What is a novated lease?

How does a novated lease work?

Here's a step-by-step look at how a novated lease works:

1. You find a new or used car that you want to buy
2. You enter into a lease agreement with a finance provider or a bank
3. You enter into a ‘salary sacrifice’ arrangement with your employer to cover the car lease repayments from your pre-tax salary. You can also some include car running costs in your lease 
4. Your employer makes repayments to your finance provider on your behalf from your pre-tax salary
5. If you change jobs, you take the car with you and continue to make repayments directly or transfer your agreement to your new employer

An example of a novated lease arrangement

If you get paid $70,000 per year (before tax) and your novated lease payments amount to $10,000, your taxable income becomes $60,000 (if you pay all of your novated lease payments from your pre-tax salary). This means you’ll pay less tax over the year. Your finance provider or an accountant can help you to work out the potential savings and the other things you’ll need to consider before entering into a novated lease based on your personal circumstances.

Novated lease benefits

• With a novated lease, you can use your car for personal use. You don’t have to be using the car for work or business purposes.
• Your income, the cost of your car and ongoing running costs each year will decide how cost-effective a novated lease may be for you. The result will be that your taxable income is reduced.
• The benefits also depend on the way your lease is structured. Some leases may package car expenses such as registration, fuel, tyres and insurance together so your repayments cover these, too. Some employers may also allow you to pay part of your novated lease from after-tax dollars (called an “employee contribution”).
• If you're not on the highest marginal tax rate, this can be cost effective because fringe benefits tax (which is based on the highest marginal tax rate) may not have to be paid to your employer from your pre-tax salary in addition to the novated lease payments.
• Novated leases can effectively mean motoring costs are goods and services tax (GST) free for employees. The GST you would ordinarily pay on the purchase price is covered by the finance provider and they can claim an input tax credit. If running costs are included in your novated lease, these can be packaged to employees with their lease payment without GST as the employer claims this tax component back as an input tax credit.   

Novated lease considerations

Keep in mind that if you change jobs or stop working, the responsibility for making the repayments remains with you. You may be able to transfer your lease to your new employer, but you may also have to take over the repayments (which may no longer be pre-tax).

When you have a car under a novated lease with your employer, the Federal Government considers it to be a fringe benefit. Fringe benefits tax may then apply. While employers are liable to pay fringe benefits tax in the case of novated leases, this cost is generally passed on to you from your pre-tax salary.

It’s important to understand how this and any other financial implications arising from entering into a novated lease can impact you, so seek help from an accountant or financial adviser.