Introduction
In the complex landscape of Australian taxation, understanding the potential tax deductions associated with novated leases can be a game-changer. A novated lease, a popular vehicle financing option, presents unique tax benefits that can significantly influence your tax obligations. This article will delve into the intricacies of these tax deductions, elucidating their workings, eligibility criteria, and their impact on your overall tax liability. Whether you’re an employee contemplating a novated lease, or an employer providing them, this comprehensive guide will equip you with valuable insights into the tax implications of novated leases in Australia. So, let’s embark on this journey to unravel the tax deductions associated with novated leases.
Understanding Novated Leases
A novated lease is a type of vehicle financing arrangement that is commonly used in Australia. Here’s a detailed explanation:
1. Basic Concept: A novated lease is a way to finance a new or used car. It involves an agreement between you (the employee), your employer, and a finance provider. You make your repayments from your pre-tax salary with approval from your employer under a ‘salary sacrifice’ arrangement. This can effectively reduce your taxable income.
2. How It Works: You find a car that you want to buy and enter into a lease agreement with a finance provider or a bank. You then enter into a ‘salary sacrifice’ arrangement with your employer to cover the car lease repayments from your pre-tax salary¹. Your employer makes repayments to your finance provider on your behalf from your pre-tax salary. If you change jobs, you take the car with you and continue to make repayments directly or transfer your agreement to your new employer.
3. Benefits: A novated lease can allow you to bundle your vehicle’s expenses into one simple payment. It can also reduce your taxable income, as the lease payments are made from your pre-tax salary. This means you’ll pay less tax over the year¹. Some leases may package car expenses such as registration, fuel, tires, and insurance together so your repayments cover these, too.
4. Considerations: While a novated lease can offer financial benefits, it’s important to consider the potential drawbacks. For instance, you don’t own the car and there can be a residual value to pay out after the lease term. Also, the benefits depend on the way your lease is structured and your income.
Remember, the specifics of how a novated lease operates can depend on the terms of the lease agreement, and it’s always recommended to seek professional advice to understand the implications fully. This information provides a general understanding and should not be considered legal or financial advice.
A novated lease is a way of financing a new or used vehicle and paying for car running costs through your pre-tax salary in Australia. Here’s how it works:
1. Find a Vehicle: You find the new or used car you want. Your novated lease provider can also help you find a vehicle.
2. Arrange the Purchase: The novated lease company arranges for the vehicle to be purchased on your behalf (with a GST discount), and then leased to you.
3. Salary Deductions: Your employer makes regular, automated deductions from your pre-tax salary and pays them to the leasing company to cover the car lease payments.
4. Include Running Costs: You can also include car running costs in your lease (with a GST discount), based on how many kilometers you expect to drive each year.
5. End of Lease: At the end of the novated lease term, you pay off the vehicle’s residual amount so you own it outright, or you can renew the lease for a new term.
This structure allows you to pay less income tax and save on GST on the up-front cost of the vehicle and ongoing costs. Because the payments come directly from your salary, novated leasing is sometimes referred to as salary packaging or salary sacrificing a car. Analysis by Money.com.au found that novated leases can be more than 25% cheaper than financing the same car with a car loan. In some cases, a novated lease with running costs included can even work out cheaper than buying a car with cash and paying for running costs the traditional way.
In a novated lease in Australia, the roles of the employer, employee, and finance company are as follows:
1. Employer:
- The employer facilitates the payment of the lease by making pre-tax salary deductions for the employee.
- The employer is charged a lease payment from the leasing company, which is then deducted from the employee’s pre-tax salary.
- The employer needs to manage lease deductions, coordinate payments with the leasing company, and update their payroll system to handle these pre-tax deductions.
- If an employee decides to leave, the lease responsibility typically shifts back to them, with no lingering obligations on the employer’s part.
2. Employee:
- The employee gets to use the vehicle as they would their own.
- The employee’s car lease and running costs come out of their pre-tax salary, which can possibly lower their taxable income.
