A novated lease is a three-way arrangement between an employee, their employer, and a finance company. The employee chooses a vehicle; the employer takes over the lease obligation and pays the running costs; the employee's pre-tax salary is reduced by the total lease and running costs. The employer claims the GST on payments made, and at the end of the FBT year (31 March), the employer lodges an FBT return covering the taxable value of the fringe benefit.
The arrangement is popular because it lets employees fund a vehicle using pre-tax salary — reducing their income tax — while employers typically pay fleet pricing rates and pass through GST credits. But for bookkeepers, a novated lease creates obligations across payroll, GST, and FBT simultaneously, with the FBT year running April to March rather than the income year (July to June). This mismatch is the source of most novated lease accounting errors.
What the Employer Pays and Claims
Under a novated lease, the employer makes two sets of payments:
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Lease rentals: Paid to the finance company (or novated lease provider) typically monthly. The employer claims a full ITC for the GST component if the vehicle is used in an enterprise. For a passenger car, the car limit applies — according to the ATO, if the purchase price of the vehicle exceeds the car limit ($69,674 for 2024-25), the ITC is capped to the car limit portion.
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Running costs: Fuel, tyres, registration, insurance, and maintenance are typically bundled into a novated lease package. The employer pays these through the package and claims ITCs accordingly. Some providers pay running costs directly from a pooled account; others reimburse the employee — the GST treatment differs depending on who holds the tax invoices.
All payments made by the employer on a novated lease are treated as employer expenses for income tax purposes — deductible, subject to the car limit.
FBT: Calculating the Taxable Value
A car benefit arises because the employee has the use of a vehicle funded by the employer. The FBT taxable value is calculated using one of two methods:
Statutory formula method: The most common method. The taxable value is: (Cost of car × 20%) × (days benefit available ÷ 365) × (1 − employee contribution rate)
The 20% statutory fraction applies uniformly, regardless of kilometres travelled, after the removal of the graduated rate structure in 2014. A vehicle available for the full FBT year with a cost of $50,000 has a statutory taxable value of $10,000 — before any employee contribution.
Operating cost method: The taxable value is the total operating costs of the vehicle (lease payments plus running costs) multiplied by the private use percentage. Private use is established from a logbook kept for at least 12 consecutive weeks during the first year the vehicle is used and refreshed every five years. This method is generally beneficial where business use is high (above 80%), because it reduces the taxable value proportionally.
The employer must choose the method that produces the lower taxable value — or the employee can provide a logbook to support the operating cost method.
Employee Contributions and the FBT Reduction
The key mechanism for reducing FBT in a novated lease is the employee contribution — amounts the employee pays towards running costs (post-tax, from their bank account, not the pre-tax salary reduction). Each dollar of post-tax contribution reduces the FBT taxable value by a dollar.
Under a properly structured fully-maintained novated lease, the pre-tax component covers the post-tax FBT liability. The novated lease provider calculates the grossed-up FBT, grosses it back to the pre-tax equivalent, and adjusts the pre-tax deduction accordingly so the employee's take-home position is optimised. The bookkeeper's job is to ensure the post-tax contributions are correctly recorded as employee payments to the employer (reducing the FBT liability) rather than just as additional payroll deductions.
Payroll Entries for Novated Leases
The payroll journal for each pay period includes:
- Debit: Wages expense (gross salary, pre-novation)
- Credit: Pre-tax novated lease deduction payable (the pre-tax component)
- Credit: PAYG Withholding payable (calculated on the reduced gross)
- Credit: Net wages payable
The pre-tax deduction is remitted to the novated lease provider. Separately, the employer receives invoices from the provider for lease payments and running costs — these are recorded as motor vehicle expenses and car lease expenses with GST claimed as an ITC.
Under STP Phase 2, the reportable fringe benefits amount from the novated lease must be reported on the employee's income statement. Where the taxable value after contributions is nil (because the employee contributed enough post-tax), there may still be a reportable fringe benefits amount if the taxable value before employee contributions exceeded $2,000.
FBT Year and Reporting
The FBT year runs 1 April to 31 March. The employer must lodge an FBT return by 21 May (or 28 June if lodged by a tax agent) and remit the FBT liability — or declare nil FBT if the taxable value is zero. Even where FBT is nil because employee contributions have eliminated the liability, if the taxable value before contributions exceeded $2,000, a reportable fringe benefits amount appears on the employee's income statement.
The bookkeeper managing FBT compliance for a novated lease needs to maintain an FBT calculation file for each vehicle: purchase price, days available, lease payments and running costs by FBT year, post-tax employee contributions, and the method chosen. This file drives the annual FBT return and the STP reportable amount.
End of Novated Lease
At lease end, the employee typically either refinances into a new lease, purchases the vehicle at residual value, or returns it to the financier. If the employee purchases the vehicle, the employer ceases to have any lease obligation and the FBT ceases for that vehicle. Any residual payment made by the employer on behalf of the employee (below the residual) is a new car benefit — this should be flagged to the tax agent before it occurs.