What is Corporation Tax and Who Pays It?

As an accountant, I often get asked about various taxes, and one that comes up frequently is what is corporation tax.

What exactly is corporation tax?

Put simply, it’s a tax imposed on the taxable profits of corporations (and some other structures). When a company earns money, it needs to pay tax on those earnings, just like individuals pay income tax on their wages and other income via the self-assessment process.

Who pays corporation tax?

You might be wondering who pays corporation tax. Here in the UK, it’s corporations or companies who pay it. Any business that operates as a separate legal entity, such as a limited company, is subject to corporation tax. This includes large multinational corporations, small local businesses that operate as a limited company, and everything in between.

How is corporation tax calculated?

Corporation tax is calculated based on a company’s taxable profits. Profits are essentially the money left over after deducting expenses from the company’s income. Expenses can include things like employee salaries, rent for business premises, equipment costs, etc. The basic principle of calculation is “Taxable profits x Corporation tax rate = Corporation Tax to pay”.

Unfortunately, this is where things get a little complicated. The company actually needs to figure out how much tax it owes. And that is not quite so simple.

Accounting profits vs Taxable profits

“Accounting profits” and “Taxable profits” are not the same thing. This is because accounting rules and tax rules do not align perfectly. In fact, rarely will the accounting profits match the taxable profits for the same business. Take the example below:

Your business associate Mr Smith placed a £1,500 order with your company, which was delivered the same week. The goods your company sold cost £500 to buy (nice markup!), leaving the business with £1,000 gross profit. The following week you bumped into Mr Smith, and asked him out for lunch to discuss further business opportunities. Naturally the bill was your shout, and you left the restaurant with £100 less in your business account, but with several other leads to follow up on.

Quite rightly you count the £100 as a legitimate business expenditure, and therefore your company is now left with £1,000 gross profit less £100 you spent on entertaining, making the company’s net profit £900. This is called the business’s accounting profit.

But the tax rules do not allow companies to get tax relief on entertainment, therefore to calculate the taxable profit we will have to add this £100 back to company’s accounting profit. So whilst the accounting profit is £900, the company’s taxable profit (the amount on which corporation tax is calculated) is actually £1,000.

It’s not all bad news though – tax rules can also work in the company’s favour with various tax allowances that could be available. Since companies may be eligible for various reliefs, allowances, and exemptions to arrive at their taxable profits from their accounting profits, you need a tax advisor who knows the rules and how to get the best out of those rules.

Groups of companies, associated companies, overseas businesses with UK operations, and other special circumstances could make this part of the calculation even more challenging.

What are the current rates of corporation tax?

Once we established the taxable profits, what about the corporation tax rate? Surely things should become simpler at this point? Let’s see…

For most companies in the UK the current rate of corporation tax is 19% for profits up to £50,000. This is called the small profits rate of corporation tax. For example, if a standalone company has £40,000 taxable profits, their corporation tax bill is £40,000 x 19% = £7,600.

For companies who make profits over £250,000 the corporation tax rate is currently 25%, which is called the main rate of corporation tax. So, a standalone company that has £300,000 taxable profits would pay £300,000 x 25% = £75,000.

But what about profits between £50,000 and £250,000? HMRC says that the corporation tax rate in this band is “the main rate of corporation tax reduced by a marginal relief” (that is assuming that the company is eligible to claim marginal relief). What does this actually mean? I’ll translate it – it means that the company effectively pays 26.5 pence corporation tax for every pound of taxable profit in this band. I guess the technical term probably sounds more palatable than actually calling it a 26.5% corporation tax rate… Therefore, a standalone company with profits of say £200,000 would pay £49,250 corporation tax (£50,000 x 19% + £150,000 x 26.5%)

As a final note on the subject of the corporation tax rates, do watch out if you have interests in several companies, as this can mean that the companies start paying corporation tax at rates above the 19% rate sooner than if you only have interests in one company.

Does HMRC tell me how much corporation tax my company needs to pay?

In short, no. Corporation tax in the UK is self-assessed, meaning that companies are responsible for calculating their own tax liabilities and reporting and paying them to His Majesty’s Revenue and Customs (HMRC) for each accounting period.

HMRC allocates a reference number to each company, which is unique to that company. This is called a Unique Tax Reference Number (also known as a UTR number). Using this UTR number, a company must file its corporation tax return annually. You may not be surprised to hear that the current basic version of the corporation tax return form is 12 pages long and includes details of turnover, profits, and any reliefs or allowances claimed – it’s not for the faint hearted!

Most companies are given 12 months after their year end to file their corporation tax returns. For example, for a company whose accounting period ends on 31 December 2023, the corporation tax return needs to be filed by 31 December 2024.

How do I pay the corporation tax bill?

Don’t wait for a corporation tax bill from HMRC. It is the company’s responsibility to make sure that the corporation tax is paid on time.

As long as the taxable profits of the company are under £1.5 million, the actual tax payment needs to be made within 9 months and 1 day after the end of the accounting period to which the corporation tax bill relates. For example, for a company whose accounting period ends on 31 December 2023, the corporation tax bill needs to be paid by 1 October 2024.

Do I need an accountant to calculate corporation tax?

Technically you don’t need to have an accountant to calculate your corporation tax. But in reality, even for smaller businesses with straightforward operations and relatively simple financial structures we rarely come across business owners who are both competent and comfortable undertaking the compilation and filing of their company’s accounts and corporation tax returns. Often they also struggle with time constraints where they simply do not have the time to sit down, learn the rules and keep abreast of the changes in legislation.

Our view (unsurprisingly) is that professional advice from accountants or tax specialists can be valuable in navigating the complexities of corporation tax, ensuring compliance with tax laws and regulations and saving the business owner time and money.

For a Tax Accountant who’s on the ball and responsive please get in touch with our team who will be happy to help.

Our goal is to help our clients solve their business problems and make their ideas come true.

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