A Comprehensive Guide to Corporation Tax

The fourth most significant source of revenue for the UK Treasury is the Corporation tax (CT) levied on the profits of incorporated companies plying their trade in the UK. Some of the companies subject to corporation tax include:

• Companies operating both in the UK and overseas but with their assets, production activities, or central management in the UK
• Companies with fewer profits and profits from patents
• Banking firms
• North Sea oil and gas production companies

In this article, I will attempt to explain Corporation Tax with respect to what it is, when it is levied, how it is calculated, who is subject to tax, and why is it a significant source of revenue.  

What is taxable profit?

Taxable profit is the profit (or loss) upon which income taxes are payable based on operating earnings, dividend income, interest income, and capital gains on the sale of long-term assets.

Therefore, if profit is revenue minus the operating costs, then corporation tax is levied on

taxable profit = income (obtained from the sale of goods and services and investments) – current expenditure (daily operating expenses including raw materials, labour wages, interest payments on debt, and other deductions) 

Capital gains (Sale Price – Original Purchase Cost when a company sells an asset), profits from selling assets for more than cost price, etc., are also subject to corporation tax. The tax is usually levied on profits over 12 months as laid down in the company accounts. While most businesses start their accounting year in April to match the tax year, if a company’s account is spread over two tax years (accounting is done on a calendar year basis) where the tax rate changes from one year to the next, then the taxable profits are calculated at an average of the two tax rates as per the number of days in the accounting period before and after the changed tax rate. The time of payment also differs based on the size of the company. 

• Large Corporations – Corporation tax is paid in four equal installments based on their anticipated liabilities for the accounting period. 
• SMB (small and medium businesses) – The Corporation tax is paid as a single bill after nine months calculated from the end of the accounting year

Rates of Corporation Tax

In general, companies pay their corporation tax at the rate that is applied in their company’s accounting year; it is currently set at 19% in 2021-22 and will rise to 25% from April 2023 for companies with profits above £250,000. The tax rates are higher for banks, North Sea oil and gas production companies but lower (10%) for companies opting into the ‘patent box’ scheme (described in the next section). On the other hand, unincorporated businesses like partnerships and sole traders pay income tax on their profits instead of corporation tax.

Multinationals – Corporation tax is levied on the profits of 

1. companies incorporated in the UK 
2. foreign companies with a UK-based central management/branch or office
3. clubs/co-operatives or unincorporated associations that trade for profit.

Companies with operations in the UK and overseas are subject to a ‘source-based’ corporation tax on their profits in the UK (where the underlying value is created), where the profits from the UK-based production activities and assets are considered taxable. On the other hand, patents and intangible assets are taxed at the asset owner’s location. But when the same multinational parent company owns several companies operating in different countries, the calculation becomes a little more complex and is done through the medium of transfer pricing (each part of the company has to transact between themselves to calculate the probable allocation of profits for corporation tax purposes). 

Banks – Since April 2016, an 8% surcharge has been levied on the taxable profits of building societies and banks. However, banks do not have to pay this surcharge on the first £25million of their taxable profits. Additionally, they are also subject to a bank levy which is an annual charge on specific equities and balance-sheet liabilities. The March 2021 Budget, however, announced a review of the bank surcharge to ensure that the 2023 corporation tax increase from 19% to 25% does not significantly impact the banking sector. 

North Sea oil and gas companies – While the overall rate of corporation tax is 30% higher for the North Sea oil and gas production companies, they are also accorded more leniency in terms of capital allowances. Additionally, a 10% supplementary charge is levied on top of the corporation tax. 

Corporation Tax Relief

Tax relief is a policy aimed at reducing the tax burden. When companies are eligible to get deductions or claim tax credits on their corporation tax, it is called tax relief. Common relief schemes include:

