How Does Company Tax Work?

After tireless days and nights of overtime and taking on new projects, you've finally done it. You've bagged that promotion. And what comes with great power? Great responsibility? Yes, that, but what else? Did somebody say a brand new company car?

Payday rolls round and you open your payslip. Where has that extra £200 in tax come from? It's not from your salary bump. It must be the company car. Did you think you could enjoy it with no strings attached? Of course you didn't. Good old HM Revenue and Customs was always going to make sure of that.

HMRC is trying to create a level playing field, making sure that there are no loopholes for tax dodgers. Company cars are classed as a benefit in kind, a perk of the job outside of your ordinary salary. Like your monthly pay packet, the taxman is going to claim a big chunk back. This is called benefit in kind tax. The amount of company car tax (or benefit in kind tax) you owe is fairly straightforward to calculate if you know what you're doing.

We all want to make sure that we're not being shortchanged so it's good to know how these levels of tax are calculated. In this article, we're going to lay out plain and simply how company car tax works.

Company Tax

Company car tax explained

When you're given a company car that's for private use as well as for day-to-day business, you're expected to cough up for it. The tax you pay is calculated differently than your income tax and National Insurance contributions. 

To manually calculate how much tax you owe HMRC, you'll need to arm yourself with a few figures (or you can cheat using the tax calculator for this tax year on Gov.uk website). You'll need:

  • The P11D value of your car.
  • The CO2 emission tax band (company car tax bands) percentage for your car.
  • Your personal tax rate.

We're not about spewing out jargon here at LeaseFetcher so we'll talk you through what these terms mean. We'll also mention a few other things to keep in mind too which could affect how much you owe.

For now, the standard calculation for working out your company car tax is:

P11D value x CO2 emission tax band percentage x personal tax rate = amount of annual company car tax.

P11D value

Step number one in your company car tax calculation: work out what your P11D value is. Actually, that's step number two. Step number one is working out what a P11D value even is.

Every year, your employer has to fill out a P11D form for HMRC. On this form, they'll outline all of your personal expenses and benefits. If one of your benefits is a company car, the form will note the "list price" of your car. The "list price" is the cost of your car as new, and is also known as your car's P11D value.

The amount of tax you pay is a percentage of your car's list price. Your car's P11D value takes into account the cost of the new model as well as any optional extras you've thrown into the mix. It doesn't include non-taxable things like the first year's vehicle excise duty (road tax) and the first registration fee.

Only the P11D value quoted by the manufacturer is taken into account. So, even if your company scooped up a hefty discount on the new car's list price, the P11D value will not change.

And even after you've had your company car for a few years, the P11D value will still not change. It always refers to the original price of the car, never accounting for depreciation. Unfortunately, no matter how long you've had the car, the amount of tax you pay will not decrease.

We said we'd lay things out plain and simply, so we're going to kick off a working example here. Based on a BMW 3 Series Saloon, valued at £31,460 with no added extras, our calculation looks like this (so far):

  • £31,460 x CO2 emissions tax band x income tax bracket = ?

CO2 emissions tax bands

The government is cracking down on car emissions so the amount of toxic fumes your car puffs out is taken into account in your tax calculation. Your chosen fuel type and carbon dioxide emissions in g/km are important here.

There are 21 emission bands which track how much your car emits, starting with 0-50g/km of CO2 up to 180g+/km. The more CO2 emissions your car produces per km, the higher your BIK tax. Every year, these CO2 bands are revised, but it won't be in your favour. The tax percentages are likely to increase over time, so you best be looking into eco-friendly alternatives!

The stats for 2019/20 begin at 16% and rise up to 37%.

The type of fuel your car guzzles impacts the percentage you'll be charged for CO2 emissions. Since the government has essentially declared war on diesel cars, they've introduced disincentives to get you to steer clear of diesel models. As of April 2018, all diesel cars have a 4% surcharge chucked on top of the standard CO2 emission tax percentage, even if they emit the same CO2 levels as a petrol car. The only exception to this is if you have a diesel car which meets Real Driving Emissions Stage 2 (RDE2) standards - and no cars on the market today do.

It used to be the case that electric vehicles weren't charged for emissions (because they don't produce any...) but now they are. HMRC have chucked an extra zero emissions band in their tax rate table, charging 16% tax on electrified vehicles. There are plans to bring this percentage down again in the near future though, so don't give up on EVs just yet.

If you're looking to reduce the amount of tax payable on your company car, consider your car's fuel type carefully, opting for a plug-in hybrid or a fully electric car.

Let's go back to our working example calculation. A BMW 3 Series Saloon on average emits 120g/km. This is marked as 28% normally, but with the diesel engine, it's 32%:

  • £31,460 x 32% x income tax bracket = ?

