Novated Lease Guide Australia

What Is a Novated Lease?

A novated lease is a three-way agreement between an employee, their employer, and a finance company that allows car costs to be paid from pre-tax salary, reducing taxable income and overall vehicle running expenses.

The word "novation" is a legal term meaning the substitution of one party to a contract for another. In a novated lease, the employer assumes the employee's payment obligations to the leasing company for the duration of employment. The employee chooses the vehicle, negotiates the price, and selects the lease term — typically 1 to 5 years. The employer then deducts lease payments and bundled running costs directly from the employee's gross salary each pay cycle.

Three documents form the arrangement: a finance lease between the employee and the leasing company, a novation agreement transferring payment responsibility to the employer, and a salary packaging agreement between the employee and employer. The vehicle remains registered in the employee's name throughout the lease term, and full private use is permitted.

Unlike a standard car loan, a novated lease bundles all vehicle expenses — including fuel, registration, insurance, tyres, and scheduled servicing — into a single fortnightly or monthly deduction. This bundling creates savings through fleet-rate purchasing, GST credits, and income tax reduction. For an employee earning $85,000, a novated lease on a $40,000 vehicle typically saves between $3,000 and $6,000 per year compared to buying the same car with after-tax dollars. Use our Salary Sacrifice Calculator to model the income tax impact of pre-tax deductions on your take-home pay.

How Is a Novated Lease Different from a Finance Lease?

A finance lease is a two-party agreement between a borrower and a lender. A novated lease adds a third party — the employer — and shifts the payment obligation from the employee to the employer via the novation deed. The Australian tax calculator treatment differs: finance lease payments come from after-tax income, while novated lease payments use pre-tax salary, reducing assessable income. The vehicle ownership structure is identical in both cases — the employee takes title after paying the residual — but only a novated lease delivers income tax brackets savings at the employee's marginal rate.

How Does a Novated Lease Work?

A novated lease works by splitting each pay into a pre-tax component (the lease payment and running costs) and a post-tax component (the employee contribution), with the employer remitting both directly to the leasing company on the employee's behalf.

Step-by-Step Process

1. Check eligibility — Confirm your employer offers salary packaging. Most medium-to-large employers, all government departments, and many SMEs participate. The vehicle must be used or available for private use.
2. Choose a vehicle — Select any new or used car (typically under 7 years old at lease end). Popular choices include sedans, SUVs, utes, and increasingly electric vehicles (EVs). The vehicle price must sit below the "Car Limit" of $69,674 for FY2025-26 to claim full GST savings.
3. Get a lease quote — The leasing company provides a quote covering the finance cost, residual value, and a running cost budget covering fuel, insurance, registration, maintenance, and tyres.
4. Sign three agreements — The finance lease, novation deed, and salary packaging agreement are executed. No deposit is required in most novated lease arrangements.
5. Salary deductions begin — Your employer deducts the total lease budget from your gross pay each period. The pre-tax portion reduces your assessable income. A smaller post-tax portion covers the employee contribution to reduce or eliminate FBT liability.
6. Drive and claim — You use the car for both personal and work purposes. Running cost invoices go to the leasing company, which pays them from your budgeted running cost pool.
7. End of lease — At lease end, you pay the residual value to own the car outright, refinance the residual into a new lease, or return the vehicle to the dealer.

Throughout the lease, your employer handles all payments to the finance company. Your payslip shows the pre-tax and post-tax deductions as separate line items — review our Understanding Your Payslip guide to see how these appear.

What Costs Are Included in a Novated Lease Budget?

A fully maintained novated lease bundles 6 cost categories into a single payroll deduction. The leasing company estimates annual costs for each category based on the vehicle type, expected kilometres, and location. The annual budget for a $40,000 sedan driven 15,000 km per year typically breaks down as follows:

The total annual budget of approximately $12,000 translates to $461 per fortnight or $1,000 per month. Any surplus remaining in the running cost account at lease end is refunded to the employee. Any shortfall is the employee's responsibility.

What Are the Tax Benefits of a Novated Lease?

A novated lease delivers three distinct tax advantages: income tax savings through pre-tax salary deductions, GST savings on the purchase price and running costs, and potential FBT exemption for eligible electric vehicles.

Pre-Tax vs Post-Tax Comparison

The table below compares the annual cost of a $40,000 car for an employee on an $85,000 salary, showing the difference between paying with after-tax dollars versus using a novated lease arrangement in FY2025-26.

The novated lease saves $3,840 per year in this scenario. The saving increases for higher income earners. An employee on $135,000 leasing the same car saves approximately $5,400 per year because the marginal tax rate jumps from 30% to 37% above $135,000. The Income Tax Calculator shows how income tax brackets affect your net position at any salary.

GST Savings

The leasing company is registered for GST, which means it claims back the 10% GST on the vehicle purchase price and all running costs. On a $40,000 car (GST-inclusive), this saves $3,636 on the purchase price alone. Running cost GST savings on fuel, servicing, and tyres add another $400–$700 per year depending on kilometres driven.

