The corporate income tax is one of the central taxes that you have to pay if you are running a business. It is a critical piece in the fundamental decision-making process. It affects many decisions when businesses emerge into the market. Among these, there are decisions to establish a company, or the type of company as well.
Likewise, Corporation Tax is more than a payment that companies have to make to the National Treasury based on their benefits. In the UK, the HMRC collects corporation tax from every business. The existence of this tax carries a set of legal obligations that every company in the UK needs to fulfil.
Understanding the Corporation Tax?
It is a direct tax; therefore, it gets cut every time a business income is generated. In that sense, it is similar to the personal income tax that workers and employees of a company are required to pay. The most crucial difference between the two is that the HMRC taxes the income of employees of the company, and the Corporate Tax levies the income of a whole business entity.
However, that dividing line (individual/legal entity) is not as defined as it seems. There are legal entities whose income is not taxed by Corporation Tax, such as civil societies, non-profit organizations, or basically, any public welfare and charitable institution which have no commercial purpose. In other words, they do not operate to make money.
And, in the same way, there are entities without legal personality subject to Corporation Tax. Investment funds are an example of this.
How is income calculated in Corporation Tax?
As a general rule, the amount of Corporation Tax is calculated based on accounting methods. This means that every company in the UK that needs to pay this particular tax must keep accounting records.
But the tax base implied by the Corporation Tax is not precisely according to what a company’s accounts show. Therefore calculation of taxable income, adjustments must be made to company accounts.
Additionally, Corporation Tax has an influence that goes beyond legal and other entities subject to it. The rules for the calculation of Corporation Tax also apply to individual entrepreneurs who estimate the income through direct estimation. They are taxed in the category of “personal income tax” on revenue whose calculation is done according to the rules.
What is the purpose of Corporate Tax?
The primary mission of corporate tax is common to all taxes.
obtaining income that contributes to the maintenance of public spending. Just like any other tax, the government uses this money to run the country.
The second mission is to try to influence the economy.
To do this, it taxes various activities with greater or lesser economic standards. For example, Corporation Tax rates are also modified for small entrepreneurs and SMEs in the form of deductions and other incentives, as a way of encouraging small businesses to exist and entrepreneurs to thrive.
There are also specific business entities that find a benefit in the Corporate Tax. In some cases, these are people or objects with an advantageous regime. With this beneficial regime, it is intended to facilitate their business activity. Two examples of this are small businesses and nonprofit entities.
The third mission is informative.
The subjection to the Corporation Tax, even at low tax rates, implies the emergence of a set of obligations that go beyond its payment.
Taxpayers must submit statements and other models, must have a tax identification code, have census obligations, etc. And, of course, they have a responsibility to keep accounting records according to the country’s laws.
The tax information collected through the Corporation Tax is beneficial for the Administration. It justifies that there are companies that are being taxed at a rate of 19% in the UK.
However, this does not mean that employees of the business do not have to pay their taxes. Their income statements will include everything not related to the market. They will also have to consider the fiscal impact (both in their declaration of income and in the corporate tax paid by the company) of possible relations between a company and the controlling partners (and the persons and entities linked to them) like the following:
- The performance of an administrator position.
- The collection of a payroll of the company.
- The performance of work as an independent professional for society.
- The collection of dividends.
- That a partner grants a loan to the company.
- The transfer of local or other elements of any kind to the company.
What are the mechanics of corporate tax?
As in other taxes, it is necessary to calculate a tax base that measures the need to pay tax. In this case, it will be a matter of obtaining income by companies and other entities subject to corporate tax.
Making models of the corporate tax rate
There are specific rules of accounting to generate corporation tax. However, its own rules indicate certain adjustments that must be made, such as these:
- Accounting expenses, not tax-deductible.
- Accounting expenses can be tax-deductible at a later period.
- Limits that mark an amount up to which an accounting expense can be tax-deductible.
- It is accounting income or expenses that are quantified differently from a tax point of view.
- Income that can be declared as collections are obtained, instead of when it is appropriate to account for them.
What is considered an economic activity?
For the HMRC corporation tax calculation, an economic activity consists of any action in which material or goods of a business are used in the allocation of goods or services. Provided that a company organizes a business activity in the marketplace, involving the sale of products or services which are charged using money. It will come under the tag of economic activity, regardless of the event, is related to social and statutory purposes.
Let’s see some examples:
- Organize a contest and collect a registration fee from participating.
- Edit a magazine and sell it to be financed.
- Organize training sessions and collect a registration fee from participating.
- Organize activities during the festivities where free concerts are held and set up a bar where they sell drinks.
What tax consequences do you have to carry out in economic activity?
