How does car allowance work?
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If you’re an employee who needs to travel by car for work, you may be offered a car allowance as a benefit (or perk) from your employer. It can sometimes be challenging to work out if it’s right for you, or if there’s another way to pay for a company car that may be a better option.
If you’re an employer and want to offer company cars to employees, you may not feel like you have all the information you need to make the right choice for your business and team.
In this article, we look at how car allowance works for both employees and employers, answer some common questions on the topic and compare car allowance to some of the other company car options – all to help you make an informed decision that’s right for your situation.
What is car allowance?
Car allowance is essentially a benefit offered by an employer to an employee where they are paid an additional amount of money, usually each month, on top of their normal salary, in their wages, for using their vehicle as part of their job.
The idea is that the car allowance they’re paid is to cover the costs of travelling for work using the car, along with covering some of the ongoing running costs like servicing, maintenance, MOTs and insurance.
Being paid a car allowance enables the employee to either use their own existing private vehicle for work purposes, or to lease or finance a car of their choice for work.
How much is an average car allowance in the UK?
There is no set amount that employers offering this benefit have to pay to their employees for car allowance, so it will vary from business to business and may depend on the specific job role and seniority in the business. For example, a sales representative would be likely to receive a lower car allowance than those in upper management.
Is car allowance taxable?
Car allowance is a discretionary amount of money that’s paid to employees along with their regular salary, and it’s taxed in the same way for the purposes of income tax and National Insurance contributions (NICs).
Tax on car allowance comes out of wages automatically via PAYE. But remember, car allowance isn’t factored into the employee salary for things like bonuses, pension contributions or redundancy like regular wages are.
When it comes to car allowance, individual businesses will include their own terms in their policies and employee contracts, so it might be specified that its not paid during any time that an employee is off work sick, or when on maternity, paternity or adoption leave, or during their notice period if they are leaving the business.
So, while in some ways getting a car allowance might feel like a pay rise and it is taxed in a similar way, it doesn’t work in quite the same way as getting an actual increase in your salary.
Do you have to spend car allowance on a company car?
Strictly speaking, as an employee receiving car allowance, you don’t need to spend it on a new car or even on running your existing car at all. Car allowance is seen under law as a discretionary benefit offered by your employer rather than claiming back the expenses of running a car for work, so you don’t need to provide proof to your employer about what the money is spent on.
However, your employer can make the car allowance they offer conditional on certain requirements being met, like the car you drive for work will need to be in line with company principles. This could mean, for example, that the car the employee uses for work might need to be within a certain age range or style of vehicle
Can you claim back mileage on top of car allowance?
If you’re using your own car for business then you can claim back mileage from your employer. This is in addition to the car allowance.
HMRC rates for this are currently 45p per mile for the first 10,000 business miles of the tax year, then 25p per mile after this. It’s essential to keep accurate records of miles driven for work purposes as proof for all mileage claims.
Do you pay Benefit in Kind (BiK) on a car allowance?
Employees receiving a car allowance do not have to pay additional tax like BiK on the money you receive from your employer for your car. You are already being taxed on it through your pay packet.
Do you pay Benefit in Kind (BiK) on a car allowance?
You may find that your employer only offers either a car allowance or a salary sacrifice scheme, but if they offer both options, it’s important to take a look at which would make most sense for you personally.
Whether it’s better for an employee to use a salary sacrifice scheme to get a company car, or take a car allowance, will depend very much on individual circumstances and personal preference.
There are different costs and taxes to take into account with both routes and it can be quite confusing; so, we’ve created a comparison table which might help.
| Car Allowance | Salary Sacrifice | |
| Taken out pre-tax and NI | N/A | Yes |
| Taken out post-tax and NI | Yes | N/A |
| Able to pick whatever car you want | Yes | N/A |
| Have a selection of cars to choose from | N/A | Yes |
| Have to maintain car and insurance yourself | Yes | N/A |
| Have to pay BiK tax | N/A | Yes |
| You’re responsible for the lease i.e. undertake credit checks etc. | Yes | N/A |
| You own the EV | Yes | N/A |
If you are planning on using an electric car for work purposes, rather than a petrol or diesel vehicle, it may add a different slant on things again. This is because electric vehicles currently benefit from a very low BiK rate if you pay for the car through salary sacrifice.
This could mean that it might be more cost-effective to lease an electric car through salary sacrifice than to have one privately using your car allowance.