How Does the Medicare Levy Surcharge Interact?

The "Medicare Levy Surcharge" (MLS) applies to singles earning above $93,000 and families above $186,000 who do not hold private hospital cover. A novated lease reduces taxable income but increases reportable fringe benefits. The MLS calculation uses "income for MLS purposes," which adds taxable income plus reportable fringe benefits. Employees near the MLS threshold gain no MLS reduction from a novated lease because the reportable fringe benefit replaces the taxable income reduction. Private hospital cover remains the only way to avoid the MLS surcharge of 1%, 1.25%, or 1.5% depending on the income tier.

Novated Lease vs Car Loan: What Is the Difference?

A novated lease uses pre-tax salary and bundles running costs into one payment, while a car loan is repaid entirely from after-tax income with running costs managed separately.

The break-even point depends on the employee's marginal tax rate. Employees in the 30% bracket ($45,001–$135,000) save enough through pre-tax deductions to offset the FBT component. Employees in the 37% bracket ($135,001–$190,000) and the 45% bracket (above $190,000) receive the largest benefit per dollar of lease cost. Check your current income tax bracket using our Take-Home Pay Calculator.

A car loan outperforms a novated lease in only two scenarios: when the employee earns below $45,000 (16% marginal rate delivers insufficient tax savings to offset FBT) and when the employee secures a heavily discounted interest rate below 4% through a credit union or employer subsidy. In all other cases, the combination of income tax savings, Medicare levy reduction, and GST credits makes the novated lease the lower-cost option over a 3-to-5-year term.

How Does ECM vs Statutory Method Work?

The "Statutory Formula Method" calculates FBT on 20% of the car's base value regardless of kilometres driven, while the "Employee Contribution Method" (ECM) reduces the taxable FBT value by the amount the employee contributes from post-tax income.

Choosing the Right Method

Most novated lease providers default to the ECM because it allows the employee to make post-tax contributions that eliminate or significantly reduce FBT. The post-tax contribution target equals the statutory FBT value: for a $40,000 vehicle, that is $40,000 × 20% = $8,000 per year. The employee pays approximately $154 per week from after-tax pay to zero out the FBT liability. The remaining lease and running costs are paid from pre-tax salary, delivering the full income tax benefit.

The operating cost method is a separate FBT calculation method that uses actual costs and a logbook to determine the business-use percentage. Employers rarely offer this for novated leases because of the record-keeping burden. For a detailed explanation of FBT calculation methods, see our Fringe Benefits Tax Guide.

FBT Calculation Example for a $40,000 Vehicle

The FBT year runs from 1 April to 31 March, not aligned with the financial year. For a $40,000 vehicle available for the full 365 days, the FBT calculation under the statutory method proceeds as follows:

The gross-up factor of 2.0802 (Type 1, where GST credits are claimed) converts the taxable value to a grossed-up amount before applying the FBT rate of 47%. When the ECM contribution equals or exceeds the statutory value, the FBT liability is zero and the employer has no FBT cost to pass on.

Worked Example: $85,000 Salary with $40,000 Car

An employee earning $85,000 gross salary leasing a $40,000 vehicle (drive-away, GST-inclusive) on a 4-year novated lease saves $3,840 per year compared to buying the same car with a personal car loan.

Year-by-Year Tax Savings

Over a 4-year lease term, total savings reach approximately $16,132. The employee pays a residual of $15,000 at lease end to own the car outright. Use the Salary Sacrifice Calculator to model different salary and lease payment combinations.

The take-home pay impact on a fortnightly basis is a reduction of approximately $323 per fortnight from net pay ($461 total deduction minus $138 in tax savings per fortnight). Without the novated lease, the same employee buying the car outright and paying running costs separately spends $461 per fortnight from after-tax income — a net disadvantage of $138 per fortnight or $3,588 per year.

Who Benefits Most from a Novated Lease?

Employees earning above $45,000 per year benefit most from a novated lease because their marginal tax rate of 30% or higher delivers meaningful savings on every pre-tax dollar deducted.

Who Is Not Eligible for a Novated Lease?

A novated lease is less beneficial for employees earning under $45,000, those within 2 years of retirement (insufficient time to realise savings), and casual employees without a guaranteed salary. Self-employed workers and sole traders are ineligible because the arrangement requires an employer-employee relationship. Contractors on ABN-only arrangements cannot access novated leasing. Employees on fixed-term contracts shorter than the proposed lease term face additional risk, though most leasing providers offer portability and payout options to mitigate this.

Use our Take-Home Pay Calculator to compare your current after-tax pay with and without salary packaging. The Contractor vs Employee Guide explains the employment classification requirements for accessing salary packaging benefits including novated leases.

What Happens at the End of a Novated Lease?

