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What is a novated lease — really?

This section explains how novated leases work and how to think about them.

First and foremost: novated leases are only available and relevant for salaried employees.

Novated lease is a salary packaging arrangement that allows part of your vehicle costs to be paid from your salary before income tax is withheld.

Understanding the leasing mechanism and its caveats is essential. Much of the confusion around novated leases comes from skipping this step and jumping straight to marketing numbers.

High-level mechanism of a novated lease

At a high level, novated lease changes the timepoint at which income tax is collected in relation to your spending.

How salary and spending normally works (PAYG)

As an employee in Australia, you are typically paid under PAYG (pay-as-you-go).

Each pay cycle:

  1. you earn a gross (pre-tax) salary
  2. your employer withholds income tax on your behalf
  3. you receive the remainder as post-tax income
  4. you spend that post-tax money on things like a car or a car loan

So the usual flow is:

pre-tax income → tax withheld → post-tax money → spend on car

Novated lease mechanism allows you to spend your income before it is taxed

A novated lease introduces a three-party arrangement between:

  1. you (the employee)
  2. your employer
  3. a novated lease provider / financier

This arrangement changes when the car expense is spent.

Instead of all tax being withheld first, a novated lease allows some of your pre-tax income to be directed straight to car costs before tax is withheld.

Through novated lease, the money flow becomes:

pre-tax income → some spent on car → tax withheld on the remainder → post-tax money

This is what people mean when they say you are “spending pre-tax money”.

Why spending pre-tax money is functionally a “discount”

If you do the maths, spending pre-tax income has a very specific effect.

The net result is equivalent to receiving a discount equal to your marginal tax rate plus the Medicare levy:1

  • 30% tax bracket → 32% effective discount
  • 37% tax bracket → 39% effective discount
  • 45% tax bracket → 47% effective discount

So for someone on the top marginal rate:

spending $1,000 pre-tax
is economically similar to spending ~$530 post-tax

This is the entire reason novated leases can work.

The catch that existed for decades: FBT

Novated leases have existed for many decades, but there has always been a major catch:
Fringe Benefits Tax (FBT).

FBT is:

  • a tax on employers, not employees
  • applied when an employer provides a non-cash benefit (like a car) to an employee

Allowing you to spend pre-tax income on a car is considered a fringe benefit. In most cases, that creates an FBT liability for your employer.

Since employers generally do not want to pay FBT, a workaround is commonly used.

The workaround: paying part of the lease post-tax (ECM)

ATO rules allow the employer’s FBT liability to be reduced to zero if the employee pays part of the lease using post-tax income.

This is commonly called the Employee Contribution Method (ECM).

However, this has an important consequence:

  • any amount paid post-tax loses the previously discussed “discount effect” of pre-tax spending

And the required post-tax contribution is not trivial.

Under the most common method, it is roughly:

20% of the car’s value per year

Once you account for this, much of the theoretical benefit of novated leasing is eroded.

This is why, for most of its history, novated leasing was often not as good a deal as it appeared, especially once interest, fees, and residual values were properly accounted for.

Example

In my lease for a car with FBT base value $75,500, I pay roughly $19,000 pre-tax for my FBT-exempt novated lease.

If this lease is FBT-applicable, I would instead have to pay $15,100 post-tax, with only roughly ~$4,000 pre-tax remaining.2

This results in much lower saving due to much less payment being funded with pre-tax dollars.

What changed in 2022: EV FBT exemption

Everything changed when the government introduced the FBT exemption for low-emission vehicles in 2022.

For eligible EVs and (previously) PHEVs below the luxury car tax threshold (as of FY 2024-25: $91,387):

  • the car benefit is exempt from FBT
  • there is no need for ECM
  • far more of the lease can be paid pre-tax

This was a genuine game changer.

Magnitude of additional saving in FBT-exempt novated leases

Without the FBT encumbrance, the pre-tax “discount effect” is amplified.

In practical terms, this removes a cost that was previously many thousands of dollars per year for an equivalently priced car.

Novated lease providers and financiers still take their cut via high “effective interest rates” and fees, but if you do the calculations carefully, the numbers can now work decisively in favour of the employee.

In some cases, the difference can be many tens of thousands of dollars over the life of the car, compared to cash or a conventional loan.

Why comparisons are still easy to get wrong

This does not mean every novated lease is a good deal.

Most novated lease calculators emphasise:

  • “tax saved” figures

while quietly ignoring:

  • interest and fees you would not otherwise pay
  • residual values
  • opportunity cost
  • risk from early termination or policy change

This is why careful, apples-to-apples comparison as well as understanding of caveats are essential.

It is the fundamental motivation behind the novated lease spreadsheet. I was curious to find out exactly what the "saving" means and many hundreds of hours of nerdy labour later the calculator was the product. Many people have found the tool useful which I take pride in and am grateful for.

Key takeaway

If you remember nothing else:

A novated lease is a tax-driven salary packaging arrangement.
The EV FBT exemption introduced in 2022 significantly increased the potential magnitude of savings.

Where to go next

If this is your first exposure to novated leases, the next essential pages are:

Everything else in this guide builds on those foundations.

Optional Support

Both this guide and the spreadsheet are free. If they prove helpful, consider:

  1. This relationship is slightly altered if the pre-tax dollar spending brings the gross salary amount past the marginal tax threshold. E.g. if the gross salary is $10,000 above 37+2% threshold, then spending $15,000 would mean the first $10,000 portion enjoys 39% effective discount and the subsequent $5,000 portion enjoys 32% effective discount. ↩

  2. Within FBT-applicable strucure, there is in fact an additional component where the GST of post-tax contribution has to be paid, though this is funded pre-tax. I have omitted this component in this discussion for simplicity sake. ↩