For employers, both car allowance and salary sacrifice schemes have potential benefits, but it should be noted that with salary sacrifice, the employer will pay less in NICs for that employee, because the portion of salary being used for the scheme isn’t subject to it.
Why might employers offer car allowance?
There are several reasons why employers might offer a car allowance to employees who are expected to travel by car for work purposes. These include:
- Offering a car allowance can be a good employee incentive when recruiting or retaining good staff.
- There is minimal admin involved for the employer as the employee is responsible for the vehicle and its maintenance.
- The employer pays this fixed cost only for the period of employment i.e. if the employee leaves, the payments stop, and the employer isn’t responsible for the vehicle in any way.
- Car allowance payments to employees are 100% tax deductible against business profits, so can reduce the business tax liability.
Can employers place restrictions or requirements on vehicle choice when paying car allowance?
When paying an employee a car allowance, it means that the employee is responsible for all of the usual vehicle ‘admin’, such as making sure it’s taxed, MOT’d and maintained adequately. It’s worth noting though, that a car that is being funded with a car allowance does mean that the employer has some health and safety-related responsibility for the vehicle.
Employers must always check that the employee is licensed to drive and has the right insurance cover for the vehicle (i.e. includes business use on their private policy). For reasons of safety, employers can also specify certain requirements or restrictions on vehicles. This can include factors such as who is allowed to drive the car, who can travel in it, the age of the car, the body type of the car, the type of engine and its level of CO2 emissions.
All of this needs to be detailed in the employer’s company policy and the employee will need to agree to the terms before they start receiving a car allowance.
Most employers are unlikely to demand a specific make or model of car that the employee must drive with their car allowance, but they may say that employees can’t drive a three-door vehicle or a convertible sports car for work purposes, for example.
Does it make a difference to car allowance if you drive an electric car?
It doesn’t make a difference to the amount that you’ll get for your car allowance if you drive an electric car for work purposes, but it might mean that you’re not getting the maximum benefit of the extra money you receive due to the way that it is being taxed.
You are taxed at your normal income tax rate when receiving a car allowance (unless it pushes you into a higher band, which means you’ll be taxed more), so the money you actually ‘take home’ from your car allowance can be significantly less than it first seems.
Comparing this to a salary sacrifice scheme, where you choose to set aside a portion of your salary each month before tax for an electric car lease payment, for many, it’s a more tax-efficient way to drive an EV that you use for work.
If you compare leasing a new electric car privately (like you could with your car allowance) and the same car leased through a salary sacrifice scheme, the monthly payments are lower with the salary sacrifice agreement.
You also need to take into account that BiK rates (which is a tax paid on company cars) for electric cars are significantly lower than for petrol or diesel vehicles, so this can have a big impact on monthly costs too.
These things combined can make a real difference to how much you’re spending on monthly electric car costs.
Who is responsible for the car maintenance and upkeep with a car allowance?
With a car allowance, the employee takes on all of the responsibility and costs of running and maintaining the vehicle. So all of the effort and time needed to organise servicing, MOTs, repairs or other maintenance falls to the employee.
With other types of company car routes, such as a salary sacrifice, the car maintenance costs and admin tasks are often included in the lease agreement, which means that less responsibility falls on the individual employee.
Can part-time employees get car allowance?
It’s down to the individual business as to whether they offer any employees a car allowance, including part-time staff. Many companies that do pay car allowances will also offer them to part-time employees, but pro rata. So, for example, if an employee works three days a week instead of five, they might be given a car allowance that is 60% of the amount that a full-time employee in the same role is offered.
If a part-time employee instead wanted to join a salary sacrifice scheme as a way to get a company car instead of a car allowance, they would be able to do so, as long as the amount sacrificed doesn’t take them under the minimum wage for the hours worked.
Does an employee have to pay back car allowance if they leave the job?
If an employee who receives a car allowance leaves the business, they’re not required to pay back the car allowance that has been paid to them while they worked there.
It’s important to remember that with car allowance, the employee has sole responsibility for the vehicle. So, if they have been using the car allowance from their employer to pay leasing costs or car finance repayments, they will need to cover these costs themselves if they continue to run the car after leaving that job.
Car allowances can be a good option, whether you’re an employer considering it as a benefit, or an employee considering using it. But it’s important to note that there are other routes out there which could be more convenient and tax-efficient for all, such as a salary sacrifice scheme.
Find out more about how electric car salary sacrifice works.
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