How a Novated Lease Works

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 is where the saving comes from: the deduction is taken before tax, and the employer claims the GST credits. How much that is worth depends on your marginal rate, the car and the FBT treatment — the novated lease calculator works it out on your own figures, and the salary sacrifice calculator shows what any pre-tax deduction does to 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 — new or used, subject to the provider's age limit at lease end. If it is an electric car, the price decides whether the FBT exemption applies: it has to sit under the luxury car tax threshold for fuel-efficient vehicles, which the calculator carries for the current year.
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.

Where the Tax Saving Comes From

A novated lease has three separate money effects, and they do not all pull the same way. Understanding which is which is the difference between a good decision and a surprise at tax time.

1. Income tax on the pre-tax deduction. The lease and running-cost budget comes off your gross pay before tax is worked out, so you keep the tax you would have paid on that slice of salary. The higher your marginal rate, the more the slice is worth.
2. GST credits. The employer is registered for GST and claims credits on the lease payments and packaged running costs. Whether — and how much of — that credit lands in your budget is set by the packaging arrangement, so read it off your quote rather than assuming it.
3. FBT, in the other direction. Giving an employee a car for private use is a fringe benefit, and FBT is charged at 47% on the grossed-up taxable value. Either the employee contribution method cancels it, or it is funded out of the same budget. An eligible electric car is exempt from FBT altogether.

The Fourth Effect Most Explanations Leave Out

A car fringe benefit with a taxable value over $2,000 in an FBT year is reported on your income statement as a reportable fringe benefits amount. You are not taxed on it — but it is added to your income for the HECS-HELP repayment test, the Medicare levy surcharge, the private health insurance rebate and Division 293 tax. So a lease can cut your taxable income and lift your compulsory study loan repayment in the same year, and an FBT-exempt electric car is not exempt from being reported.

A full employee contribution is the one thing that removes it: it takes the taxable value to nil, so there is nothing left to report. The novated lease calculator shows the reported amount, the income the tests actually use, and what it does to a HECS-HELP repayment. Private hospital cover is still the only way to avoid the surcharge itself — see private health insurance and the Medicare levy.

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.

Which one wins depends on your marginal rate, the price of the car and whether it is FBT-exempt — and on the finance rate, which is set per deal and which this site does not model. Work out where you sit with the novated lease calculator, then add your quoted finance charges to the lease side before deciding. Your current bracket is on the take-home pay calculator.

The lease is weakest where the tax saving is smallest and the FBT is largest: a low marginal rate paired with a car that is not FBT-exempt. It is strongest on an eligible electric car, where the FBT disappears entirely and the pre-tax deduction covers the whole budget. A car loan is the only option at all if you are self-employed or your employer does not offer packaging.

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 providers default to ECM, because the post-tax contribution target is simply the statutory taxable value — 20% of the base value for a full FBT year. Contribute that much from after-tax pay and the FBT falls to nil, the employer has no FBT cost to pass on, and there is no reportable fringe benefit either. The rest of the budget stays pre-tax.

The operating cost (logbook) method is a third way of valuing the benefit, using actual costs and a business-use percentage. Employers rarely offer it for novated leases because of the record keeping. For the mechanics across all benefit types, see the fringe benefits tax guide; for the two methods priced out on your own car, the novated lease calculator shows both side by side, including the break-even marginal rate.

One date trap: the FBT year runs 1 April to 31 March, not 1 July to 30 June. Contributions have to be made within the FBT year they relate to, and a lease that starts mid-year is only a part-year benefit.

Putting It on Your Own Numbers

Every worked example on a novated lease page is a worked example of somebody else's salary, car and running costs. Three inputs move the answer more than anything else: your marginal rate, the price of the car (which sets the FBT taxable value), and whether the car is FBT-exempt.

Two things no calculator can tell you, and which belong on your quote rather than on a web page: the interest rate the financier is charging, and the residual the lease is actually written to. Ask for the amount financed, the total of the payments and the residual in writing, then check the deductions on your first payslip against them.

Who Benefits Most from a Novated Lease?

The saving on the pre-tax deduction is worth your marginal rate, so the same car and the same budget are worth more to someone on 37c in the dollar than to someone on 15c. Below the tax-free threshold there is nothing to save at all, and around the bottom bracket the post-tax employee contribution can swallow most of the benefit.

But the marginal rate is only half of it. On a car that is not FBT-exempt, the FBT taxable value is fixed at 20% of the price no matter what you earn — so a cheap car on a high salary looks very different from an expensive car on a modest one. And the reportable fringe benefits amount lands hardest on people with a study loan, because it lifts repayment income without lifting take-home pay. Rather than reading a range off a table, put your own salary and car through the novated lease calculator: it prices the deductions, the FBT, the reported amount and the HECS-HELP effect together.

