The topic of novated leases often arises when a car is wrapped into a salary package as part of a salary sacrifice arrangement. What exactly is a novated lease and how does it work?
Explained simply, a novated lease is a way for an employee to buy a new or used car and have their employer assist in the organised repayment for that car to an agreed financial supplier. This is done by the employer agreeing to make the repayments out of the employee’s pre-tax salary in a salary sacrifice arrangement which, like any such arrangement, reduces the employee’s taxable income. The terms of the lease repayments are calculated according to the employee’s earnings and the amount of salary sacrificed.
A novated lease is therefore a three-way transaction – between an employee, a financier, and the employer. The employee acquires the car, and the employer agrees to make the lease repayments to the financier for that car as a condition of employment.
One obvious such condition is to remain an employee. In the event that employment ceases, the obligations and rights under the lease revert to the (former) employee. This can suit the person involved, as they keep the car (and there are no tax consequences), but can also suit the employer as they are not saddled with an extra vehicle or a financial commitment for it.
During the period of the novated lease, the employer is entitled to a deduction for lease expenses where the car is provided as part of a salary sacrifice arrangement. But it does give rise to a car benefit under fringe benefits tax (FBT) rules.
The implications of fringe benefits tax (FBT)
Fringe benefits that fall under the FBT regime include anything that can be provided directly by the employer, by an ‘associate’ of the employer, or by a third party who has an arrangement with the employer (in this case, the finance supplier). A car provided through a novated lease is considered a fringe benefit to an employee, and gives rise to an FBT liability for the employer.
A basic principle of salary sacrifice arrangements is that the employer is no better or worse off from having offered an employee a form of remuneration other than a straight salary.
However, as the leased car gives rise to an FBT liability, and as FBT is an employer’s obligation, it is generally the case that any FBT amount arising as a result of the novated lease is charged to the employee’s salary package. The employer then remits the FBT to the Tax Office as required under the fringe benefits rules.
The value of the car benefit (on which the amount of FBT is based) is taken on the actual purchase price of the car. Working out its taxable value for FBT can be done using two methods – the ‘statutory percentage’ method (the most commonly used), or the ‘operating costs’ method.
Statutory percentage method – the amount of FBT levied is taken as a percentage rate of the total number of kilometres travelled during the year (both business and private), which the Tax Office has divided into different ‘bands’ of kilometres (see tables further down the page).
The operating costs method requires working out the total operating costs of the car (fuel, oil, servicing, etc) and reducing that total amount by the portion of private kilometres travelled (which attracts FBT) as compared to the total kilometres. It is most often used where business kilometres travelled are high, but is more complicated and requires more records (log books) to be kept and calculations to be made.
Post-May 11, 2011 contracts
A change brought in with the Federal Budget in May 2011 introduced a flat 20% rate to be applied across each of these bands (before this, each band was assigned a progressively lower rate). The new flat rate applies to new lease contracts entered into after 7.30pm, May 11, 2011, but the rate will be phased in (for larger distances) over four years, as follows.
|Distance traveled during FBT year||From 10 May, 2011||From 1 April, 2012||From 1 April 2013||From 1 April 2014|
|0 - 14,999 km||20%||20%||20%||20%|
|15,000 - 24,999 km||20%||20%||20%||20%|
|25,000 - 39,999 km||14%||17%||20%||20%|
|More than 40,000 km||10%||13%||17%||20%|
The reform will be a welcome tax boost for employees with salary packaged cars who normally drive less than 15,000km during the FBT year (April to March).
Pre-May 11, 2011 contracts
Leases existing before 7.30pm, May 11, 2011 still operate under the rates that applied before the Budget changes, as per the following table.
|Total km's traveled during the FBT year||Statutory
|Less than 14,999 km||26%|
|15,000 - 24,999 km||20%|
|25,000 - 39,999 km||11%|
|More than 40,000 km||7%|
As you can see from the above, the more kilometres travelled, the less tax applies. This produces an unfortunate incentive to clock up enough distance to move into the next band of kilometres and gain a reduced FBT liability. For example, an employee using a car valued at $34,000 would have a taxable value of $6,800 (ie, $34,000 x 20%) if they drove 24,000km, but that would drop to only $3,740 if they drove more than 25,000km.
Post-tax contributions to reduce FBT for employees
The tax liability that arises from the fringe benefit of salary packaging a car through a novated lease can be reduced by the employee making contributions towards, say, the running costs of the car from after-tax dollars.
It is important that these contributions come from after-tax salary, as every dollar so contributed reduces the FBT liability dollar-for-dollar up to the total amount of FBT payable. The maximum amount able to be contributed each year is equal to the statutory percentage of the vehicle’s taxable value.
By an employee doing this, rather than paying the FBT tax rate, which is 46.5%, they will be paying their own marginal rate which for many would be much less than that. The difference between the taxable value and the total cost of the benefit will not be subject to FBT or income tax.
Conditions and outcomes for employers in a novated car lease
An employer will need to agree to the salary sacrifice arrangement that allows a staff member to obtain a vehicle through a novated lease:
• The employer makes lease repayments to the finance supplier on behalf of the employee from their pre-tax salary
• Being a fringe benefit, the arrangement gives rise to an FBT liability, which the employer pays
• The amount of the FBT liability is added to the sacrificed salary amount (that is, making a nil dollar consequence for the employer)
• Expenses incurred in arranging and maintaining the lease (not the lease repayments) are tax deductible for the employer for the period the lease is active
• The end of the employment relationship also ends the repayment commitment, as lease obligations revert to the (former) employee
• Employers making lease payments may be able to claim input tax credits for GST purposes.
Conditions and outcomes for employees in a novated car lease
Salary sacrificing reduces one’s taxable income, as the amount is assigned from pre-tax salary:
• The vehicle is of the employee’s choice, and exclusive use and ownership
• As the car is a fringe benefit, FBT must be paid. The employer is liable for this payment, however the amount due is added to the salary sacrificed amount
• FBT is based on the purchase price of the vehicle, and is calculated using a rate determined by the kilometres travelled over a year (under the statutory formula method).
Making post-tax contributions to the costs of owning the vehicle can reduce the FBT liability by the same amount contributed, up to the statutory percentage of the vehicle’s taxable value. This can reduce total tax paid if the employee’s marginal tax rate is less than the FBT rate of 46.5%.