Cash or car?

Taxing company cars

In the March Budget¹ the Chancellor, Gordon Brown, announced that from 6 April 2002 the basis of company car taxation will change from business mileage to carbon dioxide (CO2) emissions.

According to the Government, the changes to the tax regime will protect the environment by:

At present, the tax charge on a company-provided vehicle is based on the car's list price when registered, its age and the annual business mileage. For example, if a company car, less than four years old, clocks up between 2,501 and 17,999 business miles in a year, then the tax charge is 25% of the manufacturer's list price (see table 1).

From the 2002/3 tax year, the charge on the benefit of a company car will still be calculated on the list price, but it will be adjusted by carbon dioxide emission ratings instead of business mileage. For drivers of a motor with a Department for Environment, Transport and Regions approved CO2 emission, the amount of liability will rise from 15% of the car's list price in one percent steps (for every additional emission of five grams per kilometre (g/km)) up to a maximum of 35% (see table 2). In the absence of reliable and complete emissions data, cars registered before 1998 will be charged according to one of three engine-size bands (table 1 ).

The qualifying level of CO2 emissions for the minimum charge will gradually be reduced from 165g/km in 2002/03 to 155g/km in 2003/04 and 145g/km in 2004/05. Similarly, the maximum charge of 35% starts off at 265g/km, falls to 255g/km and then drops to 245g/km in 2004/05 (see table 2 ).

Diesel car drivers will have to pay an extra 3%, because, although diesel engines have typically lower CO2 emissions than petrol equivalents their exhaust fumes are more likely to cause respiratory illnesses. But this surcharge will not take them above the upper limit of 35%.

Following further consultation, the Inland Revenue says that details will be announced of a supplement waiver for very low emission diesel cars, and discounts for other environmentally friendly cars, such as those that run on electricity or a combination of petrol and gas or electricity. These discounts could reduce the charge below the usual minimum of 15% of the car's price.

Reacting to the planned reforms of company car taxation, the Society of Motor Manufacturers and Traders (SMMT) claimed that: "The Inland Revenue has failed to provide an economic and environmental assessment of the planned changes. Drivers who under the current system receive the full business mileage discount could find themselves with a very substantial tax increase for no published reason."

Pros and cons

In addition to the "green" benefits listed by the Government, the reforms abolish the need for employers to record and supply data to the Inland Revenue on annual business mileage - a requirement that has been seen by many as a time consuming and error-prone process. The Inland Revenue estimates that the scrapping of such administrative burdens should save the quarter of a million organisations that supply company cars about £25 million a year between them. However, those companies that provide fuel to company car drivers will still need to keep mileage records if they wish to prove to the tax man that this is used only for business and not private motoring.

While some records will no longer be needed, new administrative requirements will replace them. Businesses will be obliged to obtain and report CO2 emissions data for all of their company cars. For those registered from 1 November 2000, the definitive CO2 emissions figure for tax purposes will be recorded on the vehicle registration document (V5). The Vehicle Certification Agency has produced a listing of indicative CO2 emissions for every new car on sale in the UK on the internet (http://www.roads.detr.gov.uk/vehicle/fuelcom.index.htm). For employer-provided vehicles first registered from 1 January 1998, the SMMT is providing a CO2 emissions enquiry service on the internet (www.smmt.co.uk).

Because there are no reliable sources of CO2 emissions data for cars registered before 1 January 1998, the tax charge will be based on engine size. In such cases, businesses will need to return the engine capacity information to the Inland Revenue. Firms will also need to identify and record any cars that run on diesel and or use alternative fuels and technologies, because these vehicles will attract taxes at different rates. This information can be gained from the vehicle type description on the vehicle registration document.

The Government estimates that in total, the one-off cost to employers of changing from the old to the new system of taxation (such as setting up new systems, management and staff training, and changes to computer software) will amount to about £50 million.

Once these new systems are up and running, the Inland Revenue estimates that, despite the new recording requirements mentioned above, the overall net annual compliance saving for affected employers will be about £20 million a year.

However, the SMMT has listed some negative effects of the future CO2-based tax system, stating:

Outcomes

The Government estimates that at present there are about 1.75 million drivers of employer-supplied vehicles. So how will the planned changes to the company car tax regime affect these individuals financially?

