A company car allowance is a fixed sum paid with salary instead of a company car, and it works the way salary works: it is taxed at the driver's marginal rate, employee National Insurance comes off it, and the employer pays National Insurance on top. The driver then buys or leases their own car, insures and runs it, and claims business miles in it at the approved mileage rate, tax free up to the approved amount. This page answers the question in four parts: what the allowance is, how it is taxed, what the driver can still claim, and how to compare it with taking the car, with the allowance worksheet on this site setting the two against each other for your own figures.
What the allowance is
Cash, usually monthly with salary, in an amount the employer sets by grade or role. It carries no conditions in tax law about what it is spent on, though the employer's policy usually requires a car of a certain age or standard for business use. It is not a benefit in kind, it does not appear on a P11D, and it does not use the company car rules at all.
How it is taxed
As pay. Income tax at the driver's marginal rate, employee National Insurance at the rate that applies to that slice of earnings, and employer National Insurance on top, all through payroll. A higher-rate driver keeps a little over half of the allowance after tax and National Insurance, and that is the figure to set against the car, not the headline sum.
What the driver still claims
Business miles in their own car at the approved mileage allowance, 55p a mile for the first 10,000 business miles in the tax year and 25p after, tax free from the employer up to that amount, with mileage allowance relief on any shortfall. The allowance and the mileage are independent: a driver receives both, and the allowance does not reduce the approved amount.
Comparing it with the car
Allowance after tax and National Insurance, less what the driver would spend running a comparable car, against the income tax on the company car's benefit in kind. A low-percentage car, electric especially, usually beats the allowance for a higher-rate driver; a high-percentage car usually loses to it. For the employer, the allowance costs the cash plus Class 1 National Insurance, the car costs its lease or depreciation plus Class 1A on the benefit.
Questions people ask about how does company car allowance work
Is a car allowance pensionable?
That depends on the employer's scheme rules; many schemes exclude it. It is not a tax question and the sheet cannot know the answer.
Can I take the allowance and still drive a company pool car for work?
Yes, provided the pool car is not available for private use; the allowance is unaffected.
Does the allowance affect my mileage rate?
No. Business miles in your own car earn the approved rate whether or not you receive an allowance.