What Is a Novated Lease?

A Novated Lease is essentially a salary packaging method for the use of a vehicle, whereby the employee actually leases the vehicle but the employer agrees to fulfill the employee’s lease obligations from the employee’s pre-tax income.

The Financial Mechanics of the Novated Lease

A Novated Lease is a financial instrument that forms a tri-partite arrangement between employer, employee and financier, whereby the employee enters into a Finance Lease or Car Lease with the financier whilst the employer undertakes to meet the employee’s financial obligations under the lease. The employee continues to enjoy the benefits and use of the vehicle, whilst the ownership of the asset remains the title of the financier.

If for whatever reason the employer-employee relationship is broken or ceases, the novation ceases and the lease obligations revert to the employee. The financier acquires the vehicle on behalf of the borrower (the employee) and then on-leases the vehicle to the borrower in return for a fixed monthly lease rental for the term period of the lease.

At the expiry of the lease period, the borrower generally has an option to either pay a final residual balloon value and take ownership of the vehicle, or alternatively may use the vehicle as a means of trade-in or extend the lease by re-financing the residual value.

Advantages of the Novated Lease

Advantages accrue both to Employer and Employee:

For the Employer:

Able to offer enticing remuneration salary packages to lure high calibre personnel.
There is no financial exposure to meeting residual value payments on lease term expiry.
No excess or unused vehicles on hand upon an employee’s departure.
Reduction of operating costs, such as Payroll Tax and Workers Compensation premiums.

For the Employee:

Repayments are more tax-effective by being made from pre-tax income.
The option of portability allows the vehicle’s lease arrangements to be transferred to the next employment position.
Depending on the value limitation of the salary packaging arrangements, the employee has choice of vehicle and the effective care control and maintenance of the vehicle.
Equity build up in the vehicle by way of repayments belongs to the employee.

Similar to a Finance or Car Lease, other advantages include:

Fixed repayment structure is known at inception, that is - there are fixed terms that can range from two years (24 months) to five years (60) months; fixed interest rate; fixed monthly rentals and a fixed final residual value.
The GST component in the vehicle’s purchase price allows the financier to claim the GST input tax credits, therefore funding to the borrower is only on the GST exclusive purchase price of the vehicle. Hence, by financing a lower amount, means lower monthly repayments.
The Lease can be structured to make advanced payments during the term period to assist in timing issues that may result in increased tax deductibility and/or help with cash flow constraints.

Novated Lease may be suitable for:

Companies, Partnerships, Sole Traders and Business Professionals, where the vehicle is essentially used for income producing purposes.
Employees and Personnel of corporations and business entities who desire the flexibility of a novated leased vehicle in their salary package.

Points to note and consider:

The fixed monthly lease rental and residual balloon value will incur a GST charge. If the employer is registered for GST, then the GST amounts can be claimed back on lodgement of their Business Activity Statement (BAS).
Since GST is charged on the residual value, and the novation reverts to the employee on lease expiry, it is the employee who is responsible for payment of the GST component of the residual value.
Fringe Benefits Tax (FBT) applies to the private proportion use of the vehicle and the amount is payable by the employee from pre-tax income as part of the salary package arrangement. A choice between the Statutory Formula method and the Actual Operating Cost method is available in determining the taxable value for fringe benefits tax purposes.
The total amount financed for the car lease, which form part of the monthly lease rentals may be claimed by the employer as a tax deduction, subject to Depreciation Cost limits. If the total amount financed is below the Depreciation Cost Limit, the full lease rental is available as a tax deduction. Should the amount financed exceed the Depreciation Cost Limit, lease charges as a tax deduction would be limited to the Depreciation Cost Limit.