- If the employee decides to leave their job, they retain the liability to pay the lease.
- The employee is responsible for all costs associated with the vehicle, including fuel, maintenance, and insurance.
3. Finance Company:
- The finance company provides the vehicle.
- The finance company helps source the finance for the lease from a specialist lender.
- The finance company deals with the lender on behalf of the employee – for example, by preparing and submitting the finance application.
- The finance company establishes the lease agreement that the employer and employee will need to sign to finalize the arrangement.
- The finance company also takes care of any ongoing administration.
Remember, it’s recommended to seek advice from a professional business adviser, lawyer, or accountant before entering into a novated lease.
Tax Implications of Novated Leases
A novated lease is a type of vehicle lease common in Australia that has implications for an individual’s taxable income. Here’s how it works:
1. Pre-Tax Salary Deductions: With a novated lease, the finance payments for your car are deducted from your pre-tax salary. This means your taxable income will decrease, and so will the income tax based on it.
2. Fringe Benefits Tax (FBT): To offset some of this reduction in income tax, the Australian Tax Office (ATO) levies another tax called Fringe Benefits Tax (FBT) on the novated lease that your employer provides to you. This is because the ATO considers the use of a car that is paid for with pre-tax income to be a fringe benefit.
3. Reduced PAYG Income Tax: A novated lease allows you to reduce your taxable income, therefore reducing your Pay As You Go (PAYG) income tax.
4. GST Savings: With a novated lease, you can also save on the Goods and Services Tax (GST) on the up-front cost of the vehicle and ongoing costs.
It’s important to note that the exact impact on your taxable income can vary depending on factors such as your income, the cost of your car, and ongoing running costs each year. Therefore, it’s always a good idea to consult with a tax professional or financial advisor to understand how a novated lease would affect your specific situation.
Fringe Benefits Tax (FBT) is a tax paid by employers on certain benefits provided to their employees, or their employees’ families or other associates. FBT is separate from income tax and is calculated on the taxable value of the fringe benefit. The FBT rate is currently 47%.
A novated lease is a common way to provide a car fringe benefit to an employee. If you lease a car for your employee’s private use, FBT applies. The amount of FBT you pay, and the way you calculate it, depends on whether the lease is bona fide.
If it is a bona fide lease, the arrangement is a car fringe benefit. The FBT you pay is based on the taxable value of a car fringe benefit. If it is not a bona fide lease, the arrangement is a property fringe benefit (for the car itself) or residual fringe benefit (for the use of the car). This may mean you pay more FBT.
For the 2022/23 and 2023/24 financial years, FBT on a novated lease is charged at 47% on the taxable value of the benefit. That’s the equivalent of the highest tax bracket rate of 45%, plus the Medicare levy of 2%.
It’s important to note that even though novated lease payments come from your salary, it’s considered by the ATO to be a benefit on top of your standard salary and is subject to fringe benefits tax.
Please note that this is a general overview and the specifics can vary depending on the circumstances. It’s always recommended to consult with a tax professional or advisor for personalized advice.
1. GST on Vehicle Purchase: If you buy a car from a GST-registered entity (like a car dealer), you do not pay the GST. There is a GST savings threshold which is currently set at $5,234.64. If you buy a car from a non-GST registered entity like a regular private seller, there is no GST payable so no GST to save.
2. GST on Vehicle Running Costs: With a novated lease, you don’t pay GST on the running costs of your vehicle either. That means when you are filling up the tank, paying for your servicing or insurance or even getting it cleaned you could be eligible to claim all of the GST back on those transactions as well. Generally, you just need to keep the receipt, and submit it to your novated leasing provider and they will be able to do the rest of the work.
3. GST on Residual or Balloon Payments: When you first take out your Novated Lease, the residual or balloon value will not have GST applied to it. However, if you go to pay it out, the amount owing will be the residual value that is left at the end of the term plus GST.
