Car allowance and payrolling company cars: A complete UK guide

Company vehicles have long been a valuable benefit for employees who travel for work. But with changing tax rules and growing interest in electric vehicles (EVs), many UK businesses are rethinking how they provide vehicle-related perks. Two of the most common approaches today are car allowances and payrolling company cars.

We’ll dive into what they are, how they work and how to decide what’s the best option for your business. 

What is a car allowance?

A car allowance is a fixed cash payment that an employer gives to an employee instead of providing a work vehicle.

• Paid through payroll: The allowance is added to the employee’s monthly salary and processed through the usual payroll system.
• No work vehicle ownership: Unlike a work vehicle scheme, the employee uses the allowance to buy, lease or maintain their own vehicle.
• Flexibility for employees: Staff have the freedom to choose a vehicle that suits their needs and lifestyle.

How does a car allowance work?

Employers agree on a fixed monthly or annual allowance for eligible employees. The figure is usually based on factors such as role, expected business mileage and market benchmarks.

• Payment structure: The allowance is a cash sum added to gross pay and subject to normal payroll deductions.
• Flexibility: Employees may use the allowance for vehicle finance, fuel, maintenance or insurance — but they’re responsible for managing those expenses themselves.
• Standard practice: Many UK employers review allowance amounts annually to remain competitive with market rates and to adjust for rising motoring costs.

How to calculate car allowance for employees

There is no universal formula, but these steps can guide your calculation:

1. Assess the role’s travel requirements: Senior managers or field-based staff often need higher allowances.
2. Estimate annual business mileage: Use historic mileage data or expected travel needs.
3. Review HMRC’s Advisory Fuel Rates (AFRs): These rates help estimate realistic fuel costs.
4. Consider vehicle type and market averages: Benchmark against similar roles in your industry.
5. Factor in maintenance and depreciation: Allowances should help employees cover essential costs beyond fuel.
6. Review affordability for your business: Balance competitive benefits with budget constraints.

Is a car allowance taxable?

Yes. In the UK, a car allowance is treated as regular salary under PAYE:

• Income tax: The allowance is subject to the employee’s usual tax band.
• National Insurance contributions (NICs): Both employer and employee pay NICs on the allowance.
• Reporting obligations: The allowance appears on the employee’s payslip and is automatically reported to HMRC via Real Time Information (RTI).

This differs from work vehicle benefits, where the tax is calculated as a Benefit-in-Kind (BIK) based on the vehicle’s value and emissions.

What does a car allowance cover?

The allowance is designed to help employees cover all costs of running a vehicle for business purposes. Typical expenses include:

• Fuel: For both personal and business use, unless the business reimburses mileage separately.
• Wear and tear (depreciation): Vehicles lose value over time and the allowance should help offset this.
• Car maintenance: Routine servicing, MOTs, tyres and unexpected repairs.
• Insurance and road tax: Employees are responsible for arranging and paying these themselves.

What is a reasonable car allowance amount?

The “right” figure varies by industry and role, but UK benchmarks often range from £3,000 to £8,000 per year.

• Entry-level or occasional drivers: £3,000–£4,000
• Mid-level field staff: £4,500–£6,000
• Senior roles or high-mileage drivers: £6,000–£8,000+

When deciding on an amount, consider how it compares to the cost of running a work vehicle scheme. Many businesses find that a competitive allowance can save on fleet costs while still meeting employee needs.

What is payrolling company cars?

Payrolling company cars is a process where the taxable benefit of a work vehicle is collected through payroll instead of being reported annually on a P11D form.

Here’s how it works:

• Employer registers with HMRC: Businesses must sign up to payroll benefits before the start of the tax year.
• Tax collected via payroll: The BIK value of the work vehicle is calculated and added to employees’ taxable income each pay period.
• Simplified compliance: There’s no need to submit separate P11D forms for payrolled cars, making administration easier and more transparent.

HMRC encourages payrolling because it gives employees more immediate visibility of their tax deductions and reduces end-of-year adjustments.

Tax treatment of payrolled cars

The tax on a payrolled company car is based on Benefit-in-Kind (BIK) rates, which take into account the vehicle’s list price and CO₂ emissions:

• Petrol and diesel cars: Higher BIK rates due to higher emissions.
• Hybrids: Lower rates than traditional petrol/diesel vehicles.
• Electric vehicles (EVs): Ultra-low BIK rates — just 2% in 2025/26 — making them highly tax-efficient for both employers and employees.

Employers also pay Class 1A NICs on the car’s BIK value, but EV fleets often reduce this liability.

Car allowance vs payrolled company cars, pros and cons for employers

Aspect	Car allowance	Payrolled company car
Administration	Simple. No fleet management required	Requires fleet sourcing, but less paperwork than P11D.
Tax treatment	Treated as salary (PAYE/NIC).	BIK tax depends on vehicle type and emissions.
Employee choice	High. Employees pick their own vehicle.	Limited to employer-provided vehicles.
Cost predictability	Fixed cash payments.	Variable depending on vehicle models and fuel.
Sustainability	No direct incentive for low-emission vehicles.	EVs offer significant tax savings.

How to choose the right option for your business

Choosing between a car allowance and a payrolled company car scheme depends on your organisation’s needs. But there are several things you should consider, including: 

• Workforce size: Large fleets may benefit from the tax advantages of payrolled EVs.
• Budget priorities: Smaller businesses often prefer allowances for predictable cash outlay.
• Employee expectations: Some roles expect a work vehicle as part of their benefits package.
• Sustainability goals: Businesses targeting net-zero emissions may favour EVs for lower BIK rates.

Simplify car benefits and payroll with Employment Hero

Managing car allowances, work cars and payroll compliance can be time consuming and challenging. But the good news is, it doesn’t have to be. With Employment Hero, you can bring everything together in one intelligent, compliant and automated platform. 

To learn more about car allowances and payrolling company cars, download our factsheet.