How do tax and savings work with novated lease vehicles?

For most of us, these new ‘COVID-normal’ times mean finding as many ways as we can to make our dollars stretch further. Not only are we all adjusting to an uncertain and slowing economy, plus a mixed up work/life balance, but we are also reviewing how we move ourselves and our family around.

For you or your employees, this might mean planning for a new car, or a second car. While everyone’s financial circumstances are different, a novated lease generally provides some significant savings, as well as making a positive difference to many Australian employees’ tax situations.

It’s a great option to consider for any employee of a company that makes it available as part of its remuneration and benefits program.

How does a novated lease offer savings?

Many of LeasePlan’s novated lease customers are saving at least $3,000 per year.

The reasons why have a lot to do with the savings on GST that are available under a novated lease, along with the reduction in income tax as a result of the contributions to your lease payments from your pre-tax salary.

The very first saving you get with a novated lease is on the actual purchase price of the vehicle. You don’t have to pay GST on the purchase price. If you’re purchasing a $30,000 vehicle, that’s $3,000 you save immediately. You can also save GST on all of the running costs of the car during the lease.

While this exemption helps most, be aware that Luxury Car Tax and general GST discount thresholds may have an impact the other way. In short, don’t expect a $7,000 discount on a $77,000 vehicle.

Salary Sacrifice and Fringe Benefits Tax (FBT)

Salary deductions provide another opportunity to reduce your tax burden, as payments are made from pre-tax income, which can reduce your taxable income.

A novated lease will attract Fringe Benefits Tax (FBT).  This used to be applied in tiers – with less tax applied for more kilometres driven, but not anymore. Now it is a flat rate regardless of mileage.

Because you’re making the payments from salary deductions, you reduce your taxable income and you don’t pay GST, which is where most of the savings are derived from. The Australian Taxation Office recognises it as a really great benefit and they’ve applied FBT to novated leasing. The best way to manage any FBT that might be payable is by utilising ECM.

Employee Contribution Method (ECM)

To manage FBT liability, instead of having the entirety of your lease payments coming out of your pre-tax earnings, ECM means you will make a portion of your lease payments from your post-tax earnings. Post-tax payments effectively eliminate any FBT that may be payable and improve the tax effectiveness of the arrangement.

By reducing or eliminating the FBT, ECM will lower the overall packaging cost and increase disposable income.

And if your current lease is almost complete…

The end of a novated lease is another chance to make the most of further savings that might be available to you.

In a novated lease, you’re only financing about two thirds of the amount during your lease, and the other third of it is a residual value, or a residual payment that needs to be made at the end of the term. This means lower monthly payments compared to some other car finance options where you are paying down 100% of the car purchase price.

Then, at the end of your lease term, you want to pay it out and start a new lease on a new car. You can sell that vehicle privately, and any upside on the sale price compared to your residual payment is yours – tax-free.

For example, in an agreement with a $12,000 residual payment, you might sell that vehicle on the used car market for $20,000. The $8,000 difference after finalising the balloon or residual payment is 100% cash profit.

But, of course, anyone entering into a novated lease needs to be careful because it’s hard to predict what a used vehicle is going to be worth in the future market. Make sensible and informed choices about your car and your lease terms, mindful of what you might reasonably think it will be worth at the end of the lease.

Convenience on the road

When you have chosen your car and the lease has started, LeasePlan sets up your payroll deductions and there’s not much for you to worry about.

Once a lease is up and running, people get used to the deductions coming out of their pay. It’s kind of a set-and-forget situation. At the beginning, when you get into the novated lease, it’s all about the savings and questions like ‘Why is this better for me?’ and ‘How much money am I going to save?’

Then, as your lease term progresses, you really become more focused on the convenience, and you kind of even forget the money you’re saving because all you’re really seeing regularly is the amount coming out of your pay.

After understanding all the financial savings you can make with a novated lease, then all that it all comes down to is the fantastic convenience, and that you’re driving around in a nice, new car.

NOTE: all individual situations are different, and LeasePlan always advises that you seek independent financial advice before entering in to an agreement.

Want to know more about novated leases? Start a conversation with LeasePlan today.

Driving Insights