An Introduction to Corporation Tax

Starting your own limited company can be a daunting process, especially if you are new to the world of business management. Suddenly you are expected to know and understand all the regulations and legal processes that limited companies must abide by. These are wide-ranging, from employment laws and data protection to health & safety and Corporation Tax.

Getting your Corporation Tax wrong can land you in a lot of bother with His Majesty’s Revenue and Customs (HMRC). So, it’s worth doing your due diligence to ensure you do not fall foul of the UK’s complicated tax system.

What is Corporation Tax and who needs to pay it?

Corporation Tax is paid to HMRC by all limited companies in the UK and by some overseas businesses if they have a UK establishment. It is a tax on profits and is one of the few types of tax that is almost universally upheld across the world. In fact, there are only 14 countries that do not have some sort of Corporation Tax. These include Monaco, Bermuda, and the Cayman Islands.

Corporation Tax in the UK may also need to be paid by other entities including;

• Clubs, societies, and associations
• Co-operatives
• Housing associations
• Membership organisations

To pay Corporation Tax, companies must file a corporation tax return. As this can be a complicated process, many choose to work with an accountant to take care of the process on their behalf. However, taking this step will not remove business owners from the process entirely, as they remain legally responsible for ensuring it is filed accurately and on time.

Businesses that aren’t required to pay Corporation Tax include sole traders and partnerships. Instead, they may complete a self assessment tax return or have income tax applied to their earnings.

How much needs to be paid?

The way Corporation Tax is calculated has changed of late in the UK. Previously all business profits were taxed at a flat rate of 19%. However, this was amended in April 2023, and it is now calculated based on the amount of profit earned. The new regulations mean there are three different Corporation Tax rates, an upper limit, lower limit, and a marginal rate.

If profits are above the upper limit of £250,000, 25% tax will be applied. Those in the lower limit, with a profit of £50,000 or less, will be taxed at the original 19% rate. The marginal rate applies to businesses that make a profit between £50,000 and £250,000. In these cases, the 25% rate applies but they qualify for marginal rate reliefs which reduces a company’s tax liability. This creates a sliding scale to ensure businesses pay tax proportionally to their profits. 

The changes to the Corporation Tax system were made to ensure that the UK’s economy remained stable, but the rate rise was not well received by business owners. Whilst the UK has quite a low rate compared to other countries, such as Comoros in East Africa which has the world’s highest corporation rate of 50% or Puerto Rico which has the second highest rate at 37.5%, knowing that others around the world must pay more doesn’t alleviate the pain.

Corporation Tax relief might make a difference

Whilst Corporation Tax rates have increased for many businesses, there are ways to legally lower the amount owed.

1. Claiming on business expenses

Business expenses are deducted from a company’s income report. So, a business can reduce its profits courtesy of overheads and operating expenses. This in turn reduces the amount of Corporation Tax owed. However, there is a fine line over what expenses can and can’t be claimed, so it’s always best to check HMRC’s allowable business expenses list or, better still, work with a professional accountant who is well-versed in filing corporation tax returns.

• Capital Allowances

These are a type of tax relief which allow businesses to deduct some or all of the value of certain items from profits before tax is paid.

They can be claimed on:

• Equipment
• Machinery
• Business vehicles

The Annual