Social Engineering - RAY CHIDELL looks at the proposed changes for the fixed profit car scheme

'Dobby has heard of your greatness, sir, but of your goodness, Dobby never knew.' So speaks the hapless house-elf to Harry Potter in the second of the popular series of children's books.

Drivers of smaller cars may be forgiven for addressing the Chancellor in similar terms, particularly if they own their cars privately but drive them for business purposes. The proposed changes to the authorised mileage rates produce some odd results in practice, and perhaps serve as a warning that tax is a blunt instrument to use for social engineering.

Social engineering certainly seems to be the name of the game as far as the transport changes are concerned. The press release introducing the new rules on company cars was, after all, headed 'Protecting the environment' and claimed that the reform would be revenue neutral. The pre-Budget report bore the same title when announcing the proposal to change the authorised mileage rates from April 2001 and, further, from April 2002.

As a reminder, for privately owned cars the lower engine-size bands are increased from 6 April 2001 to 40p and 25p for the first 4,000 miles and subsequent miles respectively. These are therefore the amounts that an employer will be able to reimburse tax-free for an employee who uses a privately-owned car for business purposes.

Fixed Profit Car Scheme - Tax free rates for cars

From April 2002, it is proposed that a single rate will apply for all cars, i.e. irrespective of the size of the engine, of 40p for the first 10,000 miles and 25p thereafter. Alongside these changes, it is proposed to put the fixed rate per mile on a statutory basis, so that the alternative option (of claiming on the basis of the business proportion of actual costs incurred) will no longer exist. Furthermore, from April 2002 it will no longer be possible to claim interest relief on borrowings used to fund a car driven partly for business purposes, nor will capital allowances claims be admissible. However, it seems that claims for finance costs have largely been overlooked by many employees anyway.

As a simplification measure, all this is to be applauded. But how good are the green credentials?

Take the driver of a small privately-owned car with an engine size up to 1,000cc. Under the rules applying for 2000-01, he was able to claim 28p per mile for the first 4,000 miles and 17p per mile thereafter, theoretically calculated to reflect the true cost of running a car of that size. Look at the amount that can be reimbursed tax-free before and after the changes (ignoring the transitional position in 2001-02):

Admittedly, this driver is being rewarded for driving a small car, but there is also a built-in reward for high business mileage. Assuming the first column represents (in theory) the true cost of running the vehicle, the driver gains more, the greater the number of business miles covered. So for this driver, at least, tax considerations suggest that it is time to throw away the rail tickets and get behind the steering wheel.

The driver of a privately-owned car with an engine size of 1,000 to 1,500cc will similarly be a net winner under the new rules, though the gains are more modest.

For drivers of private cars with engines between 1,501 and 2,000cc, the position is more complex. If they cover little business mileage, they will be worse off under the new rules. If they cover at least 5,333 business miles in the year, on the other hand, they will be better off under the new rules than at present. Again, it seems unlikely that this is the intended outcome of the proposals.

No prizes are awarded for guessing how drivers of the largest cars fare under the new proposals; they lose out whatever their level of business mileage. It could be argued, however, that even they will be better off if they drive 10,000 business miles in their cars than if they drive (say) only 4,000 miles.

For drivers of the largest cars, however, the real issue is probably the effect the changes have on the decision as to whether to drive a company car or one that is privately owned. In this respect, these changes are merely another variable in what is already a complex decision.

Ray Chidell is a tax partner at Mazars Neville Russell. Ray also produces fortnightly employer tax bulletins. To receive these free of charge, readers can send an e-mail note containing their name and company to: ETU@mazars-nr.co.uk.

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