Corporation tax is the tax paid by companies on their profits. Unincorporated organisations (such as clubs and societies) also pay corporation tax, if they have taxable income. Non-corporate partners in both traditional and limited liability partnerships and sole traders pay income tax instead.
If you use accountants to prepare your year-end figures, or auditors to check them, they may calculate your corporation tax liability, too. But you cannot afford to ignore corporation tax until the year end, because your activities during the year could have a significant impact on the final bill.
This briefing explains:
- How corporation tax is calculated.
- When you have to pay it.
- When you can offset losses.
- How to minimise your tax bill.
1 Calculating taxable profits
Tax is levied on all the profits made during an accounting period.
1.1 Profits can arise from several sources. They have to be calculated separately and totalled at the end.
Profits from different sources have to be calculated separately, because different rules apply to income and expenditure on each.
The rules are complex. Ask your accountant, tax adviser or auditor for advice.
1.2 Companies are taxed on the profits made in an accounting period — normally their financial year.
- The end of an accounting period can also be triggered by the company going into liquidation or ceasing to trade.
- Tax rates are set for the tax year, which (for corporation tax purposes) runs from 1 April to 31 March.
- Where the company’s accounting period and the tax year do not coincide, the profits must be time-apportioned to decide which rate should apply.
1.3 The geographical basis for the tax charge depends on where the company is resident for tax purposes.
Check your situation with your accountant or tax adviser.
2 How much tax?
2.1 From 6 April 2015, there is a single rate of corporation tax.
- The main rate of corporation tax has been aligned with the small profits rate at 20%.
- Businesses with profits that can be attributed to patented inventions and certain other intellectual property can elect to pay a reduced rate of 10% tax on those profits. See 5.6.
2.2 Prior to 6 April 2015 there were three corporation tax bands:
If your profits were between £300,000 and £1.5 million, you were eligible for marginal relief.
Corporation tax will reduce to 19% in April 2017 and to 18% in 2020.
Companies are responsible for assessing their own liability to corporation tax and for ensuring that all the money which is due is paid on time.
3.1 Most companies have to pay corporation tax within nine months and one day of the end of their accounting period.
- This rule applies to small and medium-sized companies (ie those with profits of up to £1.5 million).
- Tax must be paid in full at the due date, whether or not HM Revenue & Customs (HMRC) is challenging the figures shown on the return (see 3.3).
- Interest is charged on late payments.
3.2 Larger companies have to pay the tax due in quarterly instalments.
- The first instalment has to be paid six months and 14 days after the end of the preceding accounting period (ie halfway through the accounting period to which the payments relate).
- Two further quarterly payments then have to be made with the balance payable within three months and 14 days of the end of the accounting period.
- Companies with profits in excess of £20 million will be required to pay their Corporation tax bill in instalments on the third, sixth, ninth and twelth month after the end of their accounting period from April 2017.
Special rules apply where the accounting period is not 12 months.
3.3 All companies have to notify HMRC of their profits by submitting their corporation tax return online.
Losses can sometimes be used to reduce the corporation tax bill. However, their use is subject to strict rules, to prevent tax evasion.
4.1 Trading losses can be offset against any other profits (including capital gains) made in the same accounting period.
4.2 It may be possible for other companies within the same group to make use of a company’s trading losses.
- To qualify, at least 75% of the shares must be owned by the parent company.
- There are other restrictions. For example, when a company joins or leaves the group.
4.3 Capital losses can only be offset against capital gains.
They cannot be offset against trading income.
- However, they can be carried forward indefinitely, so they should always be recorded, even if they cannot be used immediately.
The company bank account
Owner-managers should avoid using the company bank account as a second personal account.
Every payment must be accounted for.
- If cash payments to owner-managers cannot be identified as salary or dividends, they will be treated as loans from the company.
- Such loans can have serious tax consequences. To avoid these, it is generally necessary to repay the loan within nine months of the year end.
- Use of the company’s bank account for personal expenditure also creates extra work for the company’s accountants, and may lead to increased fees.
R&D Tax relief
Consider whether you can claim for research and development (R&D) tax relief.
HMRC provide 230% on qualifying R&D expenditure for small and medium-sized enterprises. This can:
- reduce the corporation tax payable
- provide a tax credit payable by HMRC
- increase tax losses which can be carried forward to offset against future taxable profits (see 4)
Large companies can also claim R&D tax relief of 130% on qualifying R&D expenditure. Since 1 April 2013, large companies have been able to claim an ‘above the line’ pre-tax credit of 11%. This provides greater cashflow support to companies without corporation tax liability. Transitional rules apply until 31 March 2016 after which date it becomes mandatory.
- Companies do not have to be developing or creating leading edge technology to claim R&D relief.
- There are spending limits.
- Losses can be carried forwards or backwards.
5 Minimising the tax bill
Increasing profits is generally more important than avoiding tax. However, you may be able to reduce unnecessary tax payments.
5.1 Consider using loans, rather than shares, to finance the company.
- Interest on loans is an allowable expense against profits, whereas dividends on shares are not.
5.2 Ask your professional advisers about methods of reducing profits without damaging the company or its prospects.
- Take advantage of capital allowances and the Annual Investment Allowance available on equipment purchases. The AIA stands at £200,000 from 1 January 2016 where it will be held.
- If possible, reinvest the proceeds of any asset sale and use ‘rollover relief’ to reduce capital gains.
5.3 Consider using benefits in kind, rather than extra salary, as a mechanism for taking money out of the company.
5.4 Consider using dividends, rather than a higher salary.
- A director/shareholder will receive more by way of dividend than salary. However, the dividend regime is being reformed. From April 2016, there will be a single Dividend Tax Allowance of £5,000 per year. Tax on income in excess of £5,000 will be taxed at 7.5% for basic-rate tax payers, 32.5% for higher-rate tax payers and 38.1% for additional-rate payers.
- You may need advice on dividend payments. You may have to pay some salary to working shareholders to compensate them for the disproportionate dividends paid to (say) retired shareholders.
- Payment by dividend may limit your rights to state benefits and the amount you can contribute to an approved pension scheme, as the amounts do not count as earnings.
This sort of planning may not be effective if yours is a personal service company and you work under the control and management of any of your clients.
In such cases you may be caught by the IR35 rules and be deemed to receive a salary larger than the one you actually draw. If you run such a company, seek professional help.
5.5 Consider whether any of your profits can be attributed to intellectual property (IP).
- Under the Patent Box scheme you can elect to pay a reduced 10% rate of tax on profits associated to your IP.
- The profits must come from patent rights you sell or license, sales of patented products or products containing a patented invention, intellectual property infringement income or damages or compensation relating to your patent rights.
- To claim the reduced rate, you must make an election in your tax return within two years of the end of the accounting period to which the profits relate. See www.gov.uk/corporation-tax-the-patent-box.
6 Where to get help
6.1 HMRC assumes that you will employ a qualified accountant or tax adviser to deal with correspondence and help you with corporation tax (see 6.2).
- HMRC will send you the appropriate forms as soon as your company is registered with Companies House.
- Your local tax office can assist with minor problems.
6.2 Most firms of accountants can provide you with advice.
6.3 Chartered Tax Advisers can advise you on your tax affairs and calculate your tax liability.
6.4 Solicitors can advise you on the legal aspects of corporation tax.