“Novated Leasing” sounds complicated and like something only a rocket scientist could come up with, but it isn’t as bad as it sounds. So let’s have a look at what a Novated Lease is and how it works in a way my mum could understand. Not that she is dumb, but when it comes to anything even slightly financial, her brain goes into melt down.
So lets look at in two parts, starting with the “Novated” part first. This is the word that sends mum’s brain to the critical stage, just before the “Leasing” tips it over into full scale melt down. Novation is a legal term, which simply means to replace or transfer. It may involve replacing either one person with another or one obligation with another, or both. So think of it as a Transfer Lease.
An example of the Novation of an agreement would be if You have a house and agree to rent it to Jenny for a year. Jenny shares the house with Rose, but after 6 months has to go overseas. Instead of cancelling the rental contact and drafting a new one with Rose we could Novate (transfer) it from Jenny to Rose. Jenny, Rose and You all have to agree to this and by doing so the original rental term remains, but now Rose is responsible for paying You the rent, not Jenny.
Now let’s look at the “Leasing” part which for most of us is a term we are familiar with. It’s the bit where one person lets another have or use property for an agreed amount of time (term of the lease) and for an agreed price (rental or lease payments).
So far so good I hope, so let’s look how these apply to a Car Lease. You may have noticed that there are three people involved when we Novate. In the above example it was Jenny, Rose and You. For a Novated Car Lease the three are the Employee (you), the Employer and the Finance Company.
So we start with a lease agreement between the Employee and the Finance Company for a Car. Then, because of the tax benefits the Employee asks their Employer to enter into a Novated Lease which would transfer the Employees obligation to make lease payments to their Employer.
Not surprisingly the Employer will only agree if they can reduce the Employee’s salary by the cost of the lease payments, so they are not out of pocket. They will then give the car to the Employee to use just as they had before they the whole round about Novated Leasing thing.
If I still have you, then you are probably wondering why the hell go to all the fuss, the Employee is still paying the lease through salary deductions. Well you are right to an extent, if they were paying $550 a month before the Novation and then had a salary deduction of $550 after then it doesn’t look like they have achieved much.
That is because the savings are only visible when you look at after tax income. If you are on a salary of $50,000 a year and have a marginal tax rate of 31.5% (Medicare levy included) then you need to earn $803 before tax to have the $550 after tax to pay the lease on your car.
If you are able to pay for the lease costs out of pre-tax income, by salary sacrificing the cost of the lease, then you pay $550 out of pre-tax income, not $803. So you have just increased your salary by $253 a month or $3,036 a year. Congratulation on your 6% pay rise (based on $50,000 annual salary).
As you can see the tax savings are what all the fuss is about, and there are more. Because the car lease has been Novated to the Employer, it is now a business expense for that employer. So the Employer gets a GST credit for the GST on the lease charge of $550, which is $50. So instead of taking $550 out of the Employee’s salary each month, they only take $500 out because they get the $50 back from the government.
Now the salary savings are up to $303 a month ($803 less $500), or $3,636 a year. That’s equivalent to a 7.2% pay rise if you are on $50,000 a year, I’ll take that thank you very much.
Ok, so why isn’t everyone doing it? I hear you ask, and the answer is that it isn’t quite as simple as that. The above example is just to show you what the advantages are and how they come about. What we also need to take into account is Fringe Benefit Tax (FBT), which is a tax that was introduced in part to combat the huge tax advantage Novated Car Leases give Employees.
The FBT rules affect this happy little arrangement by taxing the Employer for the benefit the Employee gains from having the car. Not wanting to be caught short, the Employer then deducts the tax cost from the Employee and in doing so reduced the benefit.
How this ultimately reduces the benefits depend on the personal circumstances of the Employee and the value of the car. I would require another five pages to explain this fully, so will save it for another blog entry. The best way to see how it would affect you and what the ultimate benefits are, is to get an assessment based on your personal circumstances. Fill in the form on the home page of this site to get your free assessment.
In summary, a Novated Lease is an arrangement between three parties (e.g. Employee, Employer and Finance Company), where the lease benefits and obligations of one party (Employee) are transferred to another (Employer). It is normally done with a salary sacrifice arrangement between the Employer and Employee with the ultimate benefit to the Employee being tax savings from running their car and the Employer having a happier Employee at no extra cost.
