Struggling to figure out how your car allowance is taxed? You’re not alone. Thousands of UK employees—especially mid-level professionals and field-based staff—see that extra cash in their payslip and think, “Nice perk.” But what they don’t realise is it’s often taxed just like salary. That means a chunk of it disappears before you even touch it.
If you’re not careful, that so-called benefit could push you into a higher tax bracket, shrink your take-home pay, and mess with your pension or benefits calculations.
In this guide, we’ll break it all down —what a car allowance really means, how HMRC sees it, and smarter ways to keep more of what you earn. Let’s make sure you’re not leaving money on the table.
What is a Car Allowance & How it Works?
A car allowance is a monetary benefit provided by employers to employees, intended to cover the costs associated with using a personal vehicle for work purposes. Unlike a company car, where the employer provides the vehicle, a car allowance gives employees the flexibility to choose and manage their own car.
- Payment Structure: The allowance is typically added to your monthly salary.
- Usage: Employees can use this allowance to purchase, lease, or maintain a vehicle of their choice.
- Flexibility: Offers the freedom to select a car that suits personal preferences and needs.
Read More: How to Handle HMRC Tax Investigations
Tax Implications of Car Allowances in Uk.
Understanding the tax treatment of car allowances is essential, as it directly impacts your net income.
Income Tax and National Insurance Contributions (NICs).
- Taxable Income: Car allowances are considered part of your salary and are subject to Income Tax and NICs at your standard rate.
- Impact on Tax Bracket: Receiving a car allowance may increase your total income, potentially pushing you into a higher tax bracket.
Aspect | Car Allowance | Company Car |
Tax Treatment | Taxed as regular income; subject to Income Tax and NICs | Subject to Benefit-in-Kind (BiK) tax based on the car’s value and emissions |
Employee Responsibility | Employee handles all costs: purchase/lease, maintenance, insurance, etc. | Employer typically covers maintenance and insurance costs |
Vehicle Choice | Employee has the freedom to choose any vehicle | Limited to options provided by the employer |
Benefit-in-Kind (BiK) Tax Explained
For company cars, the BiK tax is a significant consideration.
How BiK Tax is Calculated
- P11D Value: The car’s list price, including VAT and extras.
- CO₂ Emissions: Cars with higher emissions attract higher BiK rates.
- Fuel Type: Diesel cars may incur additional charges unless they meet specific standards.
- Employee’s Income Tax Rate: The BiK value is taxed according to your personal Income Tax rate.
Salary Sacrifice Schemes: An Alternative Approach.
Salary sacrifice schemes offer another method for employees to access vehicles.
How Salary Sacrifice Works
- Agreement: Employees agree to forgo a portion of their gross salary in exchange for a non-cash benefit, such as a car.
- Tax Efficiency: Reduces gross salary, potentially lowering Income Tax and NICs. However, the car is subject to BiK tax.
Pros and Cons
Pros | Cons |
Potential tax and NIC savings | Reduction in gross salary may affect pension contributions and other benefits |
Access to new vehicles with maintenance included | Committing to a salary sacrifice agreement may reduce take-home pay |
Recent Changes and Updates .
Staying informed about legislative changes is crucial.
National Insurance Contributions (NIC) Refunds on Car Allowances
Recent tribunal decisions have opened the possibility for employers to reclaim NICs on car allowances, particularly when business mileage is reimbursed below the HMRC-approved rate of 45p per mile. Employers should review their policies and consult with tax professionals to determine eligibility for refunds.
Upcoming Tax Changes
- Electric Vehicles (EVs): From April 2025, EVs will no longer be exempt from Vehicle Excise Duty (VED). Owners of EVs will be required to pay standard VED rates.
- Benefit-in-Kind Rates: BiK rates for EVs are set to increase gradually from 2% to 9% by 2029.
Practical Considerations for Employees
When deciding between a car allowance and a company car, consider the following:
Financial Implications
- Total Cost of Ownership: Calculate all expenses, including tax liabilities, maintenance, insurance, and depreciation.
- Cash Flow: Assess how each option affects your monthly budget and financial flexibility.
Lifestyle and Preferences
- Vehicle Choice: Determine the importance of selecting a car that suits your personal preferences.
- Usage Patterns: Consider your typical mileage and whether you primarily drive for business or personal purposes.
Make the Right Choice for Your Financial Future
Choosing between a car allowance and a company car requires careful thought about your personal preferences, tax obligations, and financial situation. Understanding the full tax implications of each option, including potential changes in regulations, ensures that you make a decision that benefits your long-term financial health. It’s important to evaluate factors like vehicle flexibility and the impact on your income and benefits. At Quilliammarr, we offer expert tax advice tailored to your specific needs. Our team is ready to help you navigate these choices with confidence. Contact us today to learn more!
