How should essential user allowances, paid to employees for using their own cars on business, be reported?

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Payments of mileage allowances are only reported for tax purposes on form P9D or P11D if the total of all mileage allowance payments made in the year exceed the statutory maximum for the vehicle (i.e. car, van, motorcycle or bicycle). If more than the maximum is paid, only the excess is reported. A similar procedure applies for Class 1 NICs, but the comparison between the payments made and the maximum must be made for each earnings period.

The maximum amount that may be paid without any tax liability is calculated, in the case of a car or a van, by multiplying the business mileage in the tax year by 40p for the first 10,000 miles, and by 25p for any mileage over 10,000 miles.

The question here is how essential user allowances should be handled in this context. It has been the longstanding practice of some employers, particularly local authorities and housing associations, to add such payments to gross pay in each pay period and deduct PAYE tax and NICs accordingly. This is not the correct way of taxing essential user allowances and, if they are taxed in this way, it raises complications when completing P9Ds or P11Ds and can mean that employees pay more tax and employers pay more NICs during the year than they should.

The P11D Working Sheet 6 refers simply to the total "mileage allowance payments" made during the tax year. This term is not defined and there is nothing on the P11D itself, in the P11D Guide or in the 480 Expenses and Benefits booklet that reminds employers that essential user allowances should be included in the total mileage allowance payments.

All is made clear elsewhere, however. The IR124 booklet, written for employees, refers to an allowance that "can be in the form of a lump sum or periodic payments". The 490 Employee Travel booklet describes "motoring expenses" as including "mileage allowances which are based on a set rate per mile, lump sums, business use car allowances and payments for fuel purchased for business use."

HMRC's online Employment Income Manual, at page EIM31210, gives as an example of a mileage allowance payment "a lump sum payment aimed at covering the business proportion only of the standing costs of the car - for example, we accept that the lump sum instalment payments for regular business drivers made at nationally agreed rates by many local authority and NHS employers are for this purpose."

Therefore, the intention is that an employee's tax liability under the mileage allowance rules should be determined at the year-end, not through the payroll. All the mileage payments made to the employee during the tax year, including essential user allowances, should be totalled and, if the total is less than the statutory maximum for the year, there is nothing to report on form P11D at all. If the total payments for the year exceed the statutory maximum, only the excess is reported.

All is not lost if essential user allowances have been taxed through the payroll. In section 1 of P11D Working Sheet 6, the amount from which tax has been deducted is entered as a "minus" amount in Box B, thereby reducing the total allowances for the year before they are compared with the statutory maximum amount. However, this may serve to demonstrate that the employee has paid tax on the essential user allowance unnecessarily through the payroll. The tax liability on all mileage allowance payments should only be determined at the year end.

Similarly, if all of the essential user allowances paid during the tax year have been handled through the payroll, it may well be that the employer, and possibly the employee, have overpaid Class 1 NICs. The procedures that should be followed in each earnings period are similar to but rather more complex than the tax calculation. Examples of the calculations in various situations are shown in Chapter 6 of the 490 Employee Travel booklet.

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