In the first year, effective from April 2002:

From the tax year 2003/04, the level of CO2 emissions qualifying for the minimum charge of 15% falls from 165g/km CO2 to 155g/km, and again in the following financial year to 145g/km. The maximum charge of 35% comes in at 255g/km CO2 in 2002/03, falling to 245g/km the year after. These changes mean that unless company car owners are able to change their vehicle each year to one with lower emissions, they will pay progressively more tax.

For example, a sales representative travelling 18,000 business miles a year in a 1.9 litre company-supplied VW Golf (with a list price of £16,455 and a CO2 emission of 187g/km) currently has a tax charge of 15% on the cost of a car. From 6 April 2002, the same individual will be taxed at 19% of the cost, in the following year at 21% and in 2004/05 at 23%. In monetary terms, assuming that the employee in question is a basic-rate tax payer, they would pay £543 in tax currently, £688 in the first year of the new carbon-based tax regime, £760 in the second year and £832 in 2004/05. This represents a total increase of 53%.

Employers' options

Because the minimum company-car tax rate of 15% will click in each year at a progressively lower CO2 emission rating (see table 2), one option for employers wanting to reduce the tax bill for drivers of employer-provided cars is for them to offer vehicles with lower CO2 emissions.

But, at present, the choice of cars with emissions below 145g/km is restricted to a limited number of models, such as the Perodua Nippa or the MCC Smart - and this choice is not likely to increase for some time. According to the SMMT, the average level of CO2 emission for a car was 186g/km last year, and while European car manufacturers have signed up to a voluntary target of 140g/km CO2, this will not take effect until 2008. While the present crop of low emission cars can offer tax advantages to the tax-aware, they may not be regarded by some "perk drivers" as prestige cars and, because they are small "city cars", might give less comfort to the long distance "needs driver", with possible health and safety implications.

In response to the changes announced in this year's Budget, the Association of Car Fleet Managers (ACFO) has called on organisations to check whether all future business journeys by car are really necessary. It also suggests that businesses should consider diesel cars, since these have lower emissions than petrol vehicles and, even with the 3% levy, could see drivers who select the right car better off. Drivers who own a diesel car also benefit from better fuel consumption than their petrol-car-driving colleagues.

A cash alternative

Another option to ease the tax burden is for organisations to offer a cash allowance instead of a company vehicle. A recent survey by IRS on benefits and allowances in 90 small, medium and large organisations (See Benefits and allowances: 2 ) found 34% of employers offering such a cash alternative.

However, the latest annual review of company car policies and practice by remuneration advisers Monks Partnership² finds that this practice is more widespread, with 70% of the 189 organisations surveyed allowing employees to trade a vehicle for a higher salary, compared with 69% in 1999 and 66% in 1997.

Generally, the availability of such allowances is more common in larger firms than in small ones, Monks finds. Among small employers, the median annual value of the cash allowance ranges between £11,500 for those at director level and £4,400 for those provided with a "minimum status" car. As well as job function, the value of the allowance also depends on whether or not the organisation wishes to encourage company car drivers to opt for the allowance, rather than the vehicle, the survey adds. According to Monks, a company car driver who opts for a cash alternative will usually be expected to make a car available for use on the firm's business. Traditionally, those who had previously been in receipt of a company vehicle would either buy a car outright, or acquire one under a hire purchase agreement.

Confirmation of the high incidence of cash alternatives is also provided by this year's survey of 129 employers by Alan Jones and Associates³, which reveals that 61% of participants offer employees the choice of a car or money (see chart 1 ).

But employers who decide to provide a cash alternative will need to address a range of questions, including: how to determine the size of the payment; whether to pay it all up-front or in instalments; and how to deal with those people who receive a cash allowance but subsequently leave the firm.

For employees who chose to buy their own car for company business, the disadvantages include:

Traditionally, the company car driver who chose the cash alternative would be faced with one of two options: either to purchase a car outright or to acquire one under a hire purchase agreement.

Employees who buy a motor will be expected to use the vehicle for company business. By way of compensation, firms typically pay them a mileage allowance, usually expressed as a fixed amount per mile, which covers not only fuel costs but also running expenses and vehicle depreciation.

The Inland Revenue requires employers to return details of the mileage payments made to individual employees. Employees are required to make detailed claims for tax relief based on their actual motoring expenditure - running costs, capital allowances and interest paid on a specific loan - and are then taxed on all reimbursements from their employer, less any allowable costs.

To reduce this administrative workload, the Inland Revenue operates a plan known as the Fixed Profit Car Scheme (FPCS) - see table 3 . This enables firms to pay allowances up to authorised mileage rates (AMR) without deducting tax or national insurance contributions.