• R&D tax relief – Under R&D relief, companies can deduct more than 100% of their qualifying current expenditure on research and development (R&D). This policy usually offers a greater degree of leniency for SMBs (230% deduction under R&D Relief Scheme from taxable profits) than for large corporations (13% of qualifying R&D expenditure under RDEC - R&D expenditure credit deducted from tax liability).  
• Capital allowance – Companies can claim Capital Allowances on business assets which allows them to deduct some or all of the capital investment on these assets from taxable profits (not automatically deductible). In other words, companies that claim capital allowances do not have to pay tax on their plant, machinery, and infrastructure assets. If the company sells an asset on which it has claimed capital allowances, a ‘balancing adjustment’ is made and together with the capital allowance and the capital gain/loss, it is equal to the overall change in the asset value. 
• Super deduction – Under the capital allowances clause, some companies can deduct more than the full cost of some of their capital spending - 130% first-year capital allowance for qualifying plant and machinery assets; and a 50% first-year allowance for qualifying special rate assets - from 1 April 2021 to 31 March 2023. This is the newly introduced super deduction clause linked to the corporation tax increase from 19% to 25% in April 2023. 
• Relief for losses – Under this, companies that make a loss (operating cost is more than revenue) can offset the loss against taxable profits from other years instead of claiming a tax refund. The loss is usually carried back by a single year or carried forward indefinitely. Under the new post-Covid rules, however, losses up to £2 million can be carried back by up to three years. 
• Patent Box – UK-resident companies that earn profits from their UK- or EU-registered patented technologies and inventions (including income from licensing and royalties) can opt for the ‘patent box’ scheme which allows them to pay a lower rate of corporation tax at 10%. 

Corporation Tax Revenue and its onus

According to recent studies, corporation tax is slated to “raise revenue of around £40 billion in 2021–22.” Since profits vary with time and the economic cycle of the country, the revenue generated from corporation tax differs over time. Currently, corporation tax revenue has remained in the 2-3% range of GDP for the last five decades. As per the statistics, 55% of corporate tax comes from 0.3% of multinational companies that have made a tax payment of £1 million or more. Within this, 22% of corporation tax revenue comes from the financial services industry. 

While the picture is clear about which companies contribute to the corporation tax revenue, it is much more difficult to see where the onus of the tax lies – who’s lifestyle is affected by the tax.

Individuals with direct shares, indirect shares (investment funds and private pensions), and individuals based overseas (shares listed on the London Stock Exchange but owned overseas) all bear the burden of corporation tax. Additionally, a part of it is passed on to UK-based customers and employees when a corporation tax-paying company lowers average wages or sets higher sale prices. It also affects the actual investment made by the company and the location of its production activities, i.e., fewer investments in the UK. 

Given the effects of corporation tax, it remains to be seen how the proposed increase in rate from 19% to 25% will affect the businesses and the economic incidence of tax (effect on individuals who bear the brunt of it) from March 2023. 

Corporation Tax Avoidance and Countermeasures by the Government

Firstly, it is essential to distinguish between tax avoidance and evasion.

Tax Avoidance – When a taxpayer pays less tax using legal means such as claiming tax credits, deductions, and allowances. Examples include not reporting overseas income or income from bitcoin banking, paying the nanny without reporting it, not reporting all-cash transaction income, etc.

Tax Evasion – When a taxpayer uses illegal means to evade tax payments, it becomes a case for law enforcement. Examples include under-reporting income to HMRC, dealing in all-cash transactions to avoid reporting it, hiding assets and overseas income, etc.

Successive governments in the UK have introduced the following countermeasures to reduce tax avoidance by large corporations and companies:

• Capping the interest payment amount the company can deduct during taxable profit calculations
• A diverted profits tax targets companies that conduct business in the UK but avoid setting up a permanent establishment or artificially manipulate transfer prices. The tax is charged on profits that are considered to be diverted away from the UK including ring-fence profits (both actual and notional) and profits which would have incurred a bank surcharge. The rate is set to change from April 2023.
• A new digital services tax on search engine revenues, social media services, and online revenue-generating marketplaces.

The line between tax avoidance and evasion can become blurred due to subjective interpretations. For example, owners can pay less tax in sole proprietorship companies if a large portion of their income comprises dividends instead of a fixed salary. This is because the rate of tax on dividends is lower than that of taxable income. While this makes it legal for owner-managers to minimize their tax bills, it could also be a form of tax avoidance. However, this is different from purposeful, aggressive, or abusive avoidance, which comes under the scanner of HMRC.

How to reduce your Corporation Tax Bills

There are several reasonable methods to reduce tax bills, including:

• saving money in ISA or pension schemes and claiming relief on pension
• ensuring that the tax code is correct to avoid overpaying taxes
• claiming tax relief on donations to charity
• leveraging tax-free allowances
• correctly reporting overseas income

If someone resorts to lying or deliberate evasion, the penalties range from harsh to life-changing, including prohibitive expenses and damage to reputation. Therefore, it might help to consult a  tax expert to ensure you are ethically and correctly fulfilling your corporation tax obligations to avoid getting on the wrong side of the  law.

If you require expert tax guidance in relation to Corporation Tax, drop me an email at monty.jivraj@spencer-west.com.