AASB 16: A positive disruptor for novated leases?

What changes lay ahead for novated leases when AASB 16 becomes operative?

The new leases standard brings a number of changes and challenges, but what will be its impact on novated leasing?

By Mark Shying and Denis Vinen

Salary packaging and novated leases have a long history of producing positive taxation outcomes for employers and employees.

However, the impending introduction of the new accounting standard for leases AASB 16 raises the question of whether it will be a positive disruptor for the use of novated leases, as well as various tax considerations.

What is novated leasing?

A novated lease is an arrangement whereby an employee leases a motor vehicle from a finance company and the financier and employer agree that the employer will take on the employee’s obligations under the lease. 

Under the existing accounting standard for leases AASB 117, it appears that employers do not treat novated leases as finance leases or as operating leases because:

  • the employee has control over the vehicle and can take the vehicle in or out of the novated lease at any time;
  • the lease term is not defined and can be cancelled at any time (on terminating an employee’s employment); and
  • the employer cannot direct the employee to use the vehicle for the business of the employer.

Key changes under AASB 16

AASB 16 becomes operative for accounting periods beginning on or after 1 January 2019 and many lease arrangements that were previously off-balance sheet will have to be included on-balance sheet. AASB 16 no longer distinguishes between finance and operating leases for lessees.

Regardless, we do not expect employers to include novated leases on their balance sheet under AASB 16 as they are unlikely to be caught by the requirements of the standard. For AASB 16 to apply, the employer must control the use of the vehicle “for a period of time in exchange for consideration” – and that is not the nature of a novated lease.

So, does this mean that despite the application of AASB 16, it will still be ‘status quo’ for novated leases? We don’t think so.  

In fact, we expect employers with large fleets of vehicles to consider increasing their use of novated leases to avoid the debt levels and interest costs that come with AASB 16 and its consequences for:

  • some key financial ratios and performance metrics, including leverage or gearing;
  • loan covenants; and
  • remuneration schemes.
It is also likely that some employers will look closely at the consequences of ‘grossing up’ assets and liabilities in the balance sheet that come with the requirements of AASB 16. For example, larger private companies prepare and lodge audited accounts with the Australian Securities and Investments Commission (ASIC) only if they meet at least two of the three size criteria in the Corporations Act. 

Some companies previously below the consolidated $12.5 million gross assets threshold might find that ‘grossing up’ their balance sheet results in meeting that threshold and requires the lodgment of audited accounts for the first time. Again, novated leases may be seen as a way to mitigate this outcome. 

Professional Development: Accounting for leases: in this course, you will cover the scope of the new lease standard and the principles of lease accounting for both lessee and lessor.

Top-of-mind tax matters

From a tax planning perspective, the main outcomes from a novated lease arrangement for an employer are:

  • the employer makes lease repayments to the finance supplier on behalf of the employee from the employee’s pre-tax salary;
  • expenses incurred in arranging and maintaining the lease (other than lease repayments) are tax deductible to the employer for the period the lease is active;
  • should the employment relationship end, so does the employer’s repayment commitment, as lease obligations revert to the former employee;
  • when leasing a vehicle from a finance company, an employer can claim a Goods and Services Tax (GST) credit for the GST included in lease charges; and 
  • any Fringe Benefits Tax (FBT) liability to the employer is balanced out and has a zero dollar consequence within the salary sacrifice arrangement, plus any post-tax contributions made by the employee.
The main taxation outcomes from a novated lease arrangement for an employee are:
  • ability to choose their preferred vehicle with sole use and ownership; 
  • reduction in taxable income (and tax payable) from salary sacrificing; 
  • making post-tax contributions to the costs of owning the vehicle allows an employee to reduce FBT liability by the same amount contributed;
  • the motor vehicle is usually acquired more cost-effectively given there is: 
    • no GST on purchase (claimed by employer)
    • leasing companies usually obtain fleet discounts.

A trigger for future uptake

Overall, novated leasing within a salary packaging arrangement is cost neutral for an employer and most advantageous for an employee when the amount of FBT payable is less than the income tax that would have been payable without the salary sacrifice.

According to a media report on ACA Research into the use of novated leases by fleet managers: “Just under two-thirds of businesses prefer to use vehicle finance for their fleets, typically looking at leasing as the preferred option … finance leases and novated leases making up two of the top three preferred finance options”.

With the introduction of AASB 16, we expect to see a growing preference among employers for the use of novated leases to finance their vehicle fleets.

Dr Mark Shying CPA is Industry Fellow and Denis Vinen FCPA is Associate Professor at Swinburne Business School, Swinburne University of Technology’s Faculty of Business and Law, Department of Accounting, Economics and Finance.

Read next: Everything you need to prepare for IFRS 16

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