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Save tax on your company car

publication date: May 11, 2009
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Recent Budgets have resulted in tax increases, but it’s not all bad news, as some green measures actually offer opportunities to save tax. This has been the case for the past few years where business cars are concerned.

Businesses can claim 100 per cent tax relief on the cost of cars with very low CO2 emission ratings.
Businesses and employees pay tax and national insurance on the benefit of company cars by reference to the cars’ CO2 emission ratings.

From April 2009 it is proposed (at time of going to press) to extend the green incentive, so that the amount of tax relief on the cost of buying or hiring all business cars will depend on CO2 emission ratings. So, how much can a business and its employees actually save by choosing a car with a low CO2 emission rating, instead of a comparable higher-emission car?

We will compare two similarly priced 5-door hatchbacks: the Fiat Bravo 1.4 T-Jet 150 Active 1.4 (list price £13,700) and the Volkswagen Polo 1.4TDi BlueMotion 2 (list price £14,115). The petrol engined Fiat’s CO2 emission rating is 167g/km, but the diesel Volkswagen has a very low rating of 99g/km.
To simplify the calculations, we will focus on the Income Tax and National Insurance (NI) savings that are available to the self-employed (and partnerships) and their employees. Companies can make similar savings, at the appropriate Corporation Tax and NI rates.

Savings for businesses
In this section, we will assume that proprietors and partners pay income tax at 40 per cent, and NI on the top portion of their earnings at one per cent and that no private use is made of the business car.
The first tax consequence of buying a company car is that tax relief is available on the cost. This relief is given through capital allowances. For purchases on or after 6 April 2009, it is proposed that an annual 20 per cent writing down allowance (WDA) will be available for cars with a CO2 emission rating between 111 g/km and 160g/km. For cars with a CO2 emission rating over 160g/km, the annual WDA rate will be only 10 per cent. However, for cars with a low CO2 emission rating of 110g/km or less, there is a special 100 per cent first year allowance (FYA).
The WDA for our Fiat in the first tax year will therefore be £1,370 (£13,700 x 10 per cent). However, our low-emission Volkswagen qualifies for the special FYA (£14,115) – over ten times more than the Fiat. Of course, this is just – excuse the pun – an acceleration of tax relief, as the Fiat will attract further WDAs in future years. Nonetheless, the cash flow benefit in year one is very substantial – an extra income tax saving of £5,098 and an extra NI saving of £127 for our proprietor or partner.

Hire costs
Many businesses hire, rather than buy, their cars. Here, there is a tax deduction for the hire charges, which will also be linked to CO2 emission ratings. From April 2009, it is proposed that hire costs will be fully deductible where the CO2 emissions rating does not exceed 160g/km. For cars with a CO2 emission rating over 160g/km, there will be a 15 per cent restriction. Where VAT is concerned, if the car has private use, only 50 per cent is recoverable.
For comparison purposes we will assume a similar contract hire cost of £9,500 over three years (including an initial payment and 50 per cent of the VAT). The total tax and NI relief amounts to £3,310 for the Fiat, but £3,895 for the Volkswagen – a modest saving of £585 for one car, but more significant for even a small fleet.

National Insurance
Businesses pay NI on employees’ car and fuel benefit in kind charges, which are based on CO2 emission ratings. For 2009/10 the car benefit in kind charge for the Fiat is 21 per cent of list price, increasing to 22 per cent in 2010/11, giving a total charge of £8,905 for three years. The same percentages are applied to a fixed amount of £16,900 to arrive at the fuel benefit-in-kind charge. The total fuel charge for the Fiat for three years would be £10,985. The combined car and fuel benefit charge for the Fiat is therefore £19,890.
The applicable emissions-based percentage for the Volkswagen is just 13 per cent, giving a total car benefit charge of £5,505 and a total fuel benefit charge of £6,591 for the three years – overall £12,096.
At the current Employers’ NI rate of 12.8 per cent, the saving on the difference between the two cars of £7,794 would be £998, worth £589 to a proprietor/partner after tax and NI relief.

VAT fuel scale charge
Where fuel is provided for private use, the business must account for VAT on the value of the private fuel supplied, by way of a CO2 emission-based scale charge. The charge varies slightly, depending on whether the business chooses to account for the VAT monthly, quarterly or annually. We’ll use the more commonly used quarterly scale figures. For the Fiat, the quarterly charge is £43.19 per quarter (£518 over three years at the current rate), but for the Volkswagen it’s much lower: £20.55 per quarter (£247 over three years at the current rate), a saving of £271.

Vehicle excise duty costs
The road tax, or VED, is also now based on CO2 emission ratings. Once again, this is a straightforward calculation: the Fiat falls into Band E, with an annual charge of £170, whilst the Volkswagen falls into Band A, for which there is no charge! At current levels, there is therefore a total saving of £510 over three years for the VW. The net saving after tax and NI relief is £301.

Savings for employees
We must emphasise that we are not looking at whether it is tax-efficient for an employee to use a company car (as opposed, for example, to claiming the costs of using a privately-owned car for business travel). That is a different question, and in this article we simply assume that it has been decided to buy or hire a company car, make it available for an employee’s private use and also provide fuel for private travel.
We will also assume that the employee pays Income Tax at 40 per cent and NI on the top portion of earnings at one per cent.

Benefit in kind charges
Employees pay both income tax and national insurance on car and fuel benefits in kind. As we’ve seen earlier, the difference in the combined car and fuel benefit charge for a 3-year period is £7,794. An employee who chose the Volkswagen would therefore enjoy a very substantial income tax saving of £3,118 and a national insurance saving of £78.

Significant savings can be achieved simply by keeping an eye on CO2 emission ratings when choosing a car. Businesses should therefore choose company cars very carefully – and where employees are given a choice of car, they should be made aware that their tax bill will be directly related to the CO2 emission rating.

One thing to watch is that the emissions limit for 100 per cent capital allowances purposes is 110g/km, but the limit to qualify for the lowest benefit in kind charges is 120g/km, so a car within the lower limit should be chosen for both the company and the employee. It should also be noted that these limits are subject to change – the 110g/km limit for 100 per cent capital allowances purposes was 120g/km before 1 April 2008.

Our example was based on a simple choice between low-emission and higher-emission cars, but even greater savings could be achieved by considering electric, gas, bi-fuel and hybrid cars.

Looking further ahead, other motoring charges could become emission-based in future. The proposal to make the London congestion charge emission-based has been dropped, but road pricing is another hot topic. The trend towards emission-based charges may well be followed.

Paul Howard is a Tax Director of BDO Stoy Hayward LLP, Chartered Accountants.