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Company cars have traditionally been seen as much as a perk for senior employees and directors as essential for business use. For those who do not spend their working days travelling up and down the M1 to attend meetings at far-flung offices, a company car has long been the ultimate status symbol – a sign that you had arrived.

Further, the company car is often used as a way of boosting an employee’s remuneration package, by reducing the amount of tax paid by both essential business users and status car drivers. Instead of an increase in salary, which would be subject to extra tax at the higher rate, a company car is a perk, saving business executives considerable sums of money.

But, since the introduction of the benefit in kind tax rules in April 2002, company cars are increasingly becoming more of a burden on both employers and employees than a perk. These rules are designed to encourage drivers to be more environmentally friendly when choosing their company cars.

Under the old rules, Britain’s two million company car drivers were taxed according to the miles they drove each year in the course of their business. So those who drove fewer than 3,500 miles a year, for example, had a taxable benefit charge of 35 per cent of the new car’s price. Those who drove more were given tax concessions, reducing the taxes to 25 per cent for those who covered more than 2,500 miles annually. Executives who did a lot more mileage – say more than 18,000 miles – paid less because they were taxed at 15 per cent.

While the old system was simple, it encouraged high mileage, which goes against the Labour government’s environmental principles. The change in rules was intended to put an end to the pointless high-mileage journeys made around March, as company car drivers attempted to edge above the 18,000-mile threshold before the end of the fiscal year in order to reduce their tax bill.

The benefit in kind liability is still worked out as a proportion of the car’s list price. But the percentage – ranging from 15 per cent to 35 per cent – is now based on the car’s dioxide emissions rather than the mileage covered. The rules were further tightened by chancellor Gordon Brown in his April 2003 budget, with the CO2 bandings reduced by 10g/km, forcing millions of drivers into a higher tax bracket.

This change can be significant. The driver of a four-door Audi A4 1.8T SE with emissions of 199g/km, for example, would have paid tax on 21 per cent of the list price in 2002. But in 2003, this increased to 23 per cent of the list price, meaning a bill of £1,818, an increase of £158, for higher-rate taxpayers.

Since the emissions-based regime was introduced, many employees have re-thought their company car, opting for a more fuel and tax efficient vehicle. But with the tightening of the bandings in 2003 and expected further tightening in 2004, employers and employees are questioning whether it is still efficient to run a company car, and whether it is still beneficial to take one as part of the remuneration package. Although company cars have never been cheap, the benefit in kind rules make them even more expensive.

However, for many employees who rely on them for their daily work, company cars are essential and scrapping them would be difficult. As if to prove this point, far from company-car usage decreasing, it has actually risen since the new rules were introduced. A report, Company Cars: The Driver Perspective, published in April 2003 for Bank of Scotland Business Banking, revealed a rise in business mileage of around 10 per cent on the previous year’s survey – the first year after the emissions-based regime was introduced. The report also found that more drivers are spending longer behind the wheel.

The report, published by Godfrey Davis Contract Hire, the business-to-business division of Bank of Scotland Vehicle Management, records the views of 700 company-car drivers. Some 93 per cent of those surveyed said they were aware of the emissions-based company-car tax regime – suggesting that despite exten-sive publicity, the government’s message has still to reach 7 per cent of drivers. However, only 70 per cent of these drivers were aware of the actual amount they pay, with drivers aged between 21 and 30 less clued up than their older colleagues.

To calculate what tax liabilities a company car will incur requires finding out the CO2 figure in g/km. A company’s fleet manager should be able to provide that, but it is also on the registration document and is listed at the Society of Motor Manufacturers & Traders’ website (www.smmt.co.uk ). The Vehicle Certification Agency (www.vca.gov.uk) has also produced a booklet giving the information needed.

Although these guides are useful, they are just rough estimates; each new car is tested individually and carries a unique emissions rating on its registration document. The classification can be affected by extras such as air-conditioning and satellite navigation, although most manufacturers will be able to assess the impact of upgrades.

The company car park is where the impact of the changes is most apparent. Gone are the gas-guzzling thirsty motors as drivers opt for smaller-engined cars and turbo-diesel over petrol in an effort to cut their tax bills. Prior to the change, 37 per cent of drivers said tax was an influence on their choice of car; this has increased to 70 per cent. And the proportion of vehicles over 2-litres has fallen by one-third, from 12 per cent to 8 per cent from a year ago, while the penetration of diesel cars rose from 36 per cent to 41 per cent. The number of company cars with automatic transmission also fell from 13 per cent to 8 per cent.

“For many models, exchanging a petrol for a diesel model or an auto for a manual will immediately drop them down three, four or even five bands on the scale charge, saving many hundreds of pounds in tax,” says Nigel Underdown, head of customer relationships of Bank of Scotland Vehicle Management.

Finance directors who are tempted to recommend that the company car perk be scrapped should think carefully before they do so. The bank’s report puts the company car as third in the list of ‘most-valued’ company perks, behind pensions and profit sharing/bonus schemes. But among drivers aged 21 to 30 and with female drivers, it is the second most valued perk.  

The financial benefits associated with having a company car – not needing to buy your own vehicle or worry about tax, insurance, maintenance, etc – have increased in importance, while emotional factors, such as position and status have eroded in significance.

For executives wanting to stick with a company car, the easiest way to reduce the tax burden is to downsize. Employees should think about a Peugeot 206 or Mini Cooper instead of a 4.3 litre Mercedes. But watch out for optional extras, which load the rating. And companies may find they have difficulty convincing their salesmen to drive a small car on a long journey.

Yet savings can be made by switching from petrol to turbo-diesel or opting for a manual rather than an automatic. And sports cars do not have to be ruled out: the super light Lotus Elise squeezes into the lowest tax band – although it means doing without carpets, electric windows and central-locking. And for drivers over six-foot tall, it may not be the most comfortable vehicle on a long journey.

If running a company-car fleet still seems a bit pricey, it may be worth exploring other options, such as a straightforward cash alternative that employees can use to buy their own vehicle, personal leasing agreements or registering the company’s vehicles as pool cars. All these deals carry the advantage that the car cannot be taxed as a company vehicle.

Melanie Bien is personal finance editor of the Independent on Sunday. She began her career on The European, covering European investment and personal finance issues, then became sports business editor of Sporting Life. She has written for The Times Weekend Money section, the City pages of the Independent on Sunday and Financial Adviser, plus FT Mandate. She was deputy editor of Resident Abroad before her current appointment.

(This article was originally published in Director of Finance 2004 edition)