How to set up a Car Km Allowance Pay Item

User Guide

Overview

Car Km Allowance is paid to employees using their own vehicle for work purposes. The allowance is a reimbursement of the kilometres driven exclusively for business trips.

Business Trips vs Private Trips

A business trip is defined by the ATO as a trip from the office to a customer or supplier’s site, or from one site to another.
Trips between home and the office (and vice versa) are not considered business trips. Therefore, these trips cannot be reimbursed via the Car Km Allowance. Some Awards offer reimbursement options for these trips; these are defined as Travel and Fares Allowances.

Car Allowance Rate & Tax Deductibility

Car Km Allowance rates are included across most Industry Awards. Employers should review the rate specified in their classified Award to ensure they pay the minimum reimbursement rate to which their employees are entitled.

The ATO sets a tax-free threshold applicable for this allowance, which is often less than the rate specified in the Industry Awards. This threshold, similar to the rate specified in the Awards, is reviewed and updated by the ATO each Financial Year. To find out the current ATO Car Km Threshold, refer to our Key Rates and Thresholds articles published in the blog section of our website. Superannuation is not payable on this pay item.

The rate is set to cover an average of all car’s running costs, including registration, insurance, maintenance, fuel, depreciation and leasing costs. It is calculated using the ABS Consumer Price Index’s Private Motoring subgroup. This means it takes into consideration the inflation impact specifically on motor vehicles’ costs.

The ATO also sets a maximum number of kilometres travelled per year where the tax-free threshold applies. The maximum number of kilometres per year is 5,000. This limit does not change from one year to another.

This means three separate Car Km Allowance pay items should be created in your payroll system:

• Car Km Allowance (up to the ATO Threshold) ⇒ (Non-Taxable)
• Car Km Allowance (over the ATO Threshold) ⇒ (Taxable)
• Car Km Allowance (over 5,000 km) ⇒ (Taxable)

Payroll Tax and Workers’ Compensation Implications

State Payroll Tax sets a different exemption threshold for this allowance. Although the Payroll Tax legislation differs for each state and territory, this exemption was harmonised years ago. The exempt portion of the Car Km Allowance is always the ATO threshold from the previous Financial Year.

The State and Territory Workers’ Compensation Acts generally set the Car Km allowance rate exempt up to the Award rate. Employers who choose to pay above the Award rate, must only include the difference between the rate reimbursed and the Award rate as assessable remuneration when lodging their Annual Wages Declaration.

Compliance Requirements & STP Reporting

The ATO has mandated employers to pay this Allowance exclusively through payroll and report it through STP as a Car Allowance (CD). The ATO uses the data reported under the STP code Car Allowance (CD) to prefill the Motor Vehicle Deduction section of the individual Tax Return. This means this allowance can no longer be paid via Accounts Payable.

A Table Summary of the Car Km Tax Deductible Allowance for an individual Tax Return.

Set up the Car Km Allowance Pay Item

1. In Xero, go to Payroll  ⇒ Payroll Settings
2. Select the [Pay Items] Tab ⇒ [Earnings]
3. Click on [Add] ⇒ Allowance
   • ➡️ The Pay Item screen
   • 
4. Select/Enter the following details:
   • Earnings Name ⇒ Type: Car Allowance (up/above the ATO Threshold)
   • Type ⇒ Select: Car
   • Display Name ⇒ Type: Car Allowance (up/above the ATO Threshold)
   • Rate Type ⇒ Select: Rate per Unit
   • Type of Units ⇒ Type either: hours (if you wish to include this pay item in Xero timesheets), if not, type KM
   • Rate per Unit ⇒ type the car km rate
   • Expense Account ⇒ Select Wages & Salaries
   • Exempt from PAYG withholding ⇒ Select this option only when you set the rate up to the ATO threshold
   • Include in superannuation calculation ⇒ Do not select this option
   • Report as qualifying earning ⇒ Do not select this option
   • Report as W1 on Activity Statement ⇒ Select this option
   • Contributes towards annual leave rate ⇒ Do not select this option
   • Contributes towards overtime rate ⇒ Do not select this option
5. Click on [Add]

Add the Car Allowance Pay Item to the Employee’s Pay Template

When you add a Car Km Allowance to an employee’s pay template, you should always ensure that both Pay Items (up to the ATO Threshold and above the ATO threshold) are added as Earning Line. If the employee is Award-free the above ATO Threshold pay item does not apply.

Once the employee has been reimbursed for more than 5,000 km for that Financial Year, you should then replace the two pay items with the Car Allowance above 5,000 km pay item.

1. Go to Payroll ⇒ Employees
2. Open the employee’s details and click on the [Pay Template] Tab
3. Click on [+Earnings Line]
   • ➡️ The Earnings Line
   • 
4. Select/Enter the following details:
   • Earnings Rate ⇒ Select: Car Allowance
   • Calculation Type ⇒ Select: Use Earnings Rate
5. Click on [OK]
6. Repeat the above steps to add the second Car Allowance Pay Item (above the ATO Threshold)

Pay the Car Allowance

When you pay the car allowance through payroll for the first 5,000 km, you have to enter the km reimbursed across both pay items to pay it correctly.

• ➡️ The Employee Pay Screen
• 

Report on Car Km Allowance Reimbursed

To ensure you don’t pay more than 5,000 km per year, you should monitor the number of km reimbursed during the Financial Year. You can do that by running a Payroll Activity Detailed report

1. Go to Reporting ⇒ All Reports
2. Scroll down to the Payroll Section and select: Payroll Activity Details
3. Set up/Enter the following reporting options:
   • Employees ⇒ Select the employee
   • Date range ⇒ Select the relevant Financial Year
   • Filter > Expand the Pay Item filter and type: Car KM [up to ATO Annual Threshold], Apply the filter
4. Click on [Update] to run the report
   • ➡️ The Payroll Activity Detailed Report
   • 
5. Add the total number of units paid for each pay period to identified the number of km reimbursed during the Financial Year

Training Video

Disclaimer
This educational material is for general purposes only and does not constitute legal advice. The information provided in this guide is current as of November 2026. Rulings and regulations may change, always check official government websites for the most up-to-date regulations. Additionally, as software features are continuously improved, screen displays and interfaces showcased may differ from the current version of the application.