4. GST and Finance Company: Under a full or split full novation arrangement the finance company can claim a GST credit for the GST they paid on the purchase of the vehicle¹. When the finance company leases the vehicle to you, the finance company is generally liable to pay GST to the Australian Tax Office (ATO) on that lease.
5. GST and Employer: When you lease the vehicle from the finance company, you can claim a GST credit for the GST included in the lease charges if the vehicle is being leased to you in the course of carrying on your business. However, as a general rule, you cannot claim GST credits if you make input taxed sales.
Remember, this is general information and it’s always best to consult with a tax professional or your novated lease provider for advice tailored to your specific circumstances.
Conditions for a Bona Fide Lease
A bona fide lease in Australia, particularly in the context of car leasing, is a specific type of lease arrangement that meets certain conditions set by the Australian Taxation Office (ATO). Here’s an explanation:
1. Definition: A bona fide lease is a genuine lease agreement where all dealings between the lessor, lessee, and the employer are at arm’s length and on commercial terms. An arm’s length dealing is where each party acts independently and without influence or control over the other.
2. Conditions: According to the ATO, three conditions must be met for a lease to be considered bona fide:
- Condition 1: All dealings between you, the lessor, and your employee are at arm’s length and on commercial terms.
- Condition 2: The terms of the lease are based on the residual value of the car, which is based on a reasonable valuation of estimated market value at the end of the lease.
- Condition 3: If your employee provides a trade-in vehicle or cash contribution towards the purchase of the car, this amount doesn’t reduce the lease payments or residual value.
3. Tax Implications: If it is a bona fide lease, the arrangement is considered a car fringe benefit, and the Fringe Benefits Tax (FBT) you pay is based on the taxable value of a car fringe benefit. If it is not a bona fide lease, the arrangement is a property fringe benefit (for the car itself) or residual fringe benefit (for the use of the car). This may mean you pay more FBT.
Remember, the specifics of how a bona fide lease operates can depend on the terms of the lease agreement, and it’s always recommended to seek professional advice to understand the implications fully. This information provides a general understanding and should not be considered legal or financial advice.
1. Arm’s Length and on Commercial Terms: All dealings between the lessor, lessee, and the employer must be at arm’s length and on commercial terms. An arm’s length dealing is where each party acts independently and without influence or control over the other. If this condition is not met, the lease is considered a property fringe benefit or residual fringe benefit.
2. Residual Value Based on Cost of Car: The terms of the lease must be based on the residual value of the car. This value should be based on a reasonable valuation of the estimated market value at the end of the lease. It should not be based on the reduced, or net, cost – that is, the cost to the employer or lessor after any trade-in credit or employee cash contribution. The residual value should not be less than the minimum residual values set out in ATOID 2002/1004. If an employee provides a trade-in vehicle or cash contribution towards the purchase of the car, this amount should not reduce the lease payments or residual value. If this condition is not met, the lease is considered a property fringe benefit or residual fringe benefit.
3. No Ownership Transfer Agreement: There should be no express or implied agreement that the ownership of the car would pass to the lessee at the end of the lease. That is, the car won’t become the property of the employer at the end of the term. If this condition is not met, the lease is considered a property fringe benefit or residual fringe benefit.
If all three conditions are met, the leased car is treated as a car fringe benefit. If not, the arrangement is considered a property fringe benefit (for the car itself) or residual fringe benefit (for the use of the car), which may result in more Fringe Benefits Tax (FBT) being payable.
The ATO’s Stance on Novated Leases
The Australian Taxation Office (ATO) has a data-matching program specifically for novated leases. Here are some key points about this program:
1. Program Objectives: The objectives of the novated leases data-matching program are to promote voluntary compliance, increase community confidence in the tax and super systems, ensure that individuals and businesses are fulfilling their tax and super obligations, and identify and educate those individuals and businesses who may be failing to meet their lodgment obligations.
