Can a novated lease help Australians get more tax back?

There are commonly known strategies people employ to save tax: you can claim part of your phone bill if you use it for work, you can claim your charitable donations, you can avoid the medicare levy surcharge with private health insurance – but these won’t make a huge dent. The way to make a significant reduction in the tax you pay (think thousands, not hundreds), is to start salary sacrificing. 

If you‘ve ever received professional financial advice, chances are you’ve been encouraged to consolidate and pay down loans as quickly as possible – or avoid them altogether. Conventional finance loans – such as high interest personal loans or credit cards – can be a desperate action, as there’s no long term financial benefit to taking them out. In fact, they can cost you a lot more than the amount you borrow as a penalty. And this is why a novated lease is completely different. Technically it is a type of lease not a loan, but first and foremost it’s a salary-sacrifice, tax-saving strategy. 

A salary sacrifice is where you take something you normally pay for out of your post-tax income (that’s your salary after it’s taxed), and pay for it out of your pre-tax income instead. You ‘sacrifice’ your salary, therefore it isn’t taxed. 

So what items can be salary sacrificed? Well, some companies let you sacrifice a laptop, or a phone, but the largest item you can salary sacrifice is your car. The average Australian spends around $35,000 on their car, and if you can take the cost of this out of your taxable income, you can end up saving a lot. 

You’re likely to hear friends and family talk about novated leasing as a smart move and a money saver, but to go one further – this is a product you’d likely hear your financial advisor or accountant urging you to consider. It’s the opposite of the warnings you’ll hear about credit products or conventional loans. So why is this?

Salary sacrificing your car: Using your full income

The key is not in the function of the lease itself, but in the way it utilises your salary and significantly lowers your tax bill. In fact, it’s one of the only ways to reduce your taxable income and pay less income tax. Regardless of salary size, everyone can access this benefit.

This tax effect is achievable because your employer pays for your vehicle and running costs first, in pre-tax dollars, then pays your tax obligations on the reduced income through payroll. So, you pay for your lease using your gross (pre-tax) salary, rather than your net salary after tax is taken out (as you would with all other loans and leases). Put plainly, you’re accessing money that you would otherwise never see and putting it to work for you. With your car costs paid first, what’s left is a lower salary amount for tax to be taken from, leaving you a lower tax bill and thousands of dollars saved across the life of your novated lease – sometimes as much as tens of thousands of dollars. 

One interesting thing about novated leases is that you can’t pay off the full amount of a car via your regular payments, and there’ll always be a balance at the end, or “residual”.  This is because the ATO seeks to limit your capital advantage and tax break; the residual is a limitation put in place by the ATO to avoid people paying no tax on their car, which otherwise would be possible with a novated lease. The takeaway is that this is clearly a very clever tax strategy, given that the ATO (understandably) has to put some limits on it.

Other savings with a novated lease

There are other savings with a novated lease too. You can access wholesale pricing on a new car, which vastly reduces the price. You also don’t pay GST on the vehicle or the running costs – which saves you a further 10% on the purchase of the car, as well as 10% on the running of the car. These savings are another reason why novated leasing is seen as a financially savvy product, having little in common with conventional loans. 

Reassuringly, this means of reducing tax won’t mean additional work come tax time, as these savings are on an ongoing basis.

What about the interest rate?

Even if you like the idea of saving tax and the other benefits, you may be wondering what the costs are and whether novated leases share anything in common with other types of car leasing. The answer is that novated leasing is more akin to lower rate home loans to give you an idea. There’s a relatively low interest rate the financier will charge for leasing the car to you, and a small admin cost that your novated lease provider will charge to manage your lease. But these are negligible weighed up against the considerable savings outlined above.