Indeed, the car leasing company ACL autolease⁴ believes that by using the FPCS mileage allowances, together with a salary alternative, it is possible to design remuneration packages that make it advantageous for employees to use their own vehicles for business purposes, rather than take a company vehicle.

Under Inland Revenue rules, employers can also pay up to 12 pence per mile to their employees tax-free for using their own bicycles for business travel and - since April 2000 - up to 24 pence per mile tax-free to any of their staff who use their own motorcycles for work-related journeys. Employees can claim tax relief on 12p or 24p per business mile even if their organisation pays no cycle or motorcycle allowance, or on the balance up to 12p or 24p per mile if the employer pays less than these rates.

Information about the AMR for 2001/02 is not currently available. But the Inland Revenue says that in the future it will be considering how these rates might be amended to encourage greater environmental awareness amongst drivers using their own cars for business trips. For instance, this could take the form of enticing such individuals to drive fewer business miles in cars with lower CO2 emissions, while increasing the rates for motorbikes and cycle users.

Company car owners who receive fuel from their employers are subject to tax against set fuel scale charges (see table 4), unless they can show that the fuel is provided only for business mileage, or they pay the company back for all the fuel provided for non-business use. Recent figures from Alan Jones and Associates show that 49% of enterprises provide fuel to "needs drivers", while 56% supply it to "perk drivers".

In April 2000 fuel scale charges shot up by over 40%, well above the 20% rise (for each of the five years to 2002) announced in the 1998 Budget. If this continues, the tax cost of the benefit may eventually outweigh the actual cost of the fuel. As a result, company car drivers will expect their employers to come up with a tax-efficient alternative for running their vehicles.

Personal leasing

In recent years, growing numbers of ex-company car drivers have been offered the option of personally leasing a car. Monks Partnership, in its latest survey, finds 20% of responding companies are actively considering providing company car drivers with the additional option of personal leasing during 2000. But the British Vehicle Rental and Leasing Association (BVRLA) maintains that this is not, strictly speaking, a straightforward cash-for-car swap, rather the company car driver is simply being offered a different type of product.

Part of the explanation Monks gives for the increased interest in personal leasing is that company cars have become one of the Government's favourite revenue-raising targets. Personal leasing cuts the tax burden on company car drivers because they, as owners of a personally-leased motor, are not taxed on the benefit - the contract is between the individual and the leasing company. However, the employee will still have to pay income tax on the value of the cash allowance.

Basically, there are two types of personal leasing arrangements: personal contract hire plan (PCHP) and personal contract purchase plan (PCPP).

With a PCHP a rental agreement is set up, usually based on an initial deposit followed by monthly instalments over a set period of time and for an agreed mileage. At the end of the lease the car is returned to the leasing company (lessor).

Under a PCPP, the lessor estimates what the car will be worth after the contract period, and then subtracts this sum from the initial value of the car. The amount left over is then divided up and charged as a monthly rental, over the agreed term. At the end of the contract an individual can either pay the last instalment and keep the car, or return it without making the final contribution and so owe nothing.

From the ex-company car driver's viewpoint, a leased car offers many of the benefits of an employer-provided vehicle (they do not have to worry about maintenance, servicing, breakdowns or accidents and repairs, as leased schemes usually offer these services in the package, and some may also include car insurance) while avoiding the tax liability of a company car.

However, there are possible problems with leasing. Individuals could be forced to pay a high financial penalty if they go over the agreed mileage limit set down in the PCHP or if they end a PCPP agreement before its due date.

Because personal leasing plans offer hassle-free motoring to the ex-company car driver, they make it easier for employers to move from offering company cars to providing a cash allowance. Such a move, it is argued, can produce administrative cost savings for the employer: all the firm has to do is calculate the size of the cash allowance for affected individuals and pay it. It is the leasing company that has to administer who gets what car, its maintenance and other operational issues. And the company will not have to keep detailed records on CO2 emissions for the Inland Revenue.

Companies thinking about various strategies to help reduce the company-car tax burden for their employees should seek professional advice from tax experts in this area, for instance Deloitte and Touche, Ernst & Young, KPMG or Arthur Andersen.

From BMW to BMX?

