What is a novated lease?

Novated leases explained: Get a new car, pay less tax

If you’re not sure what a novated lease is, don’t worry, many people don’t. A novated lease is just a way to pay for your car out of your pre-tax income, so you can save on the annual income tax you pay. Some people choose to keep those tax savings, and some choose to spend them to get into a better, “upgraded” car.

How does it work?

It’s pretty simple in practice. An agreement is set up between you, your employer, and a car finance provider. Instead of you paying for your car outright, you enter into a lease agreement for the car with the finance provider (for a fixed period – 1 to 5 years).

Then, you ‘novate’ your car’s lease to your employer (novate is just a fancy word for ‘assign the lease obligations to another party’). Your employer deducts the cost of your car from your salary before tax, reducing the income tax you pay each pay-cycle. Your car payments are fixed, so you know what you’re paying for your car each month.

You might have heard people say they’ve ‘salary sacrificed’ items with their employer, like a laptop or a phone or another asset. A novated lease is basically a way to salary sacrifice your car.

Novated lease example

Let’s say in 2020-21 you earn $70,000 a year and you want to purchase a car – a new Toyota RAV4. That year, you’d pay around $14,500 in tax and only keep $55,500 (excluding super). If you buy the RAV4 outright, you’d pay around $50,000 drive away for the car. 

Instead, you can use a novated lease and pay for the RAV4 out of your salary, before you pay tax, meaning you reduce your $14,617  tax bill to around $11,533 for that year. That’s an income tax saving of $3,084. 

Over a 3-year lease term, you would make income tax and GST savings of $12,606, or an average of $4,202 per year. And with a novated lease, the higher your tax bracket, the more you save.

You can add the running costs of your vehicle to your lease – including fuel, servicing, insurance, roadside assistance and your yearly rego. All are paid before tax, meaning that each running cost contributes to your tax reduction. 

There are other benefits of a novated lease:

• Because you’re not purchasing the vehicle, you’ll save on GST, so that automatically reduces the cost of the vehicle by 10% (up to the maximum claimable GST value of $5,376).

• You avoid GST on servicing parts and labour too.

• Most novated lease providers will give you wholesale prices on most cars, meaning you can get into a $40,000 car and only be paying off something like $37,000 straight off the bat.

What happens at the end of the lease?

At the end of the lease you’ll have an amount remaining, called the ‘residual’. This is usually lower than the market value of your car at the time. So at the end of the lease you have 3 options: 

1. Sell the car to pay your residual. Any profit you make is your to keep - tax free.  You can then get into a new lease for a new car; or

2. Pay the residual and keep the car. You will own the car outright; or

3. Refinance the residual. Here you enter into a new novation agreement where you finance the residual amount.

How do I get a novated lease?

Your employer just needs to be set up for novated leasing (which is fairly simple – we have a section for employers and a handy employer guide with steps).

Now you know what it is, what’s next?

If you want to understand some things you need to consider before getting a novated lease, check out our article ‘The novated lease: Advantages & disadvantages, pros & cons’. If you’d like to get an idea of savings you can get, try our novated lease calculator.

Or if you’d prefer to chat to a human, why not give us a call on 1300 888 594 and we’ll happily walk you through specific options for you. If you prefer, you can book a time that suits you, or send us a message if that suits you better and we’ll message you back.