What is a novated lease on a car and what do I need to know before signing up?

If you’re considering purchasing a vehicle but haven’t saved enough money, you may be considering a choice between taking out a car loan or a new lease (also known as a “salary sacrifice” to buy a car).

It is important to know the difference as there are numerous tax implications and what is good for one may not be for another.

So, what is a renewed lease and how does it work?

Your employer is involved in a renewed rental contract

With normal leasing, you enter into an agreement with a leasing company. They buy the vehicle you chose (and own it until the end of the lease) and you get to use it in exchange for making regular lease payments. At the end of the lease term, you can choose to make an additional payment (called a balance payment or balloon payment) and take ownership of the vehicle.

With a renewed rental contract, there is another party to the agreement: your employer.

Your employer then pays the lease company on your behalf and reduces your wages by the amount of the benefit.

This is called a salary offer or salary packaging arrangement and it refers to you end up paying less tax on your income.

To demonstrate the tax savings, see the example below based on a vehicle cost of A$12,000 for the 2022-23 tax year.

Bundled with the renewed lease is the financing or interest component, at a rate similar to that of a car loan. However, it is easier to get financing through a lease with a new contract, since your employer guarantees the payment of your salary.

Used or new car? What about running costs?

You can buy a new or used car with a new lease contract.

You may also be able to bundle not only the purchase price and the financing costs, but also the running costs such as fuel, maintenance and insurance.

This means that the total cost of owning a vehicle is bundled together and deducted from your pre-tax wages. This is called a fully maintained renewed lease.

How does it compare to a traditional car loan?

With a traditional loan, you borrow money from a lender (such as a bank) to pay for your vehicle.

You immediately become the owner of the vehicle, but you have a debt (usually covered by the vehicle itself). You must make regular repayments plus interest.

If something goes wrong and you are unable to make your regular payments, you may have to sell the vehicle to cover the debt.

You are also directly responsible for all ongoing costs, which you pay out of your after-tax salary.

Since you own the vehicle, you may be able to claim tax deductions if you use it for work.

5 things to consider before signing up for a renewed lease

1. Check whether the renewed lease arrangement is tax-efficient for you. There may be other costs associated with salary offer agreements such as surcharge tax (sometimes abbreviated to FBT), which your employer may also deduct from your wages. However, some types of employers, such as charities, are exempt of this tax. It may be worth seeking advice from your employer’s payroll or accountant

2. Leasing companies often promote the savings fleet discounts and on the GST component of both the vehicle costs and the ongoing costs when you enter into a new lease contract. You should pay attention to the total package cost. Other costs, such as interest, handling charges, and service fees, may outweigh the fleet or GST savings.

3. Leasing companies often have online calculators that show savings on an extended lease compared to a traditional car loan. However, these calculators often omit the employer’s surcharge tax, which may eventually be passed on to you. So you have to take these extra costs into account

4. Make sure you understand what will happen if you resign, are laid off, or leave your current employer for the duration of the extended lease. If you change jobs, you may become responsible for lease payments. Or you may have to conclude a different agreement with the leasing company (this usually entails additional administration costs)

5. Check the residual value or “balloon payment” that applies to your extended lease (remember, this is the amount you can pay at the end of the lease to take ownership of the car). This amount is established by the Australian tax authorities.

Pros and cons

There are pros and cons to refurbishment leases, just like traditional car loans.

So it is important to fully understand the choice you are making and the associated risks.

If you plan to keep your vehicle for the long term, a car loan may be the cheaper option.

If you want to upgrade regularly, leasing can be a convenient way to go.

In any case, get good advice and make an informed decision.