UK Corporation Tax: The Absolute Beginners Guide

May 22, 2018

Tax is definitely a little bit taxing and so it is not surprising that we often speak to Xero users who have misconceptions about Corporation Tax.

 

With this in mind, we thought we’d put together a simple list of facts about Corporation Tax to help dispel some of these misconceptions.

 

 

1. Corporation Tax is paid by all Limited companies

 

Every Limited company must pay Corporation Tax on its Taxable Profit at the prevailing corporation tax rate. There are no exceptions and and there is no zero-rated corporation tax band for companies with very small profits.

 

All companies must tell HMRC how much Corporation Tax they owe by completing a Company Tax Return. To find out more about when to submit this return and pay the tax owed, please read our post here.

 

 

2. Your Company’s Net Profit and its Taxable Profit are not the same thing

 

A company’s Taxable Profit is not the same as what most business owners would refer to as its Net Profit (before tax), which is simply a company's sales minus its costs.

 

Taxable Profit is calculated by adding together the company’s Trading Profit, Other Profit, and Chargeable Gains.

 

 

3. Trading Profit is the place to start when calculating Taxable Profit

 

Trading Profit is the primary input for calculating the Taxable Profit of most businesses.

 

It is supposed to represent the ‘real’ profit of your business from a taxation perspective and it differs from the familiar Net Profit because any income or expense that is not attributable to the core activities of the business is excluded from its calculation.

 

 

4. Non-Trading Income does not increase Trading Profit

 

Non-Trading Income is income that isn’t being generated by the core activities of your business. Typical examples are bank interest on deposit accounts and rent from a property the company owns - neither of which will normally have much to do with the operations or purpose of the company.

 

Note that while this Income does not count towards Trading Profit it is usually still added to Taxable Profit as part of the Other Profit figure described above. There are exceptions though: If, for example, your company receives income from dividends on shares that it holds in other UK companies then, in all likelihood, this income will not be counted as Other Profit and will in turn not be added to your Taxable Profit. (This is true even though it may have been recorded as a type of Income in your Xero system.)

 

 

5. Only Tax Deductible Expenses can reduce Trading Profit

 

In calculating the Trading Profit, the expenses your are permitted to include in the calculation are described as Tax Deductible.

 

The following common expenses are not Tax Deductible: Any expense of a capital nature (such as depreciation), any expense that is not wholly and exclusively for the purpose of the business, a variety of other expenses including those that are specifically classed as disallowable such as company incorporation fees and late filing penalties.

 

 

6. Chargeable Gains always add to Taxable Profit

 

Chargeable Gains will usually arise when your company disposes of an asset and profits from the disposal. They do not contribute to Trading Profit but they are always taxable and do therefore contribute to Taxable Profit. The taxable amount may however be offset against any losses made on the disposal of assets.

 

 

7. Tax Relief is exactly what you think it is: Relief from paying tax

 

There are seemingly countless ways by which Tax Relief can be obtained. Each is documented somewhere in the sprawling UK Tax Code which is purported to run to more than 10 million words.

 

Below you will find two of the most commonly-applied types of corporation tax relief available to small businesses:

 

  • Capital Allowances: This describes a family of tax reliefs that are available when the company purchases certain equipment. If, for example, the company purchases a computer, the associated expense of doing so will not be factored into your Taxable Profits because it is a Capital Expense. The company has however spent money and HMRC make a helpful provision for that reality. Most likely, a type of Capital Allowance called the Annual Investment Allowance (AIA) will be used to effectively reduce the taxable profits by the purchase price of the computer.  Learn more about Capital Allowances here.
     

  • Brought Forward Losses: Let’s say your company made a profit in its second year of trading after making a loss in the first year. Once you have calculated the second year’s taxable profits you can, in general, reduce these by the amount of the loss in the first. E.g. if the company lost £1000 in its first year of trade and made £1000 in the second year, then it should not need to pay any corporation tax in either year.  Learn more about Brought Forward Losses here.

 

Please note that these are just simple (and simplified) examples designed to explain what a tax relief is.

 

 

9. Your Corporation Tax should be calculated before you file your Company Accounts

 

It is very important to remember that the corporation tax you owe, as calculated on your company tax return, is an input for your final company accounts. You cannot prepare or file your final accounts without knowing the amount of corporation tax owed.

 

This seems circular - and it is! You first need to correctly work out the Net Profit before tax for your company accounts. Using this as a base, you then work out your Taxable Profit and apply any additions or reliefs. Finally, you calculate the tax due and adjust your company accounts - including the Net Profit before and after tax - accordingly. Fortunately this is as far as the circle goes.

 

 

As a final note, at Instafile we always recommend users prepare and file their accounts and corporation tax return at the same time. We sometimes observe that business owners rush the filing of their accounts. Instead of preparing the full set properly, they just type their balance sheet into the Companies House website, and then 3 months later, with the risk of filing an incorrect tax return present, they realise the filed accounts are incorrect.

 

Preparing and filing your accounts and corporation tax return at the same time is usually the fastest and most accurate approach to getting the job done. Instafile can help to take all the stress out of this process by using the the same data source (Xero) to quickly, accurately and simultaneously prepare and file both your company accounts and tax return.

 

 

Disclaimer: Every effort has been made to ensure the accuracy of this post but we do not warrant its accuracy. Always read and understand HMRC’s guidance on tax matters relevant to the business or person in question before taking or refraining from any action

 

 

 

 

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