Novated leases have become a popular way for employees to finance a vehicle while also offering potential benefits to employers. However, before entering into a novated lease arrangement, it’s crucial to understand how it works, the contract setup, Fringe Benefits Tax (FBT) implications, employer responsibilities, and what happens if an employee leaves. Additionally, we’ll explore the legal, accounting, and payroll administration costs involved.

What is a Novated Lease?

A novated lease is a three-way agreement between an employee, an employer, and a finance provider. Under this arrangement, the employer agrees to make lease payments on behalf of the employee using pre-tax salary deductions. This structure allows employees to reduce their taxable income while accessing vehicle benefits.

How the Contract is Set Up

1. Employee Chooses a Vehicle: The employee selects a car and a leasing provider.
2. Lease Agreement Signed: The employee signs a finance lease with the leasing provider.
3. Novation Agreement: A deed of novation is signed between the employer, employee, and leasing provider, transferring the lease obligations to the employer.
4. Salary Deductions: The employer deducts lease payments from the employee’s pre-tax salary.
5. Ongoing Management: The employer makes payments to the leasing provider until the lease term ends or the employee leaves the company.

Fringe Benefits Tax (FBT) Implications

Because a novated lease is considered a fringe benefit, it is subject to FBT. Employers must calculate and report FBT on the taxable value of the vehicle. However, FBT can be reduced using the Employee Contribution Method (ECM), where the employee contributes part of the vehicle costs from post-tax income, lowering the FBT liability.

How FBT is Calculated

• Statutory Formula Method: Uses a fixed rate of 20% of the vehicle’s value.
• Operating Cost Method: Based on actual running costs and business use percentage (requires logbook records).

Employers should consult an accountant to determine the most cost-effective FBT strategy.

Advantages for Employers

• Cost-Neutral Arrangement: Employers do not own the vehicle or carry financial risk.
• Employee Attraction & Retention: Offers a valuable perk for employees, enhancing job satisfaction.
• Tax Efficiency: FBT can be offset if employees contribute post-tax dollars towards the lease.

Disadvantages for Employers

• Administrative Burden: Managing payroll deductions and FBT reporting increases compliance workload.
• FBT Costs: If not managed properly, FBT expenses can be high.
• Liability If Employee Leaves: The lease is typically transferred back to the employee, but there may be a transition period where the employer remains liable.

What Happens If an Employee Leaves?

If an employee leaves the company before the lease term ends, the lease obligation typically reverts back to the employee. Options include:

• Transferring the Lease to a New Employer: If the employee moves to another company willing to take on the novation agreement.
• Continuing Payments Personally: The employee takes over the lease payments directly.
• Early Termination: This may involve payout fees or selling the vehicle.

Employers should have clear policies in place to manage lease transitions and minimize financial exposure.

Additional Costs and Payroll Administration Effects

Legal and Accounting Costs

• Legal Review: Employers may incur legal fees for reviewing and drafting novation agreements.
• Accounting Fees: Additional accounting costs arise from FBT calculations, compliance, and tax reporting.

Payroll Administration

• Increased Payroll Complexity: Payroll teams must manage pre-tax and post-tax salary deductions accurately.
• FBT Record-Keeping: Employers must maintain proper documentation for FBT reporting to the ATO.
• Annual Adjustments: If employees leave or vehicle usage changes, payroll adjustments may be required.

Final Thoughts

While novated leases offer benefits to employees, employers must weigh the administrative, financial, and tax implications. Proper planning, clear policies, and expert accounting advice can help businesses optimize the advantages while managing potential risks.

If you’re considering offering novated leases to your employees, consult with an accountant to ensure compliance with tax laws and avoid unexpected costs.