Income tax bracket

Third in line is the income tax bracket you fall under. In Scotland, as of February 2019, the following income tax bands were set:

  • £12,500-14,549 = 19%
  • £14,549-24,944 = 20%
  • £24,944-43,430 = 21%
  • £43,430-150,000 = 41%
  • Above £150,000 = 46%

To round off our working example, we're going to pretend you earn £30,000 a year. Our calculation will look like this now:

  • (£31,460 x 32%) = £10,067.20 x 21% = £2,114.11 per year.

Every year, you'll have to fork out £2,114.11 in tax for your company car, so each month you'll see £176.18 shaved off your final monthly takeaway figure. 

Other influences on company car tax calculations

Now we've nailed the standard, no-frills company car tax calculation, we're going to turn our attention to some other factors which influence how much you'll be expected to fork out.

How often you use the car, whether you take a cut in your salary to cover it, or if your company pays your fuel, will all alter how much you need to turn out your pockets.

Car usage

The amount of time you have access to the car will impact how much BIK tax you owe. If you use the car full-time, for business and pleasure, then you're expected to cough up the full amount of tax you'll calculate using our formula. But if you only have part-time access, the amount of BIK tax you're liable to pay for will be reduced. To check out exactly how much, you can use the HMRC calculator.

Even if you have full-time access to the car, if for any reason you don't have access to it for 30 consecutive days, like if it's undergoing repairs and you're not given a replacement, your BIK tax will be reduced to reflect the amount of time you have use of it.

Cash alternative or car salary sacrifice

Some companies operate systems which mean you can get a cash alternative to a company car or you sacrifice a portion of your salary to cover the cost of the vehicle. HMRC are cracking the whip to stop people from abusing this system to pocket some extra cash. They changed the tax rules for these instances in 2017.

Previously, if you chose a company car over a cash alternative, you were taxed on the BIK value of the car. Nowadays, you're either taxed on the BIK value of the car or the value of the cash alternative, depending on which is the most. So, if you picked out a car with a low P11D value and low CO2 emissions, you might not reap the benefits of a reduced tax bill because you'll end up paying income tax on the higher cash alternative.

For example, if your company car was a Ford Fiesta with a diesel engine, costing £15,420 brand new, emitting 110g/km, and you're on a £25,000 salary, you'd be expected to pay:

£15,420 x 30% = £4,626 x 21% = £971.46.

If you were offered a cash alternative of £1,500, then you'd be taxed on this alternative, not the BIK tax.

If you choose the salary sacrifice route, it's a similar story. You're charged tax on whatever value is highest - the cut in your salary or the BIK value.

Car fuel benefit tax 

If your company says to you, "We'd like to pay for your fuel costs too, both for work and leisure. Does that sound good to you?", you'll probably start grinning from ear to ear. Free fuel? Who could pass that up? But we suggest that you don't jump at the opportunity straight away. It sounds like a great deal, but it might not end up working in your favour.

HMRC also charge fuel tax for company cars. If your company pays for your fuel, you'll be lumped with a tax charge on it. In some cases, you might even pay more tax than what the fuel itself would cost - see why we said to hold off a little?

To work out how much your yearly fuel benefit tax is, multiply HMRC's standard fuel benefit figure by your CO2 emission % by your income tax rate. HMRC's fuel benefit figure is set at £23,400 across the board.

In the UK, the average number of miles driven per year is around 7,150. If we look at the example of the diesel engine BMW 3 Series with 56.5mpg, the annual fuel costs (using a helpful online calculator) comes to £772.63.

If we were to use this car example based on you paying 21% income tax to work out your fuel benefit tax, you'd be looking at this:

(£23,400 x 32%) x 21% = £1,572.48.

So, in this case, it looks like you'd be better off paying for the fuel yourself! If you drive extensively, then it might be worth your while, but if you're tend towards this average annual mileage, then it's likely not.

Company car tax explained

Best company cars for tax purposes

Now you've come this far, you might be wondering what car will get you the best bang for your buck. You don't want a flashy company car if you're going to be shelling out a fortune on benefit in kind tax every month.

Well, it goes without saying that electric cars will be down there with some of the lowest rates of company car tax. With zero emissions, they're in the lowest bracket for CO2 emissions tax bands. Some of them can be quite pricey to purchase outright, but you can get cars like the Nissan Leaf, the Kia e-Niro and the Hyundai Ioniq EV for under £30,000.

If you're interested in a happy medium between electric and ICE, then the low emission Toyota Prius petrol hybrid is a winner. With a P11D value of just under £24,000 and a BIK rate of 22%, it's a great option.

And if you're not ready to jump into the world of electrification just yet, the good old petrol Ford Focus comes in at just under £20,000 and a BIK rate of 25%.

Armed with all this information, you can push your company to get a fiery car that doesn't break the bank (your bank). Check out our business leasing guide to see if a business contract hire deal would suit you.