When Should You Use a Novated Lease?

Novated leases were designed to let employees salary-sacrifice motor vehicles, making them a tax-effective part of their remuneration package.

What is a Novated Lease?

A novated motor vehicle lease is an arrangement between the employee, employer and the financier, which enables the employee to salary sacrifice the financing of the vehicle of their choice.

Under this arrangement, the employee leases a car from the financier using a Finance Lease Agreement in their personal name. A Novation Agreement is entered into between the employee, the employer and the financier which transfers the obligations & responsibility of the lease payments from the employee to the employer for the term of the agreement or until the employee leaves the company, whichever occurs first.

The employer pays the full cost of the lease payments to the financier, vehicle operating costs and Fringe Benefits Tax (FBT) cost. The total amount (usually GST exclusive) is then debited from the employee’s “pre-tax” salary.

Tax Considerations

A Novated Lease allows the employer to pay the finance repayments, as well as pay the vehicle running costs, on behalf of the employee from their pre-tax salary. The employer must also pay the FBT applicable to the provision of the vehicle to the employee. The employer will then usually deduct the total cost of providing the vehicle including FBT from the employee’s Gross Salary.

The employee then needs to decide if a Novated Lease including the cost of the FBT gives them a better after-tax outcome than would be the case if they instead purchased and financed the car from their after-tax salary.

The outcome is different for each employee. Each employee needs to make the decision in conjunction with their accountant.

There are some government exemptions to FBT which make it particularly attractive to enter into a Novated lease in some instances. For example, electric vehicles receive exemptions. Some eligible government employers and charities also receive FBT exemptions.

Many employers instead choose to pay employees a vehicle allowance equivalent to the work-related portion of the vehicle cost and then leave it to the employee to arrange their own vehicle.

Flexibility

Rather than being restricted to a company vehicle nominated by your employer, many employees prefer a Novated Lease which gives them the freedom to select their own vehicle.

At the end of the finance term, the employee can choose to:

trade in the vehicle for a new car
refinance the residual amount over another year or two or
pay out the residual and own the car outright in their name.

If employment is terminated, the novation agreement is cancelled, and the responsibility of the lease falls back on to the individual. The individual has the option to continue making the payments from their own cash, enter into a new novation agreement with a new employer or pay out the contract.

Is a Novated Lease Always the Right Option?

A Novated Lease is not always the best option. Below are some key considerations:

Paying a deposit to lower the initial finance amount is not an option. Under a lease arrangement, it’s not possible to pay deposits.
The ATO sets a minimum residual amount – for each finance term, there is a different minimum residual amount. For a 5 year finance term, the residual must be at least 28.13%, for a 4 year term 37.50% and for a 3 year term 46.88%. It can be better to enter into a Chattel Mortgage – which unfortunately can’t be novated.

A Fully Maintained Novated Lease vs Non-Maintained Novated Lease

A Fully Maintained Novated Lease includes all operating costs packaged into the one monthly finance repayment i.e. insurance, registration, fuel, tyres, and servicing.

Whereas a Non-Maintained Novated Lease is where the finance is only organised for the lease portion and all of the running costs are paid separately by the employer.

Whilst a Fully Maintained Novated Lease may sound like the easy option, pay careful attention to the costs being charged for both the interest rate and the operating expenses – you are paying for the simplicity.

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