What is a novated lease?
A novated lease is a form of salary packaging that helps you finance a new or used car, while offering a range of potential benefits and tax savings. A novated lease is also known as ‘salary sacrificing’ a car.
With a novated lease, you are not usually limited to a particular car type, make or model unless stipulated by your employer. In general you are free to select a new or secondhand car of your choice. Because your repayments are partly sourced from your before-tax income, you could end up paying less tax and having a little more disposable income.
How does a novated lease work?
A novated lease is an employee benefit arrangement that involves you, your employer and a finance company. The novated lease agreement can last between one and five years. To apply for a novated lease, the first step is to talk to your employer to find out if they offer this type of benefit. If you are offered one as part of salary packaging, there may be limits on the type and value of the car.
To apply for a novated lease, you will need to complete a credit application with the finance company. They will ask you for details about your income and expenses, and perform a credit check. The finance company will the liaise with your employer to set up a lease agreement, and a deed of innovation. The novated lease agreement will include details such as the term of the lease, the estimated number of kilometres you expect to travel annually, the rental amount, and the type of car.
What happens at the end of a novated lease?
At the end of a novated lease, the Australian Tax Office stipulates that there must be a residual or balloon payment. This means that you cannot make lease payments to cover the whole car amount over the term of the lease. The ATO stipulates the percentage of the residual payment based on the term of the lease. At the end of the lease term, finance companies usually offer a range of options such as trading in your car and entering into a new lease for a new car, paying the residual amount to keep the car or selling the car to raise the money to pay it. Some people may choose to re-lease their car by entering into a new novated lease to pay the residual amount.
What types of novated leases are available?
There are two main types of novated leases – fully maintained and self managed.
- If you opt for a fully maintained lease, the finance company will manage every stage of the process, from sourcing and securing a vehicle to arranging finance and planning your budget for routine running costs. Some employers agree to provide you with a fuel card so you don’t have to claim any reimbursements for fuel.
- A self managed novated lease gives you complete autonomy over the lease. You take full responsibility for sourcing and securing a vehicle, which can include arranging your own finance and insurance. You will have to draft your own budget to cover the running costs of the vehicle before completing all the necessary paperwork to set up a pay deduction with your employer or salary packaging provider.
What are the advantages of a novated lease?
A novated lease allows your employer to take money directly from your pay, before tax, to make payments for the vehicle and its running costs. This is one of the key benefits of a novated lease – reducing your taxable income and increasing your disposable income in turn.
One of the most popular aspects of a fully maintained novated lease is the convenience of having all of your car’s running costs spread out over the course of a year, which helps with budgeting. Payroll deductions can cover your car payments plus a range of other regular costs like rego, servicing, insurance, tyres, and fuel. Before the lease commences, you need to estimate these annual running costs and then the amount is deducted regularly from your pay over the lifetime of the lease. It is easy to adjust this budget at any time, if you end up covering more or less kilometres than you anticipated for example.
At the end of a novated lease, you will typically have the option to upgrade your car to a newer model, without having to waste time and effort selling your old car.
What are the disadvantages of a novated lease?
A novated lease is considered to be a fringe benefit outside of your cash salary or wages and is therefore subject to Fringe Benefit Tax. However to counteract any Fringe Benefit Tax liable on your novated lease, your deductions can be set up to include a portion of your post-tax salary. By paying in this way, which is known as the Employee Contribution Method, you reduce the taxable value of the car which in turn reduces the Fringe Benefits Tax to zero.
Salary packaging options like novated leases are usually more effective for people on middle to high incomes. Check with your employer to find out what salary packaging options they offer. You may choose to get professional tax advice before entering into a novated lease or other salary packaging.
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