The main consequence is that of having to comply with all the financial obligations that entail:
- Submit the corresponding census declarations to notify the HMRC of the start of the business activity and, where appropriate, possible modifications or cancellation.
- Comply, where appropriate, with the corresponding obligations related to VAT or withholdings.
- Comply, with the presentation of the Corporation Tax declaration. Additionally, pay the corresponding tax if a fixed fee is issued.
We must bear in mind that, in the same way, that not all the income of a business is subject to the tax. We will not be able to deduct all the expenses that we have borne.
In this sense, as the ‘income from social activity’ (fees, subsidies, and donations) are exempt from taxation, the ‘social expenses’ will also be non-deductible. It means that we can only deduct those expenses that are part of the non-exempt income, fundamentally, the costs of the economic activities carried out.
In addition to the ‘social expenses,’ there are other expenses that are not deductible, such as fines and administrative penalties and the share of the Corporation Tax itself.
To know if we must pay something for the Corporation Tax, the first thing we should know is how to determine the tax base, which we can define as the revenue generated by a business or organization, which is not exempt from the tax.
Recall that among the mandatory accounting documents is the profit and loss account, which should reflect the total tally of both incomes for the year (exempt and non-exempt) and expenses incurred during the year.
The difference between the two is the accounting result of the fiscal year in question. It can be positive (during the year we have obtained more income than expenses), so we will have benefits. Or it can be negative (during the year we have generated more expenses than income) so that we will have obtained losses in that year.
This situation will typically occur in a business situation that has been generating positive results for a series of years and that at this time, the business decides to use that surplus so that expenses in that year will easily exceed the income obtained.
However, this accounting result will not usually coincide with the tax base of the Corporation Tax, since, there are revenues that are recorded in accounting. Still, HMRC considers exempt (so they are not part of the base taxable). Examples include membership fees, grants, and donations, and some expenses are also included in accounting records but that the Treasury does not allow the deduction, so they are not part of the tax base.
Who must file the Corporation Tax
- All kinds of business entities, whatever their form or status, provided they have their legal personality, except civil societies.
- Mercantile companies: corporations, limited liability, collective, labour, etc.
- State, autonomous, provincial and local societies.
- Cooperative societies and agrarian transformation societies.
- Sole proprietorships.
- Economic interest groups.
- European economic interest groups.
- Associations, foundations, and institutions of all kinds, both public and private.
- Public entities (State Administrations, Autonomous Communities Administration, Local Corporations, Autonomous Organizations, etc.).
In addition to the following entities lacking their legal personality:
- Investment funds regulated by the law.
- Temporary unions of companies.
- Venture capital funds.
- Pension funds.
- Mortgage market regulation funds.
- Mortgage securitization funds.
- Asset securitization funds.
- Investment guarantee funds.
- The communities that own neighbourhood forests in standard hands.
- Bank Asset Funds.
Ways to pay less corporation tax
Any business would find it an ideal situation if they could avoid paying the corporation tax. However, it is not possible and certainly not recommended because the HMRC can knock your doors at any time. However, you can implement the following strategies to pay less tax, if not all.
Delaying the tax
In some cases, we invoice operations that are not going to be carried out until next year. Well, the income must belong to the year of accrual. In this case, this income can be taken to the following year delaying the payment of Corporation Tax for this year. A clear example is an invoice dated December that will be performed in January of the next year.
Fixed assets of low value
If we buy fixed assets of low value (those that have a value of less than £300), we can fully amortize them the year of the acquisition, without having to take it via amortization year after year. For example, a printer that costs us £250. Amortization is an accounting technique to lower the value of a tangible asset in the accounting books, by spreading its costs.
Provision of invoices
Another aspect to consider is to see if we have overdue invoices with more than six months at the end of the fiscal year, generally on 31/12. In this case, the regulations allow us to provide a provision for the same amount, thereby reducing the tax base.
Negative Tax Bases
It is essential to see if we have negative tax bases from other years since there is no longer a temporary limitation and they do not expire, we can use them to compensate for the benefits of the current exercise.
As for the deductions in instalment, we must see if we have donated since we could save up to 40% of the contribution made, as long as they have been made to entities that are under the special patronage regime.
Deduction for R + D + I Expenses
The deduction applies to research, development, and innovation expenses that must be taken into account since it can reach 25% of the costs incurred for these items.
The better understanding of the Corporation Tax in the UK is fundamental in the improvement of the management of SMEs, being one of the essential pieces of business taxation, with an impact both in daily operations and in the most strategically relevant decisions in the life of the company.
Shoaib Aslam is the co-founder of Pearl Chartered Accountants, a UK-based chartered accountancy firm that has multiple locations across London. They are experts in helping startups and established businesses with all aspects of growth, strategy, scaling up, accounting and tax planning.