Understanding Fringe Benefits Tax and Novated Leases

Whether you’re an employee eyeing a new car or an employer striving to boost your team’s morale, understanding novated leases as a fringe benefit and the associated tax is crucial. 

Why? 

Because it can lead to significant financial advantages and benefits for both employees and employers.

Let’s find out more about novated leases, calculating their taxes, and the related implications so everyone on board can make the most of this benefit. 

What Is Novated Leasing?

Novated leasing is a financial arrangement where an employee leases a car, and the employer takes on the lease obligations by deducting lease payments and running costs directly from the employee’s pre-tax salary.

This setup reduces the employee’s taxable income, lowering the income tax they pay.

Another clear benefit for employees is having the car of their choice! 

For employers, offering novated leasing is an effective way to boost their employment package for staff satisfaction and retention with minimal cost or effort.

How Do You Calculate Fringe Benefits Tax on Novated Leases?

Fringe Benefits Tax on novated leases are calculated using the Statutory Formula or Operating Cost methods.

While each takes a different approach to determining the taxable value of the car benefit, both consider employee contributions, which we’ll discuss in detail later.

The Statutory Formula Method calculates FBT based on the car’s value and the distance travelled.

It applies a fixed percentage to the car’s base value, regardless of actual usage.

This percentage can vary depending on factors like the year of acquisition, but is typically 20%.

The taxable value is then reduced by any after-tax contributions the employee makes.

Example: If the car’s base value is $40,000, the statutory percentage is 20%, and the employee contributes $3,000 after-tax, the calculation would be:

($40,000 x 20%) – $3,000 = $5,000 taxable value for FBT.

The Operating Cost Method calculates FBT using the car’s actual running costs and how much of these costs are for private use.

This private use percentage is determined from a logbook kept over a 12-week period.

The employee’s after-tax contributions towards these costs reduce the taxable value. 

Example: If total car expenses are $12,000 with 30% private use, and the employee contributes $1,500 after-tax, the calculation would be: 

($12,000 x 30%) – $1,500 = $2,100 taxable value for FBT.

Choosing the right method depends on the car’s expenses, the amount of private use, and the employee’s contributions.

Often, it’s beneficial to calculate FBT using both methods to see which is more financially favourable.

FBT and the Employee Contribution Method

If you’re an employee with a novated lease, the Employee Contribution Method (ECM) can be a smart way to reduce or eliminate FBT on your lease​​​​.

Even though your employer pays the FBT, this cost is usually passed on to you through a reduction in your take-home pay as part of the salary sacrifice arrangement for the lease.

So, by reducing the FBT with your contributions, you can save money on your lease.

Every dollar you spend from your after-tax income on car expenses, like fuel, servicing, and insurance, reduces the FBT amount.

This is because FBT only applies to the “benefit” you receive.

When you contribute towards the car’s costs, you reduce that benefit value.

Let’s say your car’s running costs for the year add up to $10,000.

If your employer calculates $7,000 as the taxable value for FBT purposes, and you pay $3,000 of the running costs from your after-tax income, your FBT liability could be reduced significantly or even eliminated.

The exact amount of FBT saved depends on your specific circumstances, such as the cost of running the car and how much you can contribute after tax. 

What Does Fringe Benefits Tax on Novated Leases Mean for Employees?

What are the further financial and taxation considerations for having a novated lease as an employee?

One of the biggest perks is that your lease payments come from your pre-tax salary, reducing your taxable income.

This process, known as a salary sacrifice arrangement, can lead to paying less income tax.

Additionally, as you don’t have to pay Goods and Services Tax (GST) on your lease payments, leasing can be more cost-effective than buying a car outright. 

However, it’s important to know that there might be a balloon payment at the end of your lease.

This is a large sum you’ll have to pay if you decide to buy the car. 

What Does Fringe Benefits Tax on Novated Leases Mean for Employers? 

If you’re an employer offering novated leases to your employees, you’re responsible for the administrative aspects of the lease, including 

• Tracking the lease and any employee contributions.
• Handling FBT calculations and payments to the ATO.
• Ensuring FBT compliance.

The good news is that the expenses you incur related to the novated lease, including FBT payments, are typically tax-deductible for your business. 

Another bonus is that if your employee makes enough post-tax contributions towards the vehicle’s running costs, it can reduce your FBT liability to zero. 

Electric Car FBT Exemption

From 1 July 2022, a change came into effect regarding the fringe benefits tax on novated leases for electric vehicles (EVs) and plug-in hybrid electric vehicles (PHEVs).

They are now exempt from FBT.

To benefit from this exemption, the EV or PHEV must be

1. Used primarily for the employee’s work.
2. Valued below the luxury car tax threshold.

And what are the benefits of this exemption?

• It encourages the adoption of environmentally friendly vehicles, aligning with Australia’s sustainability goals.
• No FBT liability for employers makes offering electric vehicles as part of employee compensation packages more cost-effective.
• These vehicles are often cheaper to run than petrol or diesel cars, lowering ongoing costs for the employee.

Need More Advice on Fringe Benefits Tax on Novated Leases? Pherrus Can Help!

Still scratching your head trying to work out fringe benefits tax on novated leases?

The tax agents and consultants at Pherrus are experts in managing all FBT obligations.

We take the hassle out of tax management for your peace of mind and to free up your valuable time.

For tax advice tailored to your circumstances, contact Pherrus today by filling out this online form or calling +61 (02) 9099 9109 to book an appointment at our Bella Vista office in Sydney, NSW.