A novated lease is a three-cornered arrangement. You choose the car and sign a lease with a financier. Then a deed of novation transfers your obligations under that lease to your employer, who pays the financier out of your salary for as long as you work there. The car is yours to drive, the debt is legally the employer's while the novation stands, and the tax treatment is what makes the whole thing worth doing.
The novation ends when the job does. If you resign, are made redundant or the arrangement is otherwise wound up, the lease reverts to you personally and the payments come out of after-tax income — at a number that was calculated on the assumption they would not. Ask what happens on separation before you sign, and get the answer in writing. The second thing to settle early is the residual: it is a fixed amount you owe at the end, whatever the car turns out to be worth.
What "novated" actually means
Novation is the substitution of one party to a contract for another. Here it substitutes your employer for you as the party responsible for the lease payments. Employers agree to it because it costs them little and is a real benefit to staff; financiers agree to it because a payroll deduction is a reliable way to be paid.
What it is not is an employer car. You picked it, you drive it, and when the arrangement ends you are the one holding it.
Why FBT decides the price
Making a car available for an employee's private use is a car fringe benefit, and a novated lease inside a salary sacrifice arrangement is the ordinary way that happens. So the cost of the arrangement is really the cost of the lease plus the FBT on it, less whatever tax the pre-tax salary sacrifice saves.
Under the statutory formula the taxable value is 20% of the car's base value, pro-rated for the days it was available, less any employee contribution. Because the base value is fixed at the start, the FBT does not fall as the car ages — a five-year lease is charged 20% of the original value in year five as well as year one. Our fringe benefits tax guide works the mechanics through in full.
The employee contribution method
This is what most packaging providers actually do, and it is worth understanding because it is where the "no FBT" claim usually comes from.
You make a contribution from post-tax salary towards the car's running costs. That contribution reduces the taxable value dollar for dollar. Contribute enough and the taxable value falls to nil, the FBT falls to nil, and the reportable fringe benefits amount on your income statement falls to nil with it.
The ATO's worked example for an employee on $65,000 shows both shapes. Packaged without contributions, taxable income drops to $47,647 but a reportable amount of $13,207.60 lands on the income statement. Packaged with contributions, taxable income is $60,855 and the reportable amount is nil. The second version protects HELP repayments, Family Tax Benefit and Child Care Subsidy; the first pushes more income out of the tax net. A good quote will show you both.
The lease has to be bona fide
If the ATO does not accept the lease as genuine, the arrangement is not a car fringe benefit at all — it becomes a property or residual fringe benefit, and the FBT is usually higher. The ATO's car leasing and FBT page sets out three conditions.
- Arm's length and commercial. Dealings between employer, lessor and employee are independent.
- The residual is based on the car's cost. Not on the net cost after a trade-in or a cash contribution, and not below the published minimums.
- No pre-existing agreement to buy the car at the end, or to keep using it.
The ATO's own example makes condition two concrete. Patrick chooses a $41,600 car, of which $1,600 is registration, stamp duty and dealer delivery. He pays that $1,600 himself; the financier pays the $40,000 balance. The lease is written over $40,000, the three-year residual is 46.88% of $40,000 — $18,752 — and the base value for FBT is $40,000. His contribution reduces neither the lease payments nor the residual, which is precisely what keeps the lease bona fide.
The counter-example is Sheila, whose $20,000 trade-in is used to cut the financier's purchase price to $40,000 and the residual to $12,000. Her payments are below commercial and she can buy the car for less than market value, so the lease fails and her employer cannot treat it as a car fringe benefit.
How the residual is set
The residual is not a guess about the car's future value and it is not negotiable downwards on a whim. The ATO publishes minimum percentages of the original cost, and a lease that sets a residual below them risks being treated as a disguised sale rather than a lease.
Minimum residual as a percentage of cost
- 1 year
- 65.63%
- 2 years
- 56.25%
- 3 years
- 46.88%
- 4 years
- 37.5%
- 5 years
- 28.13%
These come from ATO ID 2002/1004 Car lease residual values, for an asset with an eight-year effective life. They are minimums, not targets — a lease can be written with a higher residual, which lowers the monthly payment and raises the lump sum at the end. See balloon payments and residual values for what that trade actually costs.
Salary sacrifice has to be arranged before you earn the money
An effective salary sacrifice arrangement has to be in place before the salary it applies to is earned. You cannot package income you have already accrued, and you cannot package leave entitlements, bonuses or commissions that accrued before the arrangement started. A direct debit from your pay is not a salary sacrifice — it is you spending after-tax money.
ASIC's Moneysmart puts the general case plainly on its salary packaging page: the benefit is larger the higher your marginal rate, which is why the same lease is a good deal for one colleague and a poor one for another.
What happens when you change jobs
Three possible outcomes, and the lease documents decide which:
- Your new employer takes over the novation. Common, but not automatic — the new employer has to be willing, and not all are.
- You keep paying it yourself. The lease continues in your name from after-tax income. The FBT disappears, and so does the tax advantage that justified the payment amount.
- You pay it out. Usually the balance plus the residual, and usually more than the car is worth part-way through the term.
None of these is a disaster if you knew about it. All of them are unpleasant surprises if you did not.
What to ask for in writing before you sign
- The base value used for FBT, and the residual amount in dollars, not just a percentage
- The total of every payment over the term, including fees, and the residual on top
- What is bundled into the payment — registration, insurance, servicing, tyres, fuel — and what is not
- Whether the quote uses the employee contribution method, and what your income statement will show either way
- What happens if you leave, and what it costs to end the lease early
- Whether the car qualifies for any concession you are being told about, in the specific case of your vehicle
If you are weighing this against simply borrowing money, ways to buy a car in Australia sets the options side by side.