Home > Blog Posts > Novated Car Lease Guide: How does it work?
Novated Car Lease Guide: How does it work?
December 17, 2020● 5 minute read●
They’re a number of financing options available if you’re on the market for a new car. You can either pay for it out of your pocket, secure a car loan or agree to dealer finance. You also have the option of signing a Novated lease. A novated lease helps you take care of your car cost and some running expenses from pre-taxed income. But how exactly does it work? Is it the right choice for you?
What is a novated lease?
A novated lease is a contract that brings in a very important figure, which is your employer. It is a three-way agreement between you, your employer and a financier that can last one to five years. In this case, the employer makes the lease payments on your behalf from your before-tax income.
How does it work?
You pick a car you wish to lease for a period of time and ask your employer for an agreement to make the lease payments from your pre-tax salary. You’ll then take out the least with a finance company that may or may not be chosen by your employer. Once the agreement is signed, your employer becomes responsible for paying your lease to the finance company. You can decide to trade with a new car model or pay off the balloon payments to acquire the car if you’ve become too attached. Since the lease payment is made from your pre-tax salary, you’re bound to have more disposable income.
How does a novated lease work with tax?
As good as paying from pre-tax income sounds, there’s a clause. They’re two tax options that are usually taken when a novated car lease is involved. This depends on the path you decide to take. You can either use the Fringe Benefits Tax method or the Employee Contribution Method. The good news is that you don’t have to worry about goods and services tax(GST). The Australian Tax Office has a regulation that exempts novated leases from GST, but you still have to calculate the cost of the overall lease to see if it suits you in the long run. Let’s take a look at the two tax methods;
- Fringe Benefit Tax method: This method allows all your lease payments to be paid from pre-tax income. However, your employer will be required to pay Fringe Benefits Tax because a novated lease counts as fringe benefits from your employer. This might in turn lead to your employer reducing your salary, depending on your salary sacrifice contract. Financiers can help you keep track with FBT in accordance with ATO guidelines.
- The Employee Contribution Method: This method allows both pre-tax and post-tax deductions to reduce the impact of Fringe Benefits Tax or eliminate it altogether. By paying using the ECM you reduce the value of the car that is taxable and liable to FBT.
Types of novated leases
There are two major types of novated leases. Fully maintained novated lease and self-maintained novated lease.
Fully maintained novated lease
In this option, the employer covers the full cost of the vehicle, including fees and interests. The employer also covers running costs like fuel, car servicing, registration and insurance. All these will be calculated into the repayments taken from your pre-tax salary. You may be provided with a fuel card and a means to send other bills to your finance company. They might also make sure that cost of servicing is fair and reasonable.
Self-maintained novated lease
Under a self-maintained novated lease, you’re totally responsible for the day-to-day runnings of your lease. Only the purchase price, fees and interests are calculated into the lease repayments from your pre-tax income. You’ll need to draw up a budget and maintain running costs for your vehicle on your own.
Pros of a novated car lease
Both you and your employer can enjoy benefits from a novated lease. Here are some of them;
For the employee
Tax and cost benefits
A novated lease offers you the benefit of covering most of your car costs on pre-tax income, this can in turn increase your disposable income. You’re also exempted from goods and services tax. You may also benefit from a fleet discount that can reduce the overall retail price of the car.
Flexibility and upgrading options
You can decide to pick any car of choice to lease. It’s also easier to upgrade your vehicle at the end of the lease with a new agreement.
If you pick the fully maintained option, then you need not worry about the running costs of your car as this is also handled by your employer and finance company. You don’t have to make any initial payment or pay multiple bills during the course of the year.
No restrictions on car usage
The fact that your employer is involved with the lease doesn’t make it an official car. You can use the car for both personal and official purposes.
Convenient loan management
Your lease repayment will be made by the employer so you’re relieved off managing and budgeting.
For the employer
- The employer will be at no risk if the employee leaves before the lease is over.
- It serves as a way for employers to offer incentives that can attract great employees.
- The lease is neither an asset or liability to your business
Cons of a novated car lease
There are also a few disadvantages that come with leasing a car. Here are some of them;
With a novated lease, you do not own the car until you decide to pay off the balloon payment at the end of the lease. You cannot make alterations to the car or claim it as a personal asset.
Residual value or balloon payment at the end of lease
You’ll be required to pay the balloon payment at the end of the lease if you’re not signing a new novated lease.
- The car becomes your full responsibility of you switch employment to a company with no novated lease offers
- Novated lease comes with extra administration fees and might have a higher interest rate compared to normal car loans.
A novated lease can be a great option for you if you’re looking for convenience and a little money saved off taxable income. Be sure to carefully read through the agreement of your lease to be sure it’s the right option for you.
Written by Jacaranda Team