Tax Talk: Company cars: back with a difference
Electric company cars can save employees and employers tax and NICs, but how does a salary sacrifice arrangement work?
Company cars are here again. The once favourite benefit for employees, typically middle managers and above, had slowly been declining in popularity since 2017. Why was this? Most likely because of the introduction of optional remuneration legislation, increasing scale rates, and changes to the way a car’s CO2 emissions are measured.
But now that electric cars are becoming more viable for day-to-day use and there are favourable tax rules for pure electric and some hybrid cars, the company car is back in fashion. Many companies are introducing them as an optional employee benefit.
The cost to the employer of providing this benefit is low, as leasing costs are often funded entirely by employees through a salary sacrifice arrangement.
Company car tax
Unlike most employee benefits the value of this benefit (for Income Tax purposes), in providing a company car to an employee, is not the cost to the employer. Instead, the annual benefit is calculated based on the list price of the car (plus any extras) and the ‘scale rate’ %, based on the CO2 emissions of the vehicle.
The scale rates applicable to company cars have been steadily increasing for almost a decade. A car that in 2016/17 had a scale rate of 15%, would today have a rate of 37% applied to its list price.
Although other factors have also contributed to the downfall of the company car, the rise in scale rates is by far the main cause. Petrol and diesel company cars simply stopped being a worthwhile benefit for employees. They would have to pay more in tax over the three-year life of the car than they would if they took a cash alternative.
Let’s look at a simple example for the 2022/23 tax year of a company car provided to an employee. It uses petrol and has a CO2 emissions of 144g/km.
|List price of car||£35,000|
|Scale rate per HMRC guidance||33%|
|Annual benefit value||£11,550|
If the employee is a 40% taxpayer, Income Tax of £4,620 is payable and the company will incur £1,593 in Class 1A NICs (this ignores the one-off rate of Class 1A NICs applicable for 22/23).
The impact of the electric car
If we go back just five years, most electric cars had a very limited range and were not seen as a viable option for everyday use.
The public’s perception of electric cars is changing fast. There have been rapid advances in electric car technology, specifically the ability of the battery to provide enough charge to travel more realistic distances. What’s more, the Government’s well publicised intention to ban the production of all new petrol and diesel cars by 2030 has influenced people’s thinking. Many people would now consider the option of an electric car when they come to change their current vehicle.
The problem, however, is that a petrol or diesel car can be much less expensive than the equivalent electric model to buy outright through the retail market. So huge is the difference in price, in fact, that it is rare for someone to buy an electric car retail. Why spend an extra £20,000 on a car that will do 400 miles less on a single charge than its petrol equivalent and has the added challenge of finding or purchasing a charging point?
So if people aren’t purchasing electric cars, why are we seeing so many on the roads?
The number of electric cars on the roads has been steadily increasing in recent years. But almost all electric cars are provided, in one form or another, as a company car.
The primary reason for this is because the tax on the provision of an electric company car (in stark contrast to petrol and diesel cars) has been exceptionally low since 2021/22. So low (1- 5%) that there is a significant tax saving for employees where they contribute towards the cost of leasing the car.
Let’s look at a similar car model to the one used in the example above but assume its list price is £10,000 more. As a fully electric car, it has CO2 emissions of 0g/km (scale rates still apply) and we are calculating the benefit for the 2022/23 tax year.
|List price of car||£45,000|
|Scale rate per HMRC guidance||2%|
|Annual benefit value||£900|
A 40% taxpayer would incur just £360 tax on this benefit, and the employer would pay only £124 in Class 1A NICs.
In a like-for-like comparison, there is a combined saving of £5,729 for the employee and the company in having an electric car versus a petrol one.
Company cars usually come with all services included: servicing, insurance, road tax, breakdown cover, even new tyres are all standard provisions for company car schemes. This low hassle factor of driving a brand new car every three years is what made the company car the favourite benefit it used to be.
With the possibility of actually saving tax, as well as removing the hidden expense of driving a car you own, it’s no wonder employees are beating down boardroom doors all over the country demanding their employer introduces a car scheme as soon as possible.
When it comes to the costs of an employee car scheme many companies have adopted the mantra: ‘If it is employees who want this benefit, then it is employees who can pay for it’.
Salary sacrifice and tax complications
Salary sacrifice is the general term given to arrangements where an employee has the option of being paid an amount in cash, or ‘sacrificing’ their entitlement to that cash and instead receiving a company provided benefit.
Using a salary sacrifice arrangement, the costs of leasing a vehicle through the Electric Car Scheme are met entirely by the employee and this is key to unlocking the tax saving. Often employers are bearing only minimal costs (for administration) in providing a new car scheme for their employees.
Salary sacrifice is not a new concept and most people associate it with generating immediate tax relief and Class 1 NICs savings on employee pension contributions.
It’s quite straightforward, right? Just a matter of deducting an amount from an employee’s taxable pay and calling it salary sacrifice on the payslip? The short answer is no.
Be warned. Familiarity with salary sacrifice for pension contributions is misleading many companies into thinking that setting up an equivalent arrangement for cars is simple and that they can ‘DIY a scheme’ without help from tax and legal professionals.
A contractual matter
The key element for a salary sacrifice arrangement to work for tax and NIC purposes is the ‘giving up the right to receive cash and, instead, being provided with a benefit’. The rights of an employee (what they will be paid, when they will be paid, what benefits they are entitled to, and so on) are generally a contractual matter.
Any change to what the employee will be paid (especially if it will be less) must effect a change on a contractual level. Simply instructing payroll to process an amount as a deduction from taxable pay does not make the sacrifice valid for tax purposes.
The contractual change is needed because employees are subject to tax on employment income received. Section 18 ITEPA 2003 states that a payment is treated as received at the earlier of: the date the money is paid to the employee or the date on which the employee is entitled to receive it.
Employees can be subject to Income Tax on money they do not receive if they legally had a right to receive the money but it was just agreed (between employee and employer) that they would not be paid.
It is this key point regarding salary sacrifice arrangements that many companies miss, as they assume that simply stating something will be a salary sacrifice is sufficient for tax purposes.
The effect on tax and NICs
There’s no doubt the return to popularity of electric company cars will increase the use of salary sacrifice arrangements to generate the very appealing tax savings on offer to employees.
For example, an employee can choose either to receive £5,000 in salary as a car allowance or to give up that right in exchange for a zero emissions company car.
Taking the car option means Income Tax (as well as employer Class 1A NICs) is payable on the benefit value of the car. Taking the cash allowance means Income Tax and NICs are payable on the total allowance at their marginal rate of tax and NI. Using the previous example for a 40% taxpayer the difference is clear to see:
|Opting for a zero emissions company car:|
|Class 1A NI||£124|
|Opting for a £5,000 car allowance:|
|Class 1 NICs employee||£100|
|Class 1 NIC s employer||£690|
Organisations should take advice when introducing a salary sacrifice arrangement to ensure that they implement it correctly and make the necessary contractual change to benefit from tax and NIC savings.
For more information on issues raised in this article, please contact Dan Kelly.