A cash car allowance is taxed as ordinary pay: the employee pays income tax and Class 1 National Insurance on every pound, and the employer pays 15% employer National Insurance on it. A company car is taxed as a benefit in kind instead, on the list price multiplied by a CO2 based percentage, with employer Class 1A National Insurance at 15% and no employee National Insurance. For 2026 to 2027 a zero emission car is taxed at just 4% of list price, which is why electric company cars usually beat a cash allowance on tax.

How is a cash car allowance taxed?

A fixed monthly allowance paid because an employee does not have a company car is earnings. HMRC’s Employment Income Manual at EIM31215 says a payment made to compensate an employee for not having a company car, or a fixed monthly amount not calculated on the basis of business mileage, is not a mileage allowance payment and must go through PAYE in the normal way. The nature of the payment is fixed when it is made, so part of it cannot later be reclassified as expenses.

That means the allowance goes through payroll like salary:

  • income tax at the employee’s marginal rate, which for 2026 to 2027 in England, Wales and Northern Ireland is 20% up to £50,270 and 40% above it;
  • employee Class 1 National Insurance at 8% between the primary threshold and the upper earnings limit, and 2% above it;
  • employer Class 1 National Insurance at 15% on earnings above the secondary threshold of £5,000 a year.

The employee then buys or leases their own car and pays all the running costs. Where they use it for work, the employer can pay mileage allowance payments for business journeys, which are tax free up to the approved amount. For 2026 to 2027 that is 55p a mile for the first 10,000 business miles and 25p after that. If the employer pays less than the approved amount, the employee can claim Mileage Allowance Relief on the shortfall. Our page on approved mileage allowance payments covers that relief in detail.

Can any of the allowance escape National Insurance?

Possibly. The National Insurance rules are separate from the tax rules. Regulation 22A of the Social Security (Contributions) Regulations 2001 lets an employer disregard “relevant motoring expenditure” up to a qualifying amount, worked out as all business miles multiplied by the approved rate, which is 55p a mile for cars from 6 April 2026. GOV.UK says relevant motoring expenditure includes any other cash payments an employer makes towards the use of the employee’s vehicle. HMRC’s example at NIM05842 shows a £200 monthly lump sum and a mileage rate added together, with only the excess over the qualifying amount subject to Class 1 National Insurance, but only where HMRC accepts the lump sum is relevant motoring expenditure. An allowance that bears no relation to business use of the employee’s car is unlikely to qualify, and NIM05802 confirms the disregard is switched off entirely where the payment is made through a salary sacrifice arrangement.

How is a company car taxed?

Under section 121 of the Income Tax (Earnings and Pensions) Act 2003, the taxable benefit starts with the car’s list price plus accessories, less any capital contribution by the employee, multiplied by the appropriate percentage. Section 139 sets the percentage by CO2 emissions. For 2026 to 2027 a car with zero emissions is 4%. A car emitting 75g/km or more is 21% plus one percentage point for every 5g/km above 75, capped at 37%. Diesel cars can carry a supplement under section 141.

The employee pays income tax on the benefit, usually through a tax code adjustment or by payrolling the benefit. There is no employee National Insurance on a car benefit. The employer pays Class 1A National Insurance at 15% on the benefit value for 2026 to 2027, reported after the tax year. Private fuel paid for by the employer is a separate charge, covered in our page on the car fuel benefit charge. GOV.UK confirms that electricity is not a fuel for car fuel benefit purposes.

What changes with an electric car?

Electric cars change the comparison in three ways.

  • The benefit is small. At 4% of list price in 2026 to 2027, a £40,000 electric car produces a benefit of £1,600, compared with £12,000 for a £40,000 petrol car emitting 120g/km (30%).
  • Business mileage can be reimbursed cheaply. HMRC’s advisory electricity rates from 1 September 2026 are 7p a mile for home charging and 15p for public charging, for reimbursing business journeys in a company electric car.
  • The employer gets a full write off. A new and unused car with zero CO2 emissions qualifies for 100% first year allowances, according to GOV.UK’s capital allowances guidance. A second hand electric car goes into the main rate pool, at 14% a year from April 2026.

Plug in hybrids are more complicated. Their percentage depends on electric range as well as CO2, and GOV.UK explains a special 1g/km rule for some cars registered between 1 January 2025 and 5 April 2028.

What if the employee is offered a choice?

Many employers offer a car or a cash alternative. Section 69A ITEPA 2003 treats a benefit taken instead of an amount of earnings as provided under optional remuneration arrangements (a type B arrangement). For most benefits the taxable value then becomes the higher of the cash given up and the normal benefit in kind value. GOV.UK’s salary sacrifice guidance makes an exception for cars with CO2 emissions of no more than 75g/km, which always use the normal benefit in kind value. So offering an electric car with a cash alternative still leaves the employee taxed at 4% of list price, but offering a petrol car with a cash alternative may tax them on the cash they gave up if that is higher. See our page on salary sacrifice schemes for how these arrangements are set up.

How do the numbers compare?

Illustration only. An employer either pays a higher rate taxpayer an allowance of £6,000 a year or provides an electric company car with a list price of £40,000. The employee’s other pay is already above £50,270.

Item Cash allowance Electric company car
Taxable amount £6,000 £1,600 (4% of £40,000)
Employee income tax at 40% £2,400 £640
Employee National Insurance at 2% £120 Nil
Employer National Insurance at 15% £900 (Class 1) £240 (Class 1A)

With the allowance, the employee keeps £3,480 after tax and must fund a car out of it. With the company car, the employee pays £640 of tax and the employer bears the lease or purchase, insurance and maintenance. The real comparison is therefore the employer’s full cost of providing the car against the allowance plus employer National Insurance, and the employee’s tax on the benefit against what they would spend running their own car out of taxed income.

What does the employer need to consider?

  • Corporation tax. An allowance is a salary cost. A bought car attracts capital allowances, and lease costs are a revenue expense subject to the rules for cars.
  • VAT. Input VAT on buying a car with private use is normally blocked, and lease rentals have their own restriction. Our page on VAT on cars, vans and fuel explains this.
  • Administration. Company cars need list price records, benefit reporting or payrolling, and Class 1A payment. GOV.UK tells employers to keep a record of the car’s list price because it is needed to value the benefit.
  • Risk and duty of care. A fleet brings insurance, maintenance and driver checks. An allowance moves those to the employee, though employers still have duties where staff drive their own cars for work.

What mistakes come up most often?

  • Treating part of a flat allowance as tax free business mileage. EIM31215 says a fixed amount not calculated by reference to business mileage is earnings in full.
  • Paying no mileage alongside an allowance and forgetting that the employee can claim Mileage Allowance Relief on business miles.
  • Applying the National Insurance disregard to an allowance through salary sacrifice, where NIM05802 says it does not apply.
  • Offering a petrol or high emission car with a cash alternative without checking the optional remuneration rules.
  • Using the wrong appropriate percentage. The table in section 139 changes most years, so check the percentage for the year the car is available.

For the full rules on the car benefit itself, see our guide to company car tax.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.