Car allowances are a popular way for companies to provide benefits to employees who need to use personal vehicles for business travel. However, the tax treatment of these allowances is complex, with nuanced rules around what qualifies for relief. 

A recent decision from the Upper Tribunal in the case of Laing O’Rourke Services Ltd and Willmott Dixon Holdings Ltd has provided useful guidance, confirming that allowances qualify for favourable tax treatment even if not directly tied to mileage or expenditures.

What are Car Allowances?

A car allowance is a sum of money paid by an employer to an employee regularly to compensate for using their own personal vehicle for business purposes. They are an alternative to providing an actual company car.

Allowances are usually conditional on the employee, ensuring a suitable insured and roadworthy car is available whenever needed for business use. But often, there is no obligation to carry out a minimum number of business miles or spend the money received on motoring expenses.

Employers may choose to offer allowances rather than company cars for several reasons:

Simplicity: Allowances avoid the administrative burden of sourcing, maintaining and managing company car fleets. No need to handle insurance, servicing, breakdown cover etc.

Cost: Surveys consistently show that car allowances are cheaper for employers than funding company cars, fuel and other running costs. 

Flexibility: Allowances provide more choice for employees over the car they drive. Company cars are usually restricted to set models eligible under scheme rules.

Control:  With company cars, employers retain ownership and control. Allowances give employees full control over their choice of vehicle.

Tax efficiency:  Properly implemented allowances can provide tax benefits for both employers and employees (more on this below).

From the employee’s perspective, the main advantage of an allowance over a company car is freedom of choice over the car. The main disadvantage is the transfer of running costs to the employee.

How do Car Allowances Work? 

Most car allowance schemes have the following characteristics:

• Eligibility is usually based on an employee’s need to drive for business rather than a minimum mileage. Seniority may also play a role.
• Allowances are normally paid monthly or annually as round-sum amounts, not on a per-mile basis. 
• Payment levels are structured around employee seniority or role, not business mileage. More senior employees receive higher allowances.
• Employees must have an insured and roadworthy car for business use. But there is usually no stipulation around car age, model, value etc.
• Ongoing payments are not conditional on driving a minimum business mileage or spending the allowance on motoring expenses. Allowances continue during illness, leave etc.  
• Employees can typically use the car allowance as they wish—no requirement to spend it on the car itself.
• Additional per-mile rates to reimburse fuel costs are often available for business journeys. These are paid tax-free up to HMRC-approved mileage allowance payments.

Tax Considerations Around Car Allowances

From a tax perspective, car allowances involve various nuances:

• Allowances are usually subject to PAYE income tax and Class 1 National Insurance contributions (NICs) via payroll.
• For income tax, allowances not spent on business motoring costs are taxable benefits. Employees can claim tax relief on allowances spent on business travel.
• For NICs, employers can reduce Class 1 NICs if allowances are structured to qualify as “relevant motoring expenditure” (RME). More on this below.
• Employees can claim tax relief on business travel that exceeds HMRC-approved mileage rates. Employers can reimburse approved mileage rates tax-free. 
• Changes to company car benefit-in-kind tax rates do not impact allowances paid as cash. But company car taxation remains complex.

It’s the NIC’s position that causes the most confusion and which was central to the recent Tribunal case. 

NICs Treatment of Car Allowances

Unlike income tax, there is no general employee deduction for costs incurred while performing employment duties. But crucially, some car allowances can qualify for NICs disregard if structured appropriately.

This requires understanding some key terms:

Relevant Motoring Expenditure (RME):  Categorization for car allowances to qualify for NICs disregard.

Approved Mileage Allowance Payment (AMAP):  HMRC’s tax-free mileage rate for employee business travel (currently 45p/mile for first 10,000 miles).

Qualifying Amount (QA):  The portion of RME eligible for NICs disregard, calculated based on business miles multiplied by AMAP rate.

If a car allowance satisfies the definition of RME, the QA portion is disregarded from NICs. The excess over QA is taxable. The crux is whether allowances meet the legal definition of RME. As the recent case clarifies, direct linkage to business mileage or expenditure is not required.

Recent Upper Tribunal Ruling on Car Allowances

In 2022, the Upper Tribunal (Tax and Chancery Chamber) handed down an important judgment on whether employers must link car allowances directly to mileage and costs to qualify for RME tax treatment. The case involved appeals from two construction firms, Laing O’Rourke and Willmott Dixon, concerning NICs paid on allowances during 2004-2018. 

The key issue was whether their allowances based on seniority rather than usage met the definition of RME. If yes, then the QA portion would be disregarded from NICs.

The Tribunal ruled that RME has a wide meaning and does not require proof of actual mileage or expenses incurred. Allowances can qualify if employees must make cars available for business use. It allowed Laing O’Rourke’s appeal, stating that mileage-based calculation was not critical. The employer just needed to show payments compensated for expected business usage.

This decision confirms that car allowances can meet RME rules even if structured around seniority and paid regardless of whether employees drive any business miles.

