By Chas Roy-Chowdhury Head of Taxation, Association of Chartered Certified Accountants

The second stage of company car tax reform is on the horizon. From April people who receive free fuel from their workplace will have their bills calculated according to their car's emissions.

Company car drivers should already be aware that carbon dioxide (CO2) emissions are a key factor when it comes to working out taxable benefit.

Since April 2002, company car taxation has been calculated on the basis of the car's CO2 emissions and its list price when new.

The intention of the reform is to increase the demand for more fuel-efficient, "cleaner" cars. Chas Roy-Chowdhury

The tax rate starts at 15% of the car's price, for a small car emitting 165 grams per kilometre (g/km) CO2, then rises in 1% steps for every additional 5g/km over 165g/km - up to a maximum of 35% of the car's price.

Diesel cars are subject to a further 3% surcharge, up to the 35% maximum.

Over the next two years, the 165 g/km minimum will be reduced by 10 g/km a year, until it reaches 145 g/km in 2004/05.

The intention of the reform is to increase the demand for more fuel-efficient, "cleaner" cars.

In turn, this will help to ensure that manufacturers are further encouraged to produce environmentally-friendly cars.

We have already seen moves by premium brand producers, such as Audi and Mercedes, to make concerted efforts to produce and market vehicles with lower CO2 emissions.

Think ahead

Anyone who is about to choose a new company car and who does not wish to pay above the flat rate of 15% should select carefully.

Best of luck in navigating your way through the complexities of company car taxation.

Generally speaking, it is advisable to buy a car which has a smaller engine and is more fuel efficient, as this will help to keep the tax charge to a minimum.

It is widely expected that the on-going reduction of the emissions band which attracts the minimum 15% charge will extend beyond the next two years.

It is therefore very likely that there will continue to be a 10g/km drop in the bands on a year-on-year basis, perhaps until cars are required to produce no CO2 at all.

Changes in taxation relating to company cars do not, however, stop there.

Company car drivers who receive free fuel also face potentially huge increases in their tax bills from 6 April this year, when the present fuel scale charge will be abolished and tax benefits and bills will be calculated using vehicles' carbon dioxide (CO2) emissions.

This will result in unwary company car drivers paying hundreds of pounds more in tax than those of their colleagues who have chosen smaller vehicles.

Save thousands

The new calculation will be based on a car's CO2 emission as a percentage of a "set figure" - which will be determined by the Inland Revenue each year.

The set figure for the fiscal year starting on 6 April 2003 is �14,400 and the CO2 emissions figure you will need to use in the calculation will be the same as the figure you use for the car benefit charge.

For the purposes of tax charges, all benefits are seen as taxable income and are given a set value.

The illustration below might help to clarify things.

In the current year, the scale fuel charge benefit for a 2.0 litre Ford Focus will result in the driver paying tax on �2,850.

Using the new formula, the same car driver will pay tax on �3,600 in 2003/04: the CO2 based emission is 207g/km, which equals 25% of the set figure of �14,400 = �3,600.

In contrast, the driver of a smaller-engined Focus 1.6 who also currently has the same scale fuel charge of �2,850 will face a smaller tax bill next year of �2,592.

This represents a difference of over �1,000 between the two engine sizes under the new tax regime.

In this case, the CO2 emission is 174 g/km, which equates to 18% of the set figure of �14,400 and results in a tax charge of �2,592.

In the light of all this, the company car driver who receives free fuel should consider:

• Whether it makes economic sense to continue to take the free fuel

• Whether to keep a company car at all, or to take a cash alternative and buy his or her own car

If your answer to these questions is that you should take both the free fuel and the car, you will be advised to see if you can change your vehicle to one with lower CO2 emissions.