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, in Taxation Determination TD 93/142 — the 8-year effective life column, which is the one its own worked example uses for a car. A lease can be written with a higher residual, which lowers the deductions now and raises the payment at the end.

A longer term means a lower balloon payment but more years of finance charges. The residual is paid from after-tax money, which is why the calculator counts it in the total — a comparison against buying the car that stops at the end of the lease is not a fair one.

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.

Electric Cars and Plug-In Hybrids: What the Exemption Covers

Private use of an eligible electric car provided under a novated lease is exempt from FBT, and so are the associated car expenses — registration, insurance, repairs and maintenance, and the electricity to charge it. That removes both the FBT and the need for any post-tax employee contribution.

The ATO's conditions are cumulative. All four have to be true:

• The car is a zero or low emissions vehicle — a battery electric vehicle or a hydrogen fuel cell electric vehicle. Nothing else qualifies, and motorcycles and scooters are not cars for FBT purposes even when they are electric.
• The first time the car was both held and used was on or after 1 July 2022.
• It is used by a current employee or their associates.
• Luxury car tax has never been payable on the importation or sale of the car — which means its value has to sit under the LCT threshold for fuel-efficient vehicles at the first retail sale and at every sale after that. One dollar over and the exemption is gone entirely, not merely reduced. If you are buying second hand, that history is yours to check.

Plug-In Hybrids Stopped Qualifying on 1 April 2025

From 1 April 2025 a plug-in hybrid is no longer a zero or low emissions vehicle under FBT law, so a PHEV novated lease entered into now attracts FBT in full. The transitional rule is narrow, and both limbs have to be satisfied: the PHEV was used, or available for use, before 1 April 2025 and that use was exempt; and there is a financially binding commitment to continue providing it for private use on and after that date. The ATO states it has no discretion to extend the date, including where delivery was delayed by circumstances outside anyone's control.

The exemption then ends the moment the commitment changes. Taking up an option to extend the lease, a break in the novation, a change to the lease payments or the residual value, or a change of employer each creates a new commitment — and the exemption stops from that point, even mid-lease. An optional extension never counts as binding, because a binding commitment has to be for a pre-determined period.

The novated lease calculator carries the current-year LCT threshold and asks the plug-in hybrid question directly, so it will not quietly treat a new PHEV lease as exempt.

An Exempt Car Is Still a Reported Car

The exemption removes the FBT, not the reporting. The notional taxable value of an exempt electric car is still worked out and still appears on your income statement as a reportable fringe benefits amount, where it counts towards HECS-HELP repayment income, the Medicare levy surcharge and Division 293. It is the single most common surprise on an EV novated lease, and the calculator shows the amount and its effect.

There is no legislated end date for the exemption for battery electric and hydrogen fuel cell cars. The government has said it will complete a review of the exemption by mid-2027.

What Are the Common Mistakes with Novated Leases?

The most common novated lease mistake is reading the pre-tax deduction as if it were the saving. It is not: the post-tax employee contribution, the FBT and the residual all sit on the other side of the ledger.

1. Ignoring the post-tax contribution — marketing highlights the pre-tax deduction and leaves the employee contribution in the footnotes. On a car that is not FBT-exempt the contribution is 20% of the GST-inclusive price every year, paid from after-tax money. Put both lines through the calculator before signing.
2. Choosing a term without pricing the residual — a shorter lease means a much larger balloon payment at the end, paid from after-tax money. The ATO minimum residual is 56.25% of the original cost on a two-year lease against 28.13% on a five-year one.
3. Underestimating running costs — setting a low budget to shrink the payroll deduction just moves the shortfall to the end of the lease, where you fund it from after-tax money. Estimate fuel or charging, insurance, registration, tyres and servicing on the kilometres you actually drive.
4. Buying an electric car just over the luxury car tax threshold — the FBT exemption depends on LCT never having been payable, so a car priced a few hundred dollars over the fuel-efficient threshold loses the exemption completely rather than partly. The current threshold is on the calculator, which warns when your price crosses it.
5. Not checking the super line on the payslip — under Payday Super, qualifying earnings include salary sacrificed amounts that would otherwise be qualifying earnings, so the pre-tax deduction should not reduce the super your employer pays. If the super line fell when the lease started, ask payroll which figure they are using.

Related Resources

Use these calculators and guides to put numbers on a novated lease and check them against your payslip.

Frequently Asked Questions