When you're looking at ways to reward staff or support day-to-day operations, company cars often come into the conversation. But before handing over the keys, it's essential to understand the rules, responsibilities, and tax implications around this company benefit. In this guide, we explore the question, 'How does a company car work?' covering all the information you'll need to help you make an informed decision that is the most tax-efficient for your business. 

So, how do company cars work?

Put simply, a company car is a vehicle that's provided by a business for an employee to use. It's often part of a benefits package and may be used for business purposes, personal journeys, or both. The key thing to understand is that when personal use is allowed, the car becomes a benefit in kind (BIK) and that has tax consequences.

From a company perspective, your business has the option to buy or lease the vehicle, and will typically cover insurance, maintenance, and other running costs. For the employee driving it, the biggest thing to consider is their personal tax obligations.

How does a company car work in terms of tax?

When an employee is allowed to use a company car for personal journeys (even just the commute), HMRC considers it a taxable benefit. This means the employee will pay tax on it, and the employer may also face extra National Insurance contributions.

The tax amount is based on several factors:

• The car's value (P11D value), including VAT and any delivery charges but excluding road tax and the first registration fee
• The CO2 emissions (the more polluting the car, the higher the tax)
• Fuel type, with electric and hybrid vehicles usually seeing lower tax rates.

If your company also pays for some or all of the fuel used privately, this is considered an additional taxable benefit.

So, while offering a high-spec petrol car might sound generous, it could end up being less tax-efficient for both parties than a modest electric car, for example.

What are the benefits of company cars for employers?

As a business, offering a company car can help with your recruitment, improve staff satisfaction, and provide practical transport for work duties. It's also a cost that can be offset against profits as long as it's structured properly.

You may be able to reclaim VAT on certain vehicles (particularly vans or electric cars used solely for business), and lease payments can often be deducted from your taxable profits. But it's important to distinguish between business and personal use when claiming.

What are the employee's responsibilities?

Your employees will need to keep track of how their company car is used, specifically distinguishing between business and personal mileage, as you will need this information for accounting.

Other typical responsibilities include:

• Keeping the vehicle in good condition.
• Reporting any damage or faults.
• Pay tax on this benefit via PAYE (usually adjusted in their tax code).

If fuel is included in their package, it becomes even more vital that your employees keep accurate records of fuel use and mileage, especially to avoid overpaying on benefit-in-kind tax.

Are company cars still worth it?

As a business owner, this is the big question that you will need to weigh up. The answer is not straightforward; it depends on your unique situation.

For example, if your team regularly drives for work, or you want to offer a competitive package to attract talent, it might make sense. On the other hand, if you are offering the perk of a company car just for occasional or personal use, the tax implications might outweigh the benefits.

It also depends on the type of car you choose. Environmentally friendly vehicles, such as electric cars, are currently the most tax-efficient. Despite the increase in the BIK tax rate for fully electric vehicles from 2% to 3% in April 2025, the tax payable is still significantly lower than that on traditional petrol or diesel models.

If you have been wondering how company cars work when it comes to tax and expenses, you're not alone. The rules can feel a bit complex at first, but with the right advice, they're manageable.

Before making a decision, it's worth seeking some professional tax advice. At Keith Graham Chartered Accountants, our experienced advisers can help you ensure your choice is the most tax-efficient for your business while complying with all the necessary obligations.

If you have any further questions about how a company car can benefit your business, please get in touch with our team, and we'll be happy to help.