How to set a car allowance policy

Before you start

Legal basis. The tax definition of earnings [2], the 2026/27 rates [3], the company car rules [4][5], the optional remuneration rules [6][7][8] and the approved mileage rates [9].

Who to involve. Reward, finance, payroll, whoever manages the fleet, and a tax adviser.

What you need. Who has a car or an allowance now and why, business mileage records, fleet costs, and the contract wording for each group.

Step 1: Decide what the policy is for

Car provision usually answers one of two needs: a job that involves a lot of driving, or a grade at which a car is part of the package.

In the lumi reward benchmark (n = 233; more than one answer allowed), 91.4% use business need as a criterion for a business need company car and 55.4% use role level. 34.9% provide company cars as a status or grade-based benefit, an alternative answer; 65.1% do not, the common answer (n = 261) (full findings).

Step 2: Choose cash, a company car or a choice

In the lumi reward benchmark, 46.1% of organisations offer a car allowance, the allowance offered most often (n = 267; more than one answer allowed). On choice, 26.1% let employees choose between a status-based company car and a cash allowance (alternative) and 73.9% do not (common) (n = 264).

The tax treatment differs:

• Cash allowance. Earnings under section 62 of ITEPA 2003 [2]. Operate PAYE and Class 1 National Insurance through payroll, at 15% for the employer above the secondary threshold of £417 a month [3].
• Company car. A car available for private use is reported on form P11D, with Class 1A National Insurance on the car benefit [4]. From April 2027, company cars and car fuel must be taxed through payroll instead [10].

Step 3: Set the amount

The lumi benchmark records whether an allowance is offered, not its amount, so it gives no average. Set the figure from what the allowance replaces: the cost of the car you would otherwise provide, or the cost to the employee of running one.

Worked example (all values illustrative). A £6,000 cash allowance against two company cars, for a basic-rate taxpayer earning between the National Insurance thresholds, with 2026/27 rates [3][5].

EMPLOYER_NIC, CLASS_1A, BASIC_TAX, EMPLOYEE_NIC = 0.15, 0.15, 0.20, 0.08
allowance = 6_000                                  # illustrative
cars = {"electric, 0 g/km": (40_000, 0.04),        # list price illustrative
        "petrol, 100-104 g/km": (30_000, 0.26)}
print(allowance * EMPLOYER_NIC, allowance * (1 - BASIC_TAX - EMPLOYEE_NIC))
for name, (price, pct) in cars.items():
    bik = price * pct
    print(name, bik, bik * CLASS_1A, bik * BASIC_TAX)

The car figures leave out the lease and running costs, which you pay.

In the lumi benchmark, "some allowances only" is the common answer on whether allowances differ by role level, at 45.1%. "No" (34.8%) and "Yes" (20.1%) are alternatives (n = 244). The question covers all allowances, not only car allowances.

Step 4: If you offer a choice, check the optional remuneration rules

Where an employee agrees to take a benefit instead of earnings, the benefit is taxed on the greater of the cash given up and its normal benefit value [6][8]. Those rules do not apply to cars with CO2 emissions of 75 g/km or less, which are taxed on the benefit value alone [7].

Worked example (illustrative). Using the cars in Step 3.

Where cash is offered, a high-emission car can cost the employee more tax than the car alone would.

Step 5: Set business mileage rates

Business travel in an employee's own car can be repaid tax-free up to the approved amount: 55p a mile for the first 10,000 business miles in a tax year and 25p after that [9]. For National Insurance, the approved rate is 55p for every business mile [3].

• Paying more. Add the excess to pay and deduct tax as normal; it also goes on the P11D [9].
• Paying less. Nothing to report. The employee can claim Mileage Allowance Relief on the difference [9].

Worked example. An employee drives 12,000 business miles in their own car.

first, after, band, miles = 0.55, 0.25, 10_000, 12_000
approved = min(miles, band) * first + max(0, miles - band) * after
print(approved, approved - miles * 0.30, miles * 0.60 - approved)

The approved amount is £6,000.00. Paid at 30p a mile (£3,600), the employee can claim relief on £2,400.00. Paid at 60p a mile (£7,200), £1,200.00 is taxable.

A flat car allowance stays earnings, whatever it is meant to cover [2]. Business mileage is paid per mile, on top.

Step 6: Set rules on emissions

In the lumi benchmark, 29.4% of organisations mandate or prioritise low-emission or electric vehicles for company cars (alternative); 70.6% do not (common) (n = 262).

For 2026/27, a zero-emission car's taxable value is 4% of its list price; the most a car can be charged is 37% [5].

Step 7: Decide whether the allowance is consolidated

In the lumi benchmark, "Never" is the common answer on consolidating allowances into base pay, at 49.6%. "Sometimes" is an alternative, at 40.5%, and "Always" is rare, at 9.9% (n = 262). The question covers all allowances.

Part-time employees must not be treated less favourably than comparable full-timers unless that is objectively justified, and the pro rata principle applies unless inappropriate [11]. Record how part-time staff are treated, and why.

Step 8: Write it down and review it

Set out who qualifies, the amount, mileage rates, emissions rules, whether the allowance is contractual and what happens on a change of role.

In the lumi benchmark, 39.6% of organisations review allowances regularly as part of reward governance (common), 34.8% ad hoc and 25.6% not at all (both alternatives) (n = 250). A flat cash sum does not move with pay awards unless someone reviews it.

Changing a contractual allowance needs agreement. Fire-and-rehire protections start in January 2027 [12].

Checklist

• Purpose agreed: business need, grade or both
• Eligibility test written, with the mileage records it needs
• Cash, company car or a choice decided
• Amount set from the cost it replaces, and costed with National Insurance
• Optional remuneration rules checked for any car-or-cash choice
• Mileage rates set against the approved amounts
• Emissions rules set
• Consolidation, pension and part-time treatment decided
• Payroll ready for company cars from April 2027
• Policy issued and a review date set

Related

• Allowances, company cars and benefits: UK benchmark 2026 — the benchmark findings behind the figures in this guide.
• How to prepare your pension salary sacrifice scheme for the 2029 NIC cap
• How to run an annual pay review: process and governance
• How lumi works: methodology — how these figures are collected and calculated.