Does a payment to obtain a better car qualify as a capital contribution?

When an employee makes, or is required to make, a capital contribution to the purchase of a company car, some or all of that contribution may be offset against the list price of the car, thereby reducing the tax charge for the tax year in which the contribution is made and for subsequent years.

The amount by which the cash equivalent of the car is reduced by such a contribution is limited to the lesser of

• any capital contributions made by the employee towards the expenditure on the provision of the car or any qualifying accessories, and
  
  
• £5,000.

If a car is replaced, a contribution to the old car does not apply to the new car. If a car is transferred from one driver to another, the reductions to which the first driver is entitled due to having made a capital contribution do not pass to the second driver.

Similarly, a capital contribution towards an accessory only serves to reduce the list price while that accessory, or an equivalent replacement accessory, continues to be included in the calculation of the car benefit charge. If the original accessory, for which the capital contribution was made, is replaced by a superior accessory, the contribution no longer serves to reduce the car's list price.

In understanding the nature of a capital contribution, it must be noted that it is a contribution towards the "expenditure" on the car and accessories. The employee is paying, in part, for the car or the accessories. Consequently, HMRC would expect the payment to be made at or about the time when the car or accessory is provided. HMRC does not rule out an arrangement whereby a capital contribution could be made in instalments, perhaps by deduction through the payroll, but it is not consistent with the concept of a capital contribution.

Therefore, care must be taken not to confuse capital contributions with

• payments made by employees in respect of private "use" of the car, which reduce the value of the car benefit at the very end of the process, and
  
  
• payments made by employees to obtain a better car than that to which they are normally entitled, often as a monthly deduction from salary, unless the payment is also specifically a capital contribution.

The terms on which the employee makes a capital contribution may provide that the employee is entitled, when the car is eventually sold to a third party, to be repaid the proportion of the capital contribution that the original contribution bears to the original cost of the car. (Such a repayment would not be subject to PAYE.)

However, if the agreement was that

• the employee would be repaid the full amount of the capital contribution at the time of disposal of the car, the employee would not be considered as having made a capital contribution in the first place
  
  
• a specified amount will be repaid whatever the sale proceeds of the car, that amount is a loan and does not qualify as a capital contribution.

Part ownership of the car by the employee is not a requirement of the legislation and, as a result, a repayment agreement is not required for there to have been a capital contribution. It is the capital nature of the original contribution that is critical, not any repayment arrangement. The fact that an employee is not entitled to any repayment when the car is sold does not in itself mean that the original payment was not a capital contribution.

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