There are pros and cons for providing either a company car or a car allowance. It is important for employers to consider these before deciding which benefit to offer employees.
Company Car
A company car can be an attractive option to an employee. It gives them the benefit of driving a brand new vehicle, usually equipped with the latest mod cons, without the burden of the initial upfront cost or everyday running costs (eg maintenance and insurance) – which are usually paid by the employer.
An employer can either provide a company car as part of the employee’s overall remuneration package or in exchange for part of the employee’s salary, via a salary sacrifice scheme - whereby employees give up part of their salary in return for a company car.
When presenting an employee with the option to select a company car, the employer will usually provide an employee with a pre-set list of vehicles to choose from, where the value of the vehicle can be linked to an employee’s role or level of service. The employee can then select a vehicle from the list, based on their preference.
Leasing vs Purchase
The employer has two ways to procure the company car; either by leasing the vehicle or to purchase the vehicle outright.
Leasing is popular way for employers to provide a company benefit. This is effectively a long-term rental arrangement, where you pay a series of monthly payments - usually over a three or four year contract term. There are generally better deals or discounts for business customers, compared to the personal lease market.
Leasing is an attractive option for both the employer and the employee as the employer does not have to pay for the initial upfront cost or take a hit on the depreciation of the vehicle. Also, the maintenance and servicing costs are usually covered by the leasing company. Leasing also allows the employee to upgrade to the latest model after the end of the lease term and is therefore appealing to those that like to change their car regularly.
Tip: If your business is VAT registered, you may be able to recover 50% of the VAT payable on the leasing cost, subject to the VAT partial exemption rules.
Smaller businesses or owner managed companies may wish consider buying the car outright or via a finance agreement (eg Hire Purchase or Personal Contract Purchase), which is beneficial if the company are looking to utilise built up cash in the bank or wish to retain the car for the long-term.
The company will receive a corporation tax deduction for the leasing costs, however, tax relief may be restricted by 15% depending on the registered CO2 emissions of the vehicle. If this applies, the company can still claim tax relief on 85% of the costs.
If the company was to purchase the vehicle outright or by finance, capital allowances can be claimed on the purchase cost of the vehicle, at a rate of either 6% or 18% each year on a reducing value basis. The rate of allowance is dependent on the registered CO2 the vehicle.
Tip: Tax relief may be claimed in full for qualifying purchases of low emission vehicles (eg new and unused electric cars).
Company Car Tax – P11d Benefit
As well as the underlying costs, the employer and employee would need to consider the company car tax payable.
When a vehicle is provided to an employee, which is available for them to use personally, a P11d income tax charge will be payable by the employee. The employer will also have an associated National Insurance (Class 1A) liability to pay on the benefit provided.
The P11d benefit charge is calculate by taking the P11d value of the car (this is usually the list price of the car, plus any additional options/extras, as well as the delivery charge) multiplied by the appropriate car benefit percentage based on the registered CO2 emissions and the type of vehicle (eg electric, hybrid, petrol or diesel).
Example
During the whole of the 2020/21 tax year, an employer provides an employee a petrol-powered car (registered on 6 April 2020) with registered CO2 emission of 120g/km (as tested under the WHLV regime) and with a P11d value of £50,000.
The P11d car benefit amounts to £13,500, being £50,000 x 29%.
The employee will pay an annual tax charge based on this value, at their marginal rate of tax (eg £2,700 as a basic rate taxpayer, £5,400 as a higher rate taxpayer or £6,075 as an additional rate taxpayer).
HM Revenue & Customs (HMRC) provide their guidance on how to calculate the P11d value, along with an online P11d benefit calculator.
Tip: Where the employer provides an employee with an option to receive a company car benefit, either in return for a reduction in their salary or as an alternative to a cash allowance, they should consider the ‘Optional Remuneration Arrangement’ rules. Under these rules, the value of the cash forgone may be exchanged as the P11d value, if higher.
The employee will pay income tax on this amount, through an adjustment in their tax code, with the benefit being taxed at their marginal rate.
The employer will pay Class 1A National Insurance at 13.8% on the P11d value, however, a corporation tax deduction is available for this liability.
In addition, the employer will need to file a P11d benefit form to HMRC each year to report the benefit.
What is the benefit of providing an electric or hybrid company car?
Over the past decade, the government have gradually increased the appropriate car benefit percentages, which has led to decline in uptake for company cars.
As part of the government’s plan to phase out petrol and diesel vehicles from 2030, they have introduced lower CO2 emissions for fully electric cars (0% - 2020/21, 1% - 2021/22, 2% - 2022/23) and reduced rates for hybrid cars, with the percentage being based on their electric range.
Due to the beneficial P11d tax rates, employers should consider providing low emission company cars to their employees where possible. If employees require the vehicle to make long distance journeys, it may be wise to continue to choose a petrol and diesel vehicle until the range of electric vehicles and/or the UK charging network has improved.
Car Allowance
As an alternative to a company car, many employers offer a cash allowance, which is effectively treated as additional salary.
This will give employees the flexibility to purchase a car of their choice, instead of selecting from a list, which they can retain ownership of.
If the employee already owns a car and have no plans to upgrade, the cash allowance will be a valuable addition to their monthly disposable income, however, they will retain responsibility for the daily running costs of the car.
In addition, the employee will need to pay income tax and Class 1 National Insurance (12% at the main rate or 2% at the additional rate). The employer will also need to pay employer’s Class 1 National Insurance (13.8%) on the cash allowance.
Employers should look at variable amounts for the cash allowance, reviewing the overall cost of the cash allowance in comparison to a company car, ensuring they save as much tax and National Insurance so the employee is no worse off.
Tip: If an employee uses their own car for business travel they may be able to claim tax relief at HMRC’s flat rates to reduce their income tax charge.
With the introduction of the beneficial tax rates for low emission vehicles we are seeing an upsurge in fully electric and hybrid company cars forming part of employee’s remuneration packages, however, where conventional petrol or diesel powered cars are being provided to employees, employers may seek to provide a cash allowance as an alternative.
The company car rules can be complex. We can help guide you through the rules, exploring the alterative options available to you, along with the calculation of the underlying costs and tax savings.