The concept of salary packaging vehicles via novated leasing is not new. If you are an employer who has thought about offering salary packaging to your staff, or have an employee interested in financing a vehicle purchase, but are not sure about the novated lease option then it may be worth understanding how the concept works. So, let’s start off with some common questions.
What is vehicle salary packaging?
In simple terms, an employee agrees to sacrifice part of their future salary income (let’s call this ‘pre-tax salary’) in return for receiving a car benefit. A well thought out salary sacrifice arrangement can result in substantial savings for employees and can also benefit employers.
Now let’s say the employee does not have the finances to purchase the car upfront. A novated lease could be one of the ways to finance the car
What is a novated lease?
A novated lease is a three-way arrangement involving the employee, the employer and the finance company. The employee enters into a finance lease with the finance company and is granted use of the car (which may be for business or private use). The title of the vehicle is transferred to the employee and the employer agrees to take on the obligation of making lease payments and/or vehicle operating expenses on behalf of the employee to the finance company. These payments are made by periodically deducting amounts from the employee’s ‘pre-tax’ salary.
From a legal perspective, there are two separate agreements prepared – the first is a ‘lease’ agreement between the finance company and the employee. The second is a ‘novation’ agreement between all three parties - the finance company, employer and employee.
What are the types of novated leases?
There are two types of novated lease - a ‘fully maintained’ and a ‘non-maintained’ novated lease. A fully maintained novated lease includes payments towards the actual lease rentals as well as certain budgeted annual operating costs such as fuel, service, registration. A non-maintained lease on the other hand only includes payments towards the lease rentals.
Are there any additional taxes payable?
Provision of a novated lease by the employer is considered to be a non-cash fringe benefit to an employee. Fringe benefits tax (FBT) is payable by the employer but the employer will generally seek to pass on this tax to the employee. However, the employee can reduce the impact of this tax by contributing a certain amount out of each pay.
It is a requirement that this contribution must come out of the employees ‘post tax’ income. Therefore, amounts deducted from an employee’s salary is often split between a ‘pre-tax’ and ‘post-tax’ component. For example, $1,000 deducted from employee’s salary each month of which $800 is a ‘pre-tax’ contribution (i.e. lease rentals, fuel) and $200 is ‘post-tax’ (i.e. towards the FBT contribution).
What about luxury cars, are there any additional charges?
Where the vehicle being leased is above the luxury car limit prescribed by the ATO, the employer will not able to claim as a tax deduction the full lease rental. Instead the deduction is limited to only the interest and depreciation components. In order to compensate the employer for this loss of deduction, a luxury car charge is generally added on to the calculation.
What happens if the employee decides to leave the company?
Novated lease agreements are generally transferable meaning that if the employee leaves their current job, or is terminated, the lease obligations get transferred to the employee. Depending on the salary packaging policies of the new employer, it may also be possible to transfer the lease obligations over to the new employer.
Example showing how an employee was better off switching to a novated lease
Company A was the owner of several vehicles which were being used by its Directors for a combination of business and private use. It was decided that one of the vehicles (which was under a chattel mortgage) needed to be moved out of the balance sheet. Initially, a sale was contemplated to the individual Director that was using the car. However, a disposal to the director would have resulted in substantial FBT and other adverse tax consequences.
The Director had heard of novated leasing previously but wasn’t sure if the savings were worth the effort. We were able to put the Director in touch with a novated leasing specialist to provide a comparison of the difference in their take home pay with and without salary packaging.
Here’s an edited version of a comparison table showing that the director would end up with an $8,500 increase in take home pay with the salary packaging option.
The savings were generated partly due to the fact that the director was on the top marginal tax bracket, which meant that the tax savings are generally higher for every dollar that gets deducted. The director was also able to substantiate business use of the vehicle by maintaining a log book, which results in a lower overall taxable value for the fringe benefit.
When spread out over the 5-year term of the lease, the savings were expected to add up to around $40,000. As a result, the director decided to negotiate a novated lease arrangement with the employer and the vehicle and lease liability were moved off the company balance sheet.
A few points should be noted:
Check employer policies in relation to salary packaging as it is vital that the employer agrees to it.
Most finance companies will require that the leased vehicle be less than 8 years old.
Confirm if there are any extra fees and charges for adjusting the lease down the track.
Generally, employees on higher tax brackets tend to benefit more from salary packaging as the savings are higher for every dollar that gets deducted under a novated lease.
It is advisable to maintain a logbook (especially when purchasing a luxury car) as the higher the business use, the lower the taxable value of the fringe benefit.
The residual value in the lease contract should be set within the ATO minimum guidelines for novated leases.
The employer and not the employee is liable for GST on the purchase price under a novated lease.
As you can see from the example above, novated leasing / salary sacrifice strategy can have some clear advantages over a traditional lease, in the right circumstances, but it is certainly not a ‘one-size fits all’ approach.
If you have any questions or would like to know more, please feel free to get in touch with one of our tax advisors.