The "gloomy forecasts predicting the demise of the company car are premature", says the BVRLA. Although various surveys, such as those by Monks Partnership, Reward and Alan Jones and Associates, have found that many firms now offer a cash alternative to the company-provided vehicle, take-up is still relatively low, as chart 1 shows. ACL autolease attributes this poor response to either the low amounts of cash on offer, or the driver's ignorance of how to make an assessment of its value. Whether the change in the basis of company car taxation from business miles to CO2 emissions will encourage a greater take-up of cash alternatives remains to be seen.

Indeed, as has been reported in car magazine Fleet News, if in the future the Inland Revenue amends the AMR that firms currently use to ensure that the ex-company car driver is not out of pocket, personal leasing could become less attractive. But the magazine also reports that ACL autolease feels that there could be increased interest in PCPPs among drivers who do over 18,000 miles, because they are worst hit under the forthcoming CO2-based tax regime.

As and when car manufacturers supply employers with Mondeo-type vehicles with low CO2 emissions, employees may stick to the convenience of the company car. If not, firms and employees may increasingly look for alternatives - such as cash payments, personal leasing arrangements, or even a company bicycle.

¹     "Budget 2000 - prudence for a purpose", March 2000, available from the Stationery Office, tel: 0845 7023474, price £35.

²        "Company car UK", February 2000, available from Monks Partnership, tel: 01799 542222, price £225.

³     "Company car survey report 2000", April 2000, available from Alan Jones and Associates, tel: 01600 716916, price £165.

⁴        "The ACL autolease guide to company car tax 2000-2001" and "The ACL autolease guide to cash alternatives for the company car", March and February 2000 respectively, both available from ACL, tel: 029 2029 8800, free.

Company car taxation¹

Before...

The existing tax charge on a company car is based on the following percentages of the price of the car:

Older car discounts - for a car four or more years old at the end of the tax year, the car benefit charge for the appropriate mileage band is further reduced by one quarter.

Second cars - the tax charge on second cars is generally on 35% of the price of the car. Where, exceptionally, the second car is also used for at least 18,000 business miles in the year, the charge is 25% of the price of the car.

Cars with no approved CO2 emissions figure - these will be taxed according to the engine size as follows: 0-1,400cc, 15%; 1,401-2,000cc, 25%; and 2,001cc+, 35%.

... and after

From 6 April 2002, the charge on the benefit of a company car is to be graduated according to carbon dioxide (CO2) emissions, and the reductions for business mileage, older and second cars will no longer apply.

Cars with an approved CO2 emission figure - the charge will build up from 15% of the car's price, for cars emitting CO2 at or below a qualifying level, in 1% steps for every additional 5 grams per kilometre (g/km) over that level. The maximum charge will be on 35% of the car's price. The qualifying level will gradually be reduced as cars get more fuel-efficient (see table 2).

Diesel cars - these will be subject to a 3% supplement, but this will not take the maximum charge above 35%.

Older cars - cars registered before 1 January 1998 will also be taxed according to engine size as follows: 0-1,400cc, 15%; 1,401-2,000cc, 25%; and 2,001cc+, 35%.

Cars with no recognised cylinder capacity and no approved figure of CO2 emissions - will be taxed on 35% of the car's price (or 32% if the car was registered before 1 April 1998), unless it runs solely on electricity, in which case the charge will be on 15% of the car's price.

¹     The price of a car for tax purposes is the list price of the vehicle and is the same under both the old and new schemes.

New charges from April 2002

The example below shows how it is proposed to calculate a car benefit charge in 2002-2003:

A car with a petrol engine, registered on 1 March 2000, with a list price of £15,000 and an approved CO2 emission factor of 197g/km (rounded to 195g/km).

Car benefit charge for 2002-2003 is: list price £15,000 x 21% = £3,150.

¹     The exact CO2 figure is rounded down to the nearest five grams per kilometre (g/km).

Source: Inland Revenue.

Where employers pay the same rate of mileage allowance irrespective of engine size, the average of the two middle bands is used, ie 40 pence per mile for the first 4,000 miles and 22.5 pence per mile thereafter.

Employers can pay up to 12 pence a mile tax-free to staff who use their own bicycles for business journeys and up to 24 pence a mile tax-free to any employees who use their own motorcycle for work-related purposes.

¹     Unleaded petrol at 80.9 pence per litre. For every penny more or less add or subtract:

²     Diesel at 81.9 pence per litre. For every penny more or less add or subtract:

Source: Automobile Association, April 2000.

The scale charges increase by 20% over and above the increases in pump prices in each year to 2002/03.