Hiring your first employee in the UK brings a string of decisions most overseas businesses haven’t faced before, and how to handle a company vehicle benefit is one of the more common ones. Get it wrong and you either overpay tax you didn’t need to, or you fall out of step with HMRC without realising it.
There are two main routes: a car allowance, paid through payroll as part of salary, or a mileage allowance, which reimburses an employee for business use of their own car. Many UK employers use a combination of both, and which one fits depends on the role, how much driving it involves, and how you want the cost to sit in your UK payroll.
This guide sets out how each scheme works, the current HMRC rates, and the compliance points that catch out overseas employers who are setting up UK payroll for the first time.
What Is a Car Allowance and What Is a Mileage Allowance
A car allowance is a fixed sum added to an employee’s salary, usually monthly, to help them buy, lease, or run their own car. It’s processed through payroll like any other earnings, which means it’s taxed at the employee’s normal income tax rate and attracts National Insurance for both employer and employee. Some employers agree the allowance as part of the salary negotiation before employment starts, in which case it simply forms part of the gross salary rather than appearing as a separate line on the payslip.
A mileage allowance works differently. Rather than a fixed monthly sum, it reimburses an employee for the actual business miles they drive in their own car. HMRC sets an approved rate for this, known as the Approved Mileage Allowance Payment, or AMAP. Provided you pay at or below that rate, the payment is tax-free and doesn’t need to be reported to HMRC. Employees shouldn’t claim a full mileage allowance if they’re driving a company-provided vehicle, since the mileage allowance exists specifically to cover the cost of using a personal car for work.
Most UK employers offer one or the other, though some combine a modest car allowance with mileage reimbursement for employees who drive heavily for work, such as a country manager or field-based sales role.
Car Allowance vs Mileage Allowance: The Key Differences
The core difference is tax treatment. A car allowance is treated as income, so it’s taxed in full and pushes up the employer’s National Insurance bill. A mileage allowance, kept within the HMRC-approved rate, is tax-free for the employee and doesn’t create an equivalent National Insurance cost for the employer.
The second difference is what each one is meant to cover. A car allowance gives the employee flexibility to spend the money however they like, whether that’s a new car, a lease, or simply keeping their existing vehicle on the road. There’s no requirement to prove how it’s spent. A mileage allowance, by contrast, only covers the cost of business journeys actually driven. It isn’t a benefit in the same sense; it’s a reimbursement tied to real mileage.
The third difference is predictability. A car allowance is a fixed monthly cost, which makes it easier to budget and administer through payroll. A mileage allowance varies month to month depending on how much an employee actually drives for work, which means it needs proper mileage tracking to stay compliant.
Why It Matters for Overseas Companies Hiring in the UK
For an overseas business setting up its first UK employee, this decision usually comes up during contract negotiation, often before the finer points of UK payroll have been worked through. Getting it wrong at that stage is more common than it should be, because the terminology looks similar to equivalent schemes in other countries but the tax treatment is entirely UK-specific.
A car allowance agreed without factoring in employer National Insurance can quietly cost more than expected once it’s running through payroll https://www.paulbeare.com/payroll-services-uk/. A mileage scheme set up without a mileage log or a clear policy on rates can end up either underpaying the employee, who then claims the shortfall back from HMRC themselves, or overpaying and creating an unplanned taxable benefit. Neither outcome reflects well on a new UK operation in its first year.
This is also a benefits package decision, not just a payroll one. How you structure it affects the offer you’re making to a UK hire, and getting it wrong in either direction, too little or badly structured, can be a factor in whether that hire accepts the role or stays in it.
How It Works in the UK: Setting Up the Scheme Through Payroll
Once you’ve decided which scheme, or combination, fits the role, it needs to be built into UK payroll https://www.paulbeare.com/payroll-services-uk/Â from the outset. A car allowance is set up as a payroll element, calculated with PAYE and National Insurance applied automatically each pay run, and stated clearly in the employment contract, including whether it’s a standalone allowance or rolled into gross salary.
A mileage scheme needs a written policy: what counts as business mileage, how often employees submit claims, and what rate you’re reimbursing at. Monthly claims are the norm, so employees receive reimbursement promptly and your payroll team, or your outsourced payroll provider, can check the numbers before payment. Ordinary commuting between home and a fixed workplace doesn’t count as business mileage under HMRC rules, which is a distinction worth setting out clearly in the policy from day one to avoid disputes later.
Both schemes should sit inside the employee’s contract of employment https://www.paulbeare.com/hiring-employees-in-the-uk/Â as part of the wider benefits package, not bolted on informally after the employee has started.
Key Compliance Requirements
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The current HMRC rates and thresholds you need to work to are set out below.
These rates apply for the 2026/27 tax year and were increased from 6 April 2026, the first change to AMAP since 2011. If you’ve been reimbursing mileage at the old 45p rate since April, you can top up the difference without any tax or National Insurance consequences. Pay above the approved rate and the excess becomes a taxable benefit that needs reporting through payroll or a P11D.
Common Mistakes International Businesses Make
The most frequent mistake is agreeing a car allowance figure during recruitment without checking how it will actually cost out once employer National Insurance is applied through UK payroll. What looks like a competitive offer on paper can come with a materially higher true cost than expected.
The second is running a mileage scheme with no written policy and no consistent mileage log, which makes it difficult to demonstrate compliance if HMRC ever queries the payments. The third is applying outdated rates. HMRC’s mileage rate had been frozen at 45p for fourteen years before the 2026 increase, and a fair number of UK employers, let alone overseas ones, are still working from the old figure.
The fourth, and the one that causes the most friction, is treating this as a one-off decision at hiring rather than a policy that needs reviewing as the UK team grows. What works for one employee on a car allowance doesn’t necessarily scale cleanly once you have five or ten people on UK payroll with different mileage patterns.
How Paul Beare Helps With This
We run UK payroll https://www.paulbeare.com/payroll-services-uk/ for overseas companies from the point they take on their first UK employee, which includes setting up car allowance and mileage schemes correctly from day one, applying current HMRC rates, and making sure both are reflected properly in the employment contract. Where the wider benefits package needs shaping, our HR and employment support https://www.paulbeare.com/hr-employment-services/ covers that alongside payroll, so you’re not piecing together tax advice and contract terms from separate sources.
If you’re still working out your first UK hire more broadly, our guide to hiring employees in the UKÂ https://www.paulbeare.com/hiring-employees-in-the-uk/Â is a useful starting point before you get into individual benefit decisions like this one.
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Questions & Answers
Can I offer both a car allowance and a mileage allowance to the same employee?
Yes. It’s common where a role involves significant business driving, such as a country manager, and the car allowance alone wouldn’t reasonably cover the mileage involved.
Is a car allowance pensionable?
Generally no. It’s usually excluded from pension, bonus, and redundancy calculations, though this should be stated clearly in the employment contract to avoid ambiguity later.
What happens if I pay mileage above the HMRC rate?
The excess becomes a taxable benefit. It needs to be reported through payroll or a P11D, and both employer and employee will pay tax and National Insurance on the difference.
Do these rules apply the same way to a UK branch as a UK subsidiary?
Yes. The tax treatment sits with HMRC and applies to the UK payroll regardless of whether your UK entity is structured as a branch or a subsidiary.