2. Data Collection: The ATO collects information on novated leases from various sources, including McMillan Shakespeare Group, Smartgroup Corporation, SG Fleet Group, Eclipx Group, LeasePlan, Toyota Fleet Management, LeasePLUS, and Orix Australia.
3. Taxation Risks: The program allows the ATO to identify and address several taxation risks, including incorrect motor vehicle expense claims, incorrect claiming of goods and services tax (GST) credits, and fringe benefits tax (FBT) compliance.
4. Nudge Messaging: The ATO uses the collected data to initiate nudge messaging to taxpayers and tax professionals through online services at, or before the time of lodgment. This messaging informs the taxpayer that motor vehicle expenses under a novated lease arrangement are not tax-deductible.
5. Data Analytics and Insights: The data helps the ATO inform individuals with novated lease arrangements of their tax obligations, identify relevant cases for administrative action, and design ways to make it easier for clients to interact with the system and get their affairs right.
6. Program Duration: The ATO’s data matching program on novated leases runs through 2023–2026, initially started in 2021.
Before entering into a novated lease, it’s recommended to seek advice from a professional business adviser, lawyer, or accountant.
The Australian Taxation Office (ATO) has made significant efforts to educate individuals about novated lease arrangements.
One of the key initiatives is the Novated Leases Data-Matching Program. The objectives of this program are to promote voluntary compliance, increase community confidence in the tax and super systems, and ensure that individuals and businesses are fulfilling their tax and super obligations. The program also aims to identify and educate those individuals and businesses who may be failing to meet their lodgment obligations.
The ATO uses the data collected under this program to provide tailored advice and guidance to individuals on the tax implications of their novated lease. This includes initiating “nudge messaging” to taxpayers and tax professionals through online services at, or before the time of lodgment. This messaging informs the taxpayer that motor vehicle expenses under a novated lease arrangement are not tax-deductible.
The ATO also provides detailed information on its website about how novated leases work and how GST applies if you enter into a novated lease arrangement.
These efforts by the ATO aim to ensure that individuals with novated lease arrangements are aware of their tax obligations and can make informed decisions.
Example 1: Let’s say you get paid $70,000 per year (before tax) and your novated lease payments amount to $10,000. If you pay all of your novated lease payments from your pre-tax salary, your taxable income becomes $60,000. This means you’ll pay less tax over the year.
Example 2: Consider a scenario where you have a novated lease on an electric vehicle (EV) or plug-in hybrid electric vehicle (PHEV) valued below $89,332. In this case, your novated lease is exempt from Fringe Benefits Tax (FBT). Even if FBT does apply, it can be offset by post-tax contributions toward your running costs.
Example 3: If FBT does apply to a novated lease, it’s applied at 47% of the taxable value of the car. The ‘taxable value’ of the car is key here. There are two different ways of calculating the taxable value of a vehicle for novated lease FBT:
- Statutory method: This is the simpler formula. It’s essentially 20% of the ‘base value’ of the car. The base value is the driveaway price minus any government charges (stamp duty and rego). Whatever this works out is the amount of the lease contributions that will come from your after-tax pay.
- Operating cost method: With the operating cost method, you base it on the annual operating cost of the vehicle (this can factor in depreciation). That amount is multiplied by the percentage of the vehicle’s use that’s private. If you use the operating cost method, you’ll need to keep a logbook to track the business use of the vehicle.
Please note that these are general examples and the specifics can vary depending on the circumstances. It’s always recommended to consult with a tax professional or advisor for personalized advice.
Conclusion
Novated leases offer a unique opportunity for employees in Australia to optimize their tax savings while enjoying the benefits of a new vehicle². The ability to claim various vehicle-related expenses as tax deductions, coupled with the reduction in taxable income, makes novated leases an attractive option. However, it’s important to note that you can’t claim expenses for a car that’s paid under a salary sacrifice or a novated lease. As with any financial decision, it’s crucial to understand the implications fully and seek professional advice to ensure a novated lease aligns with your personal and financial circumstances.
