How Does a Novated Lease Help Lower Your Income Tax?

‍What is a novated lease?

A novated lease is a specific type of salary packaging arrangement where employees use pre-tax income to pay for leasing a car.

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Novated leasing can reduce your taxable income, lessening the income tax payables.

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Example: Novated lease

Here is the difference between purchasing a $40,000 car with and without a novation lease.

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The annual running cost of the car is $15,400 (GST inclusive).

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The FBT before employee contribution is calculated based on the statutory cost method.

$40,000 x 20% x 365/365 days = $8,000

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To offset the tax payable, the employee is making a post-tax $8,000 contribution, which reduces the FBT to $0.

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FBT =  ($8,000 - $8,000) x 2.0802 x 47% = $0

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*Refer to Fringe benefits tax on cars 

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Purchasing a $40,000 car through a novated lease could save you $2,826 in cash. This significant saving is primarily due to the GST credit applied and the reduction in your taxable income which decreases the income tax you pay.

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Although an FBT liability of $7,821.55 ($8,000 × 2.0802 × 47%) could apply, it can be fully offset by making a post-tax employee contribution equal to the taxable amount. This allows the employee to pay tax on the contribution at their personal income tax rate instead of the higher FBT rate. Consequently, the employee benefits from the difference between the FBT rate (47%) and their lower marginal income tax rate.

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Note that electric cars are exempt from FBT, allowing the employee to fully benefit from a novated lease without needing to make a post-tax contribution.

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CTK Accounting is a full-scope accounting firm based in Wollongong, servicing clients nationally.

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For advice on Tax, BAS, GST, Bookkeeping, and Payroll issues visit us at ctkaccounting.com.au