Car allowance vs company car: how each is taxed in 2026/27

An employer that needs staff on the road can give them a car or give them money. The tax rules treat the two in opposite ways. A car allowance is pay: taxed in full through PAYE, whatever it is spent on. A company car is a benefit: taxed on a percentage of its list price set by its CO2 emissions, which for an electric car in 2026–27 is 4%. This page quotes HMRC’s manual on what a car allowance is and is not, sets the two side by side with the 2026–27 rates, and covers the case in between — a choice of car or cash.

What HMRC says a car allowance is

HMRC’s Employment Income Manual draws the line between a mileage allowance, which can be tax-free, and a car allowance, which cannot. Among the payments that are not mileage allowance payments:

The same page adds that a payment made “a payment not related to business mileage, e.g. for private mileage, or to compensate the employee for the fact that they no longer have a company car (such payments are earnings which should be subjected to PAYE in the normal way)”. So a flat £500 a month to run a car, or a payment replacing a withdrawn company car, goes through payroll as pay, with income tax and employee and employer National Insurance.

There is one exception worth knowing. A lump sum can be a mileage allowance payment if it is “a lump sum payment aimed at covering the business proportion only of the standing costs of the car - for example, we accept that the lump sum instalment payments for regular business drivers made at nationally agreed rates by many local authority and NHS employers are for this purpose.” But “It must not, for instance, be a payment made merely because the person no longer has a company car.”, and “those estimates must be reasonable when made and reviewed during the year to ensure that they remain reasonable”. The NHS version is on NHS lease cars.

Business miles on top of a car allowance

Because the allowance is pay, business mileage is a separate question. The employer can pay up to the approved rate tax-free — 55p a mile for the first 10,000 business miles in 2026–27, then 25p — on HMRC mileage rates. If it pays less, or nothing, the employee claims the difference. GOV.UK: “If you use your own vehicle or vehicles for work, you may be able to claim tax relief on the approved mileage rate.” “This covers the cost of owning and running your vehicle.” To work it out, “take away any amount your employer pays you towards your costs, (sometimes called a ‘mileage allowance’)”.

A flat car allowance is not a mileage allowance, so it is not deducted. HMRC notes the logic of this: “Any apparent inequity is accounted for by the availability of Mileage Allowance Relief(MAR)”. Claims need logs showing “the reason for every journey the postcode for the start point of every journey the postcode for the end point of every journey”, and “You can claim for the current tax year and the 4 previous tax years, if you’re eligible.”

The two side by side

Worked figures for 2026/27

These figures compare tax only, for an allowance of £6,000 a year (an assumed amount) against two illustrative company cars. The running costs of a private car bought with the allowance, and the employer’s lease and insurance costs for a company car, are commercial figures we have no published source for.

National Insurance differs too. On the allowance the employee pays Class 1 at 8% (or 2% above the upper earnings limit) and the employer 15%: £900 on £6,000. On a company car the employee pays no NI on the benefit, and the employer pays Class 1A at 15%: £240 on the electric car above, £1,350 on the petrol one. The full percentage table is on company car tax (BIK) rates.

The choice of car or cash

Where employees can pick between a car and cash, that choice is an optional remuneration arrangement. ITEPA s.69A defines the second kind: ““Type B arrangements” are arrangements (other than type A arrangements) under which the employee agrees to be provided with the benefit rather than an amount of earnings within Chapter 1 of Part 3.” For cars, s.120A then applies where “the car's CO2 emissions figure (see sections 133 to 138) exceeds 75 grams per kilometre.” — the employee is taxed on the higher of the cash given up and the normal benefit. For a car at 75g/km or less the normal benefit always applies. The mechanics, shared with salary sacrifice, are on salary sacrifice car schemes.

What an allowance moves onto the employer

Paying an allowance takes the car benefit off the P11D, but it does not move the duty of care. Cars bought with an allowance are employees’ own cars for tax and for safety: HSE counts them as grey fleet, with the same checks on licence, insurance for business use and roadworthiness. The fuel in them is also reportable under SECR for large companies when the employer reimburses business mileage.

A checklist

• Pay the allowance through payroll as pay; do not split it into ‘expenses’ afterwards.
• Pay business mileage separately at a stated rate, or tell staff they can claim Mileage Allowance Relief.
• If staff choose between a car and cash, value cars over 75g/km under the optional remuneration rules.
• Run grey fleet checks on allowance cars.
• Compare total cost, not tax alone, before switching.

This page quotes HMRC guidance and ITEPA 2003 as read on 2026-10-10; it is not tax advice.

Common questions