A novated lease agreement for vehicles can serve as an effective employee retention strategy, offering key advantages to those who opt into this arrangement. As an employer or employee, you need to understand the practicalities of novated lease arrangements before you enter into one. This article will guide you through what novated lease agreements are and the critical factors to consider, including the:
- benefits;
- namely tax advantages;
- potential drawbacks; and
- other key factors.
What is a Novated Lease Agreement?
With a novated lease agreement, you can finance a motor vehicle through your salary packaging. When you opt for salary packaging, you make repayments from your pre-tax income, a process commonly known as ‘salary sacrificing’. This arrangement mainly benefits you by reducing your taxable income instead of using after-tax earnings to buy a vehicle.
How Does a Novated Lease Agreement Work?
In a novated lease agreement, three parties are involved:
- employer;
- employee; and
- finance company.
The employee enters into a novated lease agreement with the finance company, outlining the lease terms, such as:
- payments;
- duration; and
- obligations of all the parties.
Often, the employer might guide the choice of the finance company, potentially based on existing corporate relationships or agreements, to secure more favourable terms or streamline the administrative process.
Employer
As an employer, you enter the agreement through novation and assume certain obligations. This includes directly deducting lease payments from your employee’s pre-tax salary and making the payments on their behalf.
Employee
As an employer, you should limit your obligations. Your employee should take responsibility for:
- Maintaining and covering the running costs of the car (if it is a ‘non-maintained lease’);
- compensate you against losses that result from their failure to perform their obligations; and
- being liable for any damage to the vehicle (you should not be held responsible for your employee’s actions).
Finance Company
The finance company is responsible for:
- financing the vehicle on behalf of the employee;
- processing payments made by you on behalf of the employee; and
- fully maintaining the vehicle if the lease arrangement is a ‘fully-maintained lease’, including:
- servicing;
- repairs; and
- insurance.
When an employee leaves your company, your involvement in the arrangement ends, and the responsibility for lease payments shifts to the employee. The employee will make these payments from their post-tax income unless they find a new job where the new employer becomes bound to the novated lease agreement and covers the payments on their behalf.
Continue reading this article below the formWhat Are the Tax Benefits of Having a Novated Lease Agreement?
Offering novated lease agreements as salary sacrifice schemes benefits your staff without costing your business much. However, handling administrative tasks may be more demanding and expensive for smaller companies like yours compared to larger organisations that handle such arrangements more efficiently.
For employees, the main advantage of a novated lease agreement is the financial benefit gained by paying from pre-tax income. While Fringe Benefits Tax (FBT) applies to benefits provided by employers, like gym memberships, novated lease agreements can qualify for FBT exemptions under specific conditions.
Electric Vehicles
For example, if you, as an employer, facilitate an employee entering a novated lease for an electric vehicle meeting certain criteria (like a value cap), you can exempt them from FBT. This exemption can also extend to covering running costs.
Not-for-Profit Employees
Additionally, employees of not-for-profit (NFP) organisations may receive exemptions from FBT on their vehicles. The eligibility for these exemptions depends on certain criteria that vary depending on the type of employer you are.
Dual-Cab Motor Vehicles
Some vehicles, such as a dual cab, may qualify for an FBT exemption under the work-related travel category. To qualify for this exemption, a vehicle must meet specific criteria and adhere to certain usage restrictions.
What Happens at the End of a Novated Lease Agreement?
Lease Renewal
When you renew the lease, you can keep using the vehicle without facing immediate financial pressure from the balloon payment. You can also continue enjoying the tax savings provided by a novated lease agreement.
Balloon Payment
If an employee opts to own the car outright, they can make a balloon payment. The required balloon payment amount is influenced by the car’s value and the original lease term. Generally, a shorter lease term means a higher residual payment. Australian Taxation Office (ATO) regulations guide this option.
Trade-in
Trade-in involves you trading in the employee’s current vehicle. The proceeds from the sale are used to settle the residual of the existing lease. If the sale proceeds exceed the residual amount, the leasing company may return the surplus to you. However, if the trade-in value does not cover the residual amount, your employee is responsible for covering the difference.
This guide will help you to understand your options when you purchase a business with leased premises.
Key Takeaways
Novated lease agreements help you finance vehicles for your employees through salary packaging as it reduces their taxable income. In this three-way arrangement between you, the employer, your employees, and finance companies, you take on specific responsibilities through a process called novation, including paying lease obligations directly from your employees’ pre-tax salaries
This setup is often beneficial for you as it allows you to offer this benefit to your employees at little to no additional cost. Within novated lease agreements, there are specific FBT exemptions, each with particular conditions. Your employees have various options when a novated lease ends, such as renewing, making a balloon payment for ownership, or upgrading to a new vehicle.
If you need help with your novated lease agreement, our experienced commercial lease lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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