A novated lease is a popular type of vehicle lease for employers and employees. It provides an alternative arrangement to the standard company car, allowing the employee to take on the responsibility and control of the lease, and associated benefits, while the monthly rental payments are made by the employer out of pre-tax salary.
The novated lease is a three-way agreement between the employer, the employee and the lease company. The employee agrees to the terms of the lease with the finance company, and must then select a vehicle; this operates in a similar way to a conventional lease, the difference being that their employer subsequently takes on the payment obligations on the employee's behalf.
The employer makes the rental payments from the employee's pre-tax income, as a form of salary packaging. Because payments come out of pre-tax income, novated leases often represent tax implications including FBT. Full taxation advice from an accountant is recommended before any purchase decision is made.
Types of lease
There are two main types of novated lease:
- Novated finance lease – where just the vehicle is leased.
- Fully maintained novated lease – the vehicle and all its running costs are included in the lease agreement.
When the lease ends
At the end of the lease agreement, or if the employee changes jobs, the vehicle remains in the control of the employee but all the obligations previously assumed by the employer now revert to the employee.
As with other vehicle leases, at the end of the loan term usually a residual value remains. In most instances, the employee then has the option of either buying the car outright (at a predetermined value); or the employee can pay off the residual value and walk away.
In the event of the employee changing jobs, it can be arranged for the new employer to take over the novated lease from the former employer, or the employee can take on the lease themselves for the remainder of its term.
Novated leases - Steps for employees
- Step 1: Choose the vehicle you want
- Step 2: Your employer signs a Deed of Novation, which officially states that they take on the obligations of making the lease payments.
- Step 3: Your employer deducts your monthly payments from your pre-tax income, thereby reducing your taxable income. Beware of FBT contributions and also other costs included in the lease.
- Step 4: Although your employer has taken on the obligations for payment, the lease remains in your name, which means you have control over what to do at the conclusion of the lease period – buy, trade in, or refinance.
Novated Leasing and Benefits for the employee
- Savings – lease payments can sometimes be lower than loan repayments from ownership.
- Repayments are made by your employer.
- Control – the vehicle and lease remain in your name; you look after the car, you use it when you want (even for 100% private use).
- GST implications – your employer can claim an Input Tax Credit that effectively renders a novated lease GST-free; they can pass the savings on to you.
- Retention – the vehicle stays with you if you switch jobs
- Choice – you can sometimes determine what happens at the end of the lease, depending upon your situation.
Disadvantages of a Novated Lease
- Sometimes there is a limited ability to negotiate the price of the vehicle – novated lease companies can often restrict who you buy your vehicle off.
- Tax implications – Not tax effective for certain types of individuals.
- Hidden clauses – many novated leases feature a plethora of clauses, even known to cause confusion when read by experienced lawyers let alone the layperson.
Benefits for the Employer
- Salary packaging – used as a method to increase employees' salaries.
- Simplicity – an alternative to manning a fleet of company cars
- Off balance sheet – from an accounting perspective, no requirement for 'on balance sheet' reporting due to no ongoing liability or equity accumulation.
- Tax deduction – Income tax write-off for all payments made under the agreement.
- Termination – If the employee leaves the job, all responsibilities for making lease payments go with them, meaning employers are not left footing the bill for a vehicle that is just gathering dust.
Fringe Benefits Tax Because a novated lease is a form of salary packaging, the employer pays Fringe Benefits Tax (FBT) on the benefit provided by the fully maintained novated lease. FBT is calculated depending on the value of the car and the number of kilometres travelled per year. It is the FBT calculation that often makes novated leases prohibitive for employees. For accurate information on FBT, please contact your accountant.
Input Tax Credit Both the lease company and the employer are able to claim an Input Tax Credit (ITC) that covers all the GST payable on the purchase price and monthly lease payments for the vehicle. These deductions are then handed on to the employee, rendering a novated lease effectively GST-free. We are not accountants but recommend you do consult with one if you are looking for taxation advice.