In Australia, a novated lease is a three way agreement (“novation agreement”) between an employer, employee and lease company, under which the employee leases a vehicle from the lease company, and employer agrees to take on the employee’s obligations under the lease.
Normally, the employer then makes the lease payments on behalf of the employee, and deducts them out of the employee’s pre-tax income (known as salary packaging a vehicle). If the employee ceases to be employed by that employer, or the lease agreement ends, the employee retains the vehicle but all obligations assumed by the employer under the novation agreement revert back to the employee.
Vehicles salary packaged through a novated lease attract Fringe Benefits Tax (FBT) in Australia. However, FBT is treated concessionally for vehicles, so novated leasing can be a tax-effective way for an employee to purchase a vehicle, depending on the type of vehicle, kilometres travelled annually, FBT method used and employee’s salary.
There are three main types of novated lease: a novated finance lease, where just the vehicle is leased, a fully maintained novated lease, where the vehicle and its running costs are wrapped up into the lease, and a fully maintained novated operating lease, where the vehicle and its running costs are wrapped up into the lease, and the residual value risk is assumed by the lessor.
Fully maintained novated leases and fully maintained novated operating leases are normally managed by a third-party lease management company, and the benefit of their perceived convenience can often be outweighed by high management fees and hidden costs associated with the lessor assuming the residual value risk (in the case of a fully maintained novated operating lease).
Benefits for the employee:
- potential for significant income tax savings
- savings on GST that would normally be incurred on vehicle expenses
- potential access to volume discounts if the employer has many vehicles under this scheme
- more flexibility in the choice of a car compared to a company car arrangement
- vehicle stays with the employee and can be transferred to a new employer
Benefits for the employer:
- a way to provide an effective increase in employees’ salaries with no or minimal cost to the business
- potentially a cost effective alternative to operating a fleet of company vehicles
- compared to company cars, the business does not assume any risk for the vehicles
- compared to company cars, employee vehicles are “off balance sheet”