Key Lessons from the Ruling

This case provides several key lessons for employers in structuring tax-efficient car allowances:

• No need to link allowances directly to business mileage or expenses incurred. As long as an expected vehicle is available for business use, payments can qualify as RME.
• Allowances calculated by seniority rather than usage can still qualify. The purpose of the payments, not the calculation method, is the critical factor.
• Allowances can still be RME even if some employees provided with allowances end up driving zero miles. Entitlement to relief should not be affected by how others use their allowances.
• While tax and NICs rules aim to align, they differ in some areas. NICs relief depends on the expected availability of cars for business rather than actual mileage or costs incurred.

Practical Implications of the Ruling

This Tribunal decision brings helpful clarity on designing and implementing car allowance schemes:

For employers:

• Allowances can be structured around bands by seniority rather than mileage if preferred.
• No need to reduce allowances if employees drive fewer miles year-on-year. Payment levels can remain constant.
• Keep contracts stating allowances are conditional on employees making suitable cars available for business use when required.
• Ensure payroll systems disregard the QA portion of allowances from NICs.

For employees: 

• Request clarity from the employer on whether allowances are intended to qualify for RME tax treatment.
• Maintain logs/records of all business mileage to support claims for income tax relief.
• Keep invoices/receipts related to business mileage expenses.
• Be aware that personal tax position depends on whether allowances exceed or fall short of costs.

Wider Issues – Company Cars vs Allowances

Beyond the tax considerations, what are some of the wider issues around company cars versus allowances?

For employers:

• Company cars remain popular benefits, but the administration is complex, with tricky rules around eligibility criteria, allowable models, taxation etc. Allowances are simpler.
• The provision of low-emission company cars enables the reduction of taxable benefit-in-kind but restricts choice. Allowances give employees the freedom to select lower-emission cars.
• Large company car fleets are challenging to manage. Allowances pass these headaches to employees.

For employees: 

• Company cars limit choice to models approved by scheme rules. Allowances give freedom to choose any car.
• Using a company car for personal use increases taxable benefit-in-kind. Allowances give full private and business use with no benefit-in-kind.
• Company cars must be maintained to employer standards. Allowances let employees determine servicing schedules. 
• Termination of employment usually requires returning the company car. Allowances mean employees keep their cars.

Overall there are pros and cons to company cars versus allowances from administrative, cost and choice perspectives. Tax treatment is just one piece of the puzzle for employers to weigh up.

Record-Keeping Requirements 

Robust record-keeping remains important for both employers and employees when car allowances are provided:

Employer record-keeping:

• Keep copies of employment contracts and car allowance policy documents setting out eligibility criteria, payment structures and requirements around business use.
• Maintain databases on which employees receive allowances, business mileage rates and car allowance payment history. 
• Preserve payroll records showing QA portions disregarded for NICs.
• Keep evidence demonstrating how allowance payment tiers are set by seniority.
• Retain analysis justifying allowance rates regarding running costs of equivalent company cars.

Employee record-keeping:

• Log business mileage on an ongoing basis. Records enable tax relief claims on costs exceeding car allowance.
• Keep copies of mileage expense claims submitted to the employer. Retain details of reimbursement payments received.
• Preserve invoices/receipts evidencing business motoring costs incurred – fuel, parking, maintenance etc. 
• Maintain diary records of journeys, including date, reason, start location and destination.
• Keep annual car allowance payment summaries provided by an employer. Retain P60 end-of-year pay statements.

Thorough record-keeping remains vital even though allowances do not depend directly on mileage. Evidence is still required to validate payments and support tax relief claims.

Government Incentives Around Company Cars

Various government incentives influence company car choice for employers and employees:

For employers:

• Reduced benefit-in-kind taxation for the provision of low-emission company cars to employees. Incentivises uptake of electric and hybrid models.
• Writing down allowances enabling tax relief on the purchase of low-emission cars. Accelerated relief is available for zero-emission models.
• VAT relief on lease rentals for leasing zero emission company cars. Saves 20% VAT cost.

For employees: 

• A lower benefit-in-kind tax on low-emission company cars. Electric models attract just 2% benefit-in-kind.
• Grants and incentives for employees leasing low-emission company cars via salary sacrifice arrangements. Can substantially reduce employee contributions.

These incentives continue to make company car schemes attractive from a tax perspective if structured around low-emission vehicles. Allowances remain simpler to administer but do not trigger the enhanced reliefs.

Car allowances continue to be a popular alternative to company cars. But careful attention must be paid to tax treatment and record-keeping requirements. It is more important than ever to take expert tax advice when implementing car allowance arrangements to ensure full compliance with tax guidelines and maximize available reliefs.

This can be a complex area that is only sometimes well understood by employers and employees. Taking a step back to understand the fundamentals around allowances can help put tax obligations and potential benefits into perspective.

If you need help regarding tax advice or compliance, please contact Tax Accountant at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.