I hope this has helped make sense of what a Novated Lease is and why they are of benefit. Feel free to leave a comment about this article or ask any questions. We are looking for topic’s that interest you for future blogs, so would love to hear from you.
Best Wishes,
Tom Collins
So lets look at in two parts, starting with the “Novated” part first. This is the word that sends mum’s brain to the critical stage, just before the “Leasing” tips it over into full scale melt down. Novation is a legal term, which simply means to replace or transfer. It may involve replacing either one person with another or one obligation with another, or both. So think of it as a Transfer Lease.
An example of the Novation of an agreement would be if You have a house and agree to rent it to Jenny for a year. Jenny shares the house with Rose, but after 6 months has to go overseas. Instead of cancelling the rental contact and drafting a new one with Rose we could Novate (transfer) it from Jenny to Rose. Jenny, Rose and You all have to agree to this and by doing so the original rental term remains, but now Rose is responsible for paying You the rent, not Jenny.
Now let’s look at the “Leasing” part which for most of us is a term we are familiar with. It’s the bit where one person lets another have or use property for an agreed amount of time (term of the lease) and for an agreed price (rental or lease payments).
So far so good I hope, so let’s look how these apply to a Car Lease. You may have noticed that there are three people involved when we Novate. In the above example it was Jenny, Rose and You. For a Novated Car Lease the three are the Employee (you), the Employer and the Finance Company.
So we start with a lease agreement between the Employee and the Finance Company for a Car. Then, because of the tax benefits the Employee asks their Employer to enter into a Novated Lease which would transfer the Employees obligation to make lease payments to their Employer.
Not surprisingly the Employer will only agree if they can reduce the Employee’s salary by the cost of the lease payments, so they are not out of pocket. They will then give the car to the Employee to use just as they had before they the whole round about Novated Leasing thing.
If I still have you, then you are probably wondering why the hell go to all the fuss, the Employee is still paying the lease through salary deductions. Well you are right to an extent, if they were paying $550 a month before the Novation and then had a salary deduction of $550 after then it doesn’t look like they have achieved much.
That is because the savings are only visible when you look at after tax income. If you are on a salary of $50,000 a year and have a marginal tax rate of 31.5% (Medicare levy included) then you need to earn $803 before tax to have the $550 after tax to pay the lease on your car.
If you are able to pay for the lease costs out of pre-tax income, by salary sacrificing the cost of the lease, then you pay $550 out of pre-tax income, not $803. So you have just increased your salary by $253 a month or $3,036 a year. Congratulation on your 6% pay rise (based on $50,000 annual salary).
As you can see the tax savings are what all the fuss is about, and there are more. Because the car lease has been Novated to the Employer, it is now a business expense for that employer. So the Employer gets a GST credit for the GST on the lease charge of $550, which is $50. So instead of taking $550 out of the Employee’s salary each month, they only take $500 out because they get the $50 back from the government.
Now the salary savings are up to $303 a month ($803 less $500), or $3,636 a year. That’s equivalent to a 7.2% pay rise if you are on $50,000 a year, I’ll take that thank you very much.
Ok, so why isn’t everyone doing it? I hear you ask, and the answer is that it isn’t quite as simple as that. The above example is just to show you what the advantages are and how they come about. What we also need to take into account is Fringe Benefit Tax (FBT), which is a tax that was introduced in part to combat the huge tax advantage Novated Car Leases give Employees.
The FBT rules affect this happy little arrangement by taxing the Employer for the benefit the Employee gains from having the car. Not wanting to be caught short, the Employer then deducts the tax cost from the Employee and in doing so reduced the benefit.
How this ultimately reduces the benefits depend on the personal circumstances of the Employee and the value of the car. I would require another five pages to explain this fully, so will save it for another blog entry. The best way to see how it would affect you and what the ultimate benefits are, is to get an assessment based on your personal circumstances. Fill in the form on the home page of this site to get your free assessment.
In summary, a Novated Lease is an arrangement between three parties (e.g. Employee, Employer and Finance Company), where the lease benefits and obligations of one party (Employee) are transferred to another (Employer). It is normally done with a salary sacrifice arrangement between the Employer and Employee with the ultimate benefit to the Employee being tax savings from running their car and the Employer having a happier Employee at no extra cost.
I hope this has helped make sense of what a Novated Lease is and why they are of benefit. Feel free to leave a comment about this article or ask any questions. We are looking for topic’s that interest you for future blogs, so would love to hear from you.
Best Wishes,
Tom Collins