establishment documentation and automating the required deductions, novated leases are essentially automatic devices that require very little direct management or supervision by the employer.
4. Low Obligations
Some employers are reluctant to consider novated leasing because they harbour lingering reservations that there might be a problem or obligation if the employee leaves the business - but this preconception could not be further from the truth.
In fact, in the event an employee leaves the business, the employee’s novated lease also leaves with them.
There is no ongoing obligation on the part of the employer in this situation. Nor is there a chance of being left with a vehicle that is simply surplus to requirements, or unsuitable for a new employee with different needs or preferences.
In some cases, novated leasing programmes also reduce the incidental cost of employment - in the context of payroll tax and/or WorkCover, for example.
Nor are the vehicles part of the business’s balance sheet - they are neither an asset or a liability for accounting purposes.
Thus the novated lease can be a very cost-effective way to reward employees, with limited direct cost and minimal downside to the business in terms of either cost or administrative red tape.
New and used
Novated leases are not just for new cars. Good quality used cars up to seven years old can also be acquired under a novated lease.
Term and Amount
The term of the lease agreement is flexible, to suit you. Generally, terms of one to five years are available under a novated lease, although 7 year terms are also possible.
Who is Eligible?
Generally, full-time and permanent part-time employees are eligible for novated leasing - provided the employer supports a novated leasing programme. Your financier can provide more details here.
What Happens at the End of the Lease?
Novated leases are taken out for a fixed term, established at the beginning of the lease. When the lease ends, sometimes there is an opportunity to extend the existing lease. Alternatively. you can also purchase the vehicle, or sell it and pay out any residual amount owing - and remember, any equity realised by you at sale time remains tax-free.