When it comes to salary packaging in Australia, the novated lease tax benefit is one of the most talked-about options. Employees often hear that a novated lease can save them thousands in tax, but the reality depends on how the lease is structured, whether running costs are included, and most importantly, the type of car.
In this guide, I will break down the mechanics of novated leases, explain how Fringe Benefits Tax (FBT) works, and compare the tax benefits across different scenarios.
What Is a Novated Lease?
A novated lease is a three‑way agreement between employee, employer, and a finance company. Instead of paying for car and running costs from after‑tax income, employer deducts payments directly from employee’s salary.
There are two main types of novated lease:
Fully maintained lease: Includes car repayments plus running costs i.e.; fuel, rego, insurance, servicing etc.
Non‑maintained lease: Covers only the car repayments; employee pay running costs separately from his own pocket.
The primary advantage of a novated lease is the tax benefit derived from paying a portion of the vehicle’s costs with pre-tax income, which directly reduces the employee’s taxable income.
However, the overall savings an employee gains is heavily influenced by the Fringe Benefits Tax (FBT). This is because the employer is legally required to pay FBT on the taxable value of the car. If the employer passes the FBT liability onto the employee, then it may reduce the net benefit of the lease arrangement.
Therefore, minimizing or eliminating FBT is key to maximizing the financial advantage of a novated lease.
How Fringe Benefits Tax (FBT) Works
The FBT is the key factor in determining the tax benefit of a novated lease. The ATO considers a vehicle provided through a novated lease to be a fringe benefit. To calculate the FBT liability for the employer, the most common approach is to use a formula.
Under this formula, the taxable value is calculated as 20% of the car’s initial purchase price, regardless of the actual distance driven. The FBT rate of 47% is then applied to this taxable value.
For instance, if a car costs $40,000, the annual taxable value is $8,000$ ($40,000 X 20%). The resulting FBT liability for the year would be $3,760 ($8,000 X 47%).
Please note, the annual taxable value remains the same irrespective of your annual package, as it is based on the initial car cost (it will not include the running cost). So, it will be wise to understand the lease term period, annual package, car running cost etc. to get the yearly or entire tax benefit over the lease term.
However, since employers typically pass this cost directly back to the employee, avoiding or reducing this FBT liability is absolutely crucial to maximizing the financial benefit of the lease.
The Employee Contribution Method (ECM)
The most common strategy for legally avoiding Fringe Benefits Tax (FBT) on a novated lease is the Employee Contribution Method (ECM). Under this method, the employee makes a post-tax contribution towards the vehicle’s costs, specifically matching the amount equal to the car’s taxable value. This dollar-for-dollar contribution effectively reduces the taxable value to zero, which in turn means no FBT is payable by the employer.
For example, if a car’s taxable value is calculated to be $8,000 per year as stated above, the employee would contribute exactly $8,000 of their after-tax income. The rest of the car’s package costs (including the lease payments and running costs, minus the $8,000 contribution) can then be paid using pre-tax income, maximizing the employee’s tax savings.
Fully Maintained vs Non‑Maintained Leases
The presence of FBT liability, which is typically passed on to the employee, means that paying the full lease amount pre-tax might not be tax-efficient for all employees. This is particularly true if the employee’s marginal income tax rate (e.g., 32%, including the Medicare Levy) is significantly lower than the current FBT rate of 47%.
In such cases, the FBT amount paid on the benefit could potentially be higher than the employee’s personal income tax liability would have been otherwise. This makes minimizing the FBT liability a critical consideration. A key decision in managing this tax burden is determining whether to include the car’s running costs within the novated lease arrangement.
While the following analysis provides two scenarios, it is important to remember that the most financially advantageous outcome will ultimately vary on a case-by-case basis.
Fully Maintained Lease
Suppose your total annual package is $20,000 (car + running costs).
- Post‑tax contribution = $8,000.
- Pre‑tax deduction = $12,000.
- Tax saving = $12,000 × 32% = $3,840 per year.
Non‑Maintained Lease
If you only package the car repayments ($15,000 per year):
- Post‑tax contribution = $8,000.
- Pre‑tax deduction = $7,000.
- Tax saving = $7,000 × 32% = $2,240 per year.
Including running costs increases the pre‑tax portion and delivers a much larger tax benefit. While the tax benefit derived from a novated lease on a petrol or diesel car can fluctuate and is complicated by the need to manage Fringe Benefits Tax (FBT), the tax benefit achieved with an eligible Electric Vehicle (EV) is fundamentally different. For an EV, the current FBT exemption simplifies the calculation and typically may offers a much larger, more stable tax saving.
Electric Vehicle (EV) Exemption: The Game Changer
The introduction of the Electric Vehicle (EV) Exemption is a significant game changer that makes novated leases exceptionally attractive for eligible cars. To qualify for the exemption, please check details from the ATO website.
Since the eligible EV is completely FBT-free, the employee is not required to make any post-tax contribution to cover the FBT liability. This means the entire cost of the car package, including the lease payments and all associated running costs, can be paid using pre-tax income.
To illustrate the impact, consider an employee who pays a combined marginal tax rate of 32%, including the Medicare Levy. If this employee’s annual car package is valued at $25,000, they achieve a tax saving of approximately $8,000 per year ($25,000 X 32%). Over a two-year lease term, the total saving would be around $16,000.
This substantial financial benefit is why novated leases are currently the most advantageous option for financing eligible electric vehicles under Australian tax law.
Practical Examples: Petrol Car vs EV, 2‑Year Lease
Example 1: $40k Petrol Car
- Annual package = $25,000.
- Post-tax (ECM) = $8,000 (Used to reduce FBT to zero).
- Pre-tax = $17,000.
- Tax saving = $5,440 per year ($17,000 x 32%).
- Total saving = $10,880 over 2 years.
Example 2: $40k Eligible EV
- Annual package = $25,000.
- Post-tax (ECM) = $0.
- Pre-tax = $25,000.
- Tax saving = $8,000 per year ($25,000 x 32%).
- Total saving = $16,000 over 2 years.
Other Benefits Beyond Tax
Even when the tax benefit is modest for petrol car, novated leases offer:
- GST savings: Employers can claim back GST on lease payments.
- Fleet discounts: Lower purchase price, servicing, tyres, and insurance.
- Budgeting convenience: All costs bundled into one deduction.
- Cash flow flexibility: No large upfront payment required.
Final Thoughts
The novated lease tax benefit depends heavily on the car type, lease length, and your specific income level. For traditional petrol cars, the benefit requires careful management of FBT through the ECM.
For eligible EVs, the benefit is substantial, making novated leases one of the most tax-effective ways to own a car in Australia today.
DISCLAIMER: The information provided in this guide is general in nature only and does not constitute personal financial, taxation, or legal advice. It has been prepared without taking into account your individual objectives, financial situation, or needs. Before acting on any information, you should consider the appropriateness of the information to your own circumstances and seek advice from a qualified financial adviser, tax agent, or legal professional.
