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A novated lease is a tax effective way of financing a new or second-hand car. It involves an employee setting up a ‘salary sacrifice’ arrangement with their employer to lease the car. The employee is free of any obligation to buy the car at the end of the lease period.
Repayments on the lease are deducted from the employee’s pre-tax salary, which effectively reduces a person’s taxable income and requires less income tax to be paid.
Unlike a standard car lease, a novated lease does not require the car to be used for at least half the time on business purposes. As most employees’ commute to work would not make up half its total use, a novated lease provides an alternative leasing arrangement.
With wages remaining stagnant across Australia, a novated lease appeals to many because it provides a tax break. It is also arguably more obtainable than a pay rise, because it does not cost the employer anything extra.
A person needs to be employed and receive a salary to qualify for a novated lease so this naturally excludes self-employed sole traders. However, a company owner can have a novated lease if they pay themselves a salary.
It’s a growing trend, with new data from the Australian Bureau of Statistics and IBISWorld suggests that approximately 5% of the new car market was supported through novated leasing in 2022—a figure that is expected to rise again. Here’s how novated leases work, as well as the pros and cons.
How Does It Work?
A novated lease is a way of financing a new or used car through salary packaging. Repayments are made from a person’s pre-tax salary with agreement from the employer.
It is essentially a three-way agreement between a financier, employer and employee, and it requires entering into a lease agreement with a finance provider or a bank, as well as a ‘salary sacrifice’ arrangement with the person’s employer to cover repayments.
The employer then makes repayments to the finance provider on behalf of the employee, which is drawn from their pre-tax salary.
If the employee changes jobs, the car goes with them if the agreement can be transferred to the new employer. The employee can also make their own payments directly.
It works like this: an employee with a before tax annual salary of $70,000 whose novated lease payments amount to $10,000 per annum will have their taxable income reduced to $60,000. That reduces the overall amount of income tax paid.
An accountant can help you decide if a novated lease suits your personal circumstances. The cost effectiveness of a novated lease depends on an individual’s income, the cost of the car and ongoing running costs.
However, leaselab Co-Founder and Sales Director Alex Davis says there’s been an uptake in novated leases due to Aussies realising how much money it can put back into their pockets, “as well as how easy the process is”.
“For many, cars are a non-negotiable expense. Novated leases help change car ownership from a liability to something
that can actually benefit drivers financially. When you compare the costs to traditional finance, the savings speak for
themselves.”
Different Types of Novated Leasing Explained
There are two main types of novated lease agreements – fully maintained and non-maintained.
A fully maintained arrangement includes the lease amount for the car plus any ongoing costs, such as fuel, servicing, registration, tyres, insurance and on-the-road assistance in the event of a breakdown or accident.
This creates a single payment that bundles all the vehicle’s expenses into one payment, which some prefer.
A non-maintained arrangement is only the lease amount for the car and excludes all other associated costs with the vehicle, which the employee will have to fund.
Benefits Of A Novated Lease
The biggest benefit is paying less tax, which means keeping more of your salary and gaining access to a car.
An employee with a novated lease does not need to pay GST on the running costs of their car. The GST that would usually be paid on the purchase price is covered by the finance provider, who can claim an input tax credit (that’s a levy paid by a business on acquired goods and services).
With a novated lease, the car can be used for personal purposes—there is no requirement for it to be used exclusively for business.
Lenders may be more lenient in agreeing to a novated lease, because it is perceived as less risky in terms of defaults, as payments are coming automatically and from the employer.
A novated lease is attractive to employers because if their employee leaves, he or she will take the car and the lease obligations with them, and may be less effort than managing a fleet of company cars. It may also reduce a company’s payroll tax liabilities, because their reportable taxable salaries have decreased.
“We’ve also seen people drawn to novated leases for the added benefit of bundling all of their car expenses into one
regular and easily manageable payment, so they don’t get that bill shock when their service is due or their rego is up
for renewal,” Davis explained.
What are the Disadvantages of a Novated Lease?
A novated lease agreement is tied to the employee, not the employer. If an employee quits and moves to another company, the new employer must agree to facilitate the agreement. Alternatively, the employee can make payments as they would with a standard lease agreement. This will be the default situation until a new employer is found.
How To Get A Novated Lease
The employer must agree to enter into a novated lease arrangement with their employee.
A leasing company will be more lenient in its approval decisions for novated leases than it would for a standard lease. The risk of defaulting is regarded as lower, because the payments come from the employer before the salary is paid.
What Happens at the End of the Lease?
At the end of a novated lease, you typically have three options: pay the residual value to take ownership the car, refinance the residual value to continue using the car, or trade in the car for a newer model by entering into a fresh lease arrangement.
Frequently Asked Questions (FAQs)
Are novated leases a good idea?
A novated lease reduces taxable income and therefore often results in the employee paying less tax. For most people, that is reason enough for the idea to hold appeal. However, speak with your accountant if you’re uncertain as he or she will be able to outline the tax implications.
How long does a novated lease go for?
A novated lease typically runs for one to five years. When the lease ends, there are three options: trade the vehicle in for a new one, refinance it and keep it, or buy it to take ownership.
This last option involves paying the ‘residual’, which is another term for the final payment. This lump-sum amount is calculated at the beginning of the lease. A shorter-term lease will have a higher residual, because a newer car is a more expensive car. For example, a one-year lease may have 65% of the car’s total value as a residual.
Who owns the car on a novated lease?
Throughout the lease, the finance company owns the car. The employee will only own the car if at the end of the lease period, a residual payment is made, which allows them to take ownership of the car. Doing so is their choice.
Does a novated lease include car insurance?
Car insurance can be included in a novated lease. This makes it cost effective because it reduces the amount of income a person must pay.
