Capital Contributions on Company Cars
How company owners can make big tax savings
COMPANY owners can save tax by making capital contributions towards their company cars.
What exactly is a capital contribution? According to the legislation (ITEPA 2003 s132), it is when “the employee contributes a capital sum to expenditure on the provision of a) the car or b) any qualifying accessory”.
Your contribution must not be a loan to the company or an amount repayable by some other means – such as a bonus, pay rise or other benefit. You must effectively wave goodbye to that money.
Having said that, you could still be entitled to a partial rebate when the car is eventually sold (where you have a written agreement with the company), but it must be pro-rata to the disposal proceeds. For example, suppose you contribute £5,000 to a car costing £20,000 which is sold four years later for £8,000. You would be entitled to a maximum rebate from your company of £2,000 – one quarter of the sale proceeds.
Capital contributions are restricted to a maximum of £5,000. Any contribution in excess of that figure will be ignored for tax purposes, although you may be able to treat the excess as a personal use contribution instead.
Capital contributions only apply to company cars, so obviously you need to work through a limited company. They do not apply to sole traders or partnerships, but of course they cannot be taxed on a company car anyway as they are not employees.
How does a capital contribution work? Basically, it is deducted from the list price of the car so you are only taxed on the balance.
For example, suppose your company buys a new BMW with a list price of £32,000 and you contribute £5,000 out of your own pocket. The car would only be taxed at £27,000.
Let’s say the car is a diesel with CO2 emissions of 130 g/km so it is taxed at 20% in 2012/13. The car benefit that year would normally be £32,000 x 20% = £6,400. If you are a 40% taxpayer, that would cost you £2,560. However, with a capital contribution of £5,000 you would only pay £2,160. You would save £400 tax each year that you drive the car.
Not only that, but the company would also save employer National Insurance of £138 (i.e. £5,000 x 20% x 13.8%). Employer NI is deductible against corporation tax so, if your company pays tax at the small profits rate of 20% the true saving to your company would be £110.40 (£138 x 80%).
For a regular employee it is very difficult to save money on capital contributions. For example, suppose a higher rate taxpayer invests £5,000 in a car with a purchase price of £25,000 which is sold four years later for £6,000. They would get back £1,200 (i.e. £5,000 x 6/25), so their net capital cost would be £3,800.
If, say, that car was taxed at an average rate of 25% over those four years, the employee would save £2,000 tax (i.e. £5,000 x 25% x 40% x 4 years). Therefore, at the end of the day, they would be £1,800 worse off (i.e. £3,800 less £2,000). The only benefit they would get is the joy of driving a more expensive car than their employer might otherwise have been able to afford.
For an owner-director the position is very different because the amount given to your company towards the cost of the car still effectively belongs to you. If you own 100% of the shares, all the assets of the company and all the retained profits ultimately belong to you.
True, one day you will have to extract those profits as either salary or dividend (or maybe as a capital gain if you sell the company or cease trading). Normally that means paying tax on them, so your net capital contribution would eventually suffer some kind of tax charge.
However, one of the privileges of running your own company is that you can choose when to do this, and you may be able to do so in a year when your income is below the higher rate tax threshold. Basic rate taxpayers pay no income tax on dividends, so in that case you would avoid tax on your net capital contribution completely.
The only other downside is that making a capital contribution will reduce the capital allowances claimed by your company. For instance if a car costs £25,000 and you pay £5,000 towards it, your company can only claim £20,000 in capital allowances.
However, that is becoming less relevant now as capital allowances have gone down to just 18% per annum (on a reducing balance basis) for cars up to 160 g/km (or 8% above that). Also, companies can no longer claim balancing allowances on the disposal of cars purchased since April 2009 (even for cars acquired before then, they will vanish from the last day of your company’s first accounting period ending after March 2014).
Capital contributions should always be made around the time the car is purchased. It may look a bit contrived if you paid it much later, so if you cannot afford it straight away, it would be best to document the arrangement with a board minute and take out a loan from the company.
You may well be taxed on this loan if you owe the company more than £5,000 in total (including other loans). As always with arrangements of this nature, it is important to have contemporaneous evidence that it was agreed at the time.
The capital contribution should be paid separately from any other monies you owe the company. In particular, it should not be mixed up with personal use contributions, private fuel payments, contributions towards running costs or one-off payments such as accident repairs.
As a company owner/director how much tax could you save by making a capital contribution? That depends on a number of different factors:
- The amount of the capital contribution
- The taxable percentage of the car
- Your own personal tax rate
- Your company’s marginal tax rate
- The capital allowances foregone
- The length of time you keep the car
- The market value of the car on disposal
- The number of times you change your car
- The general rate of inflation over the years
- Your own personal cost of capital
Because a capital contribution saves you tax for each year you keep the car, it would seem obvious that you benefit most by keeping the car for many years. However, the market value of the car will also gradually decline.
Of course other factors are usually more important when it comes to deciding how long to keep a car, such as running costs, warranty periods, etc. Obviously, it is wise to buy cars that hold their value, but they tend to cost a lot more too!
If you always have a company car and merely change one for another every few years, it does not really matter how long you keep the car. In this situation, you need to annualise the figures to determine the tax efficiency of a capital contribution.
For example, suppose you change your car every three years, always contribute £5,000 towards the purchase price, always get £2,000 back when the car is sold, and the cars are taxed at an average rate of 25%. You are a 40% taxpayer and your company pays tax at 20%.
Your tax saving each year would be £500 (i.e. £5,000 x 25% x 40%). Your employer NI saving each year would be £138 (i.e. £5,000 x 25% x 13.8% x 80%). You therefore save £638 per annum. The NI saving would be subject to 25% tax if you extracted it as a dividend, so that brings the net tax saving down to £603.50.
Meanwhile, your net capital contribution would be £1,000 per annum, so each year capital allowances would be reduced by an extra £1,000 x 18% (or 8% for high-emission cars).
Over ten years, a net capital contribution of £1,000 per annum would cost the company a total of £6,073 in foregone capital allowances (at 18%). The foregone corporation tax relief would be £1,215 (at 20%) or £121.50 per annum.
Assuming that your dividends would also go down by £121.50 per annum (as post-tax profits would be lower) and you pay 25% tax on dividends, that would reduce your tax bill by £30.38 per annum, so the net cost of capital allowances foregone would be £91.12 per annum.
However, over ten years it would also cost you £2,500 tax on extra dividends to extract the capital contributions from the company (i.e. £1,000 x 10 x 25%), so that’s another £250 a year. Add that to the £91.12 above and the total cost of capital contributions is £341.12 a year.
Subtract that figure from the £603.50 in tax/NI savings calculated above and you would be better off by £262.38 per annum.Not a huge saving, but over time one probably worth having. The bigger question is whether it is large enough to offset the higher taxes of running a company car in the first place. That would necessitate a much more complex cost/benefit analysis.