At lease end, the employee has three options: pay the residual value to own the car outright, refinance the residual into a new novated lease on the same vehicle, or trade the car in and start a new lease on a different vehicle.

ATO Residual Value Table

The ATO sets minimum residual values as a percentage of the vehicle's original cost (including GST). These are non-negotiable and apply to all novated leases.

Longer lease terms result in lower residual payments but higher total interest costs. A 5-year lease has the lowest residual (28.13%) but accumulates more interest than a 3-year lease. Most employees choose a 4 or 5-year term to balance lower repayments with reasonable total cost.

What Happens If You Leave Your Job Mid-Lease?

The novation deed automatically unwinds when employment ends. The lease reverts to a standard finance lease between the employee and the leasing company. The employee has 3 options at that point: transfer the lease to a new employer (if the new employer offers salary packaging), continue paying the lease personally from after-tax income, or pay out the remaining balance and residual in a lump sum. Most leasing companies offer a portability guarantee that allows seamless transfer to a new employer within 60 to 90 days. No early termination fee applies when transferring to a new employer. Paying out early incurs a break cost equal to the remaining lease payments plus the residual, minus a discount for early settlement typically worth 1–3 months of interest.

What Changed in FY2025-26? The Electric Car Discount

The "Electric Car Discount" exempts eligible battery electric vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs) from fringe benefits tax, making EV novated leases $2,000–$5,000 per year cheaper than equivalent petrol or diesel vehicles.

The exemption, introduced on 1 July 2022, applies to vehicles first held and used on or after that date. For FY2025-26, the key eligibility criteria are:

• The vehicle must be a zero or low emissions vehicle — battery electric (BEV), hydrogen fuel cell (FCEV), or plug-in hybrid (PHEV) first used before 1 April 2025
• The vehicle's value must sit below the "Car Limit" for fuel-efficient vehicles: $91,387 for FY2025-26
• The car must not have been held or used before 1 July 2022
• The arrangement must be a legitimate novated lease or salary packaged vehicle

PHEVs first used on or after 1 April 2025 are no longer eligible for the FBT exemption. Only BEVs and FCEVs retain the full exemption from that date onwards. This change reflects the Australian Government's tightening of the policy to focus on fully zero-emission vehicles.

EV vs ICE Novated Lease Comparison

The FBT exemption makes EV novated leases the most tax-efficient way to acquire a new car in Australia. Popular FBT-exempt models include the Tesla Model 3, BYD Atto 3, MG ZS EV, Hyundai Ioniq 5, and Kia EV6. For employees considering salary packaging alongside a novated lease, our Salary Sacrifice Guide explains how pre-tax arrangements interact with superannuation and other benefit types.

How Long Will the EV FBT Exemption Last?

The Electric Car Discount has no legislated sunset date as of the 2025-26 financial year. The Treasury confirmed the exemption continues indefinitely for BEVs and FCEVs first held and used from 1 July 2022. The PHEV restriction (effective 1 April 2025) narrows eligibility but does not affect existing PHEV leases entered before that date. Employees entering a new EV novated lease in FY2025-26 lock in the FBT exemption for the full lease term — typically 3 to 5 years — even if legislation changes during the lease period. The exemption applies per vehicle, not per employee, so an employee can novate multiple FBT-exempt EVs sequentially.

What Are the Common Mistakes with Novated Leases?

The most common novated lease mistake is overestimating savings by ignoring the post-tax employee contribution, which reduces the net benefit by $3,000–$8,000 per year for ICE vehicles.

1. Ignoring the post-tax contribution — Marketing materials highlight the pre-tax deduction but omit the ECM contribution. On a $40,000 car, the post-tax component is approximately $7,273 per year. The net tax saving after accounting for this contribution is $3,840, not the $12,000 gross deduction sometimes quoted.
2. Choosing too short a lease term — A 2-year lease has a 56.25% residual ($22,500 on a $40,000 car), resulting in high fortnightly repayments and a large balloon payment at lease end. A 4 or 5-year term spreads the cost more effectively.
3. Underestimating running costs — Setting a low running cost budget to reduce the payroll deduction creates a shortfall that the employee must fund at lease end. Fuel, insurance, and tyre costs should be estimated realistically based on 15,000–20,000 km of annual driving.
4. Leasing a car above the Car Limit — The "Car Limit" for FY2025-26 is $69,674 for ICE vehicles. GST savings only apply up to this threshold. Purchasing a vehicle above the limit forfeits the GST credit on the amount exceeding the cap.
5. Not checking employer super calculation — Some employers calculate the superannuation guarantee on the post-sacrifice salary rather than the pre-sacrifice gross. This reduces super contributions by 12% of the pre-tax deduction. Verify your employer's super calculation method before signing. The Superannuation Guide explains how the SG rate interacts with salary packaging.

Related Resources

Use these Australian tax calculators and guides to model the full impact of a novated lease on your take-home pay, superannuation, and overall tax position.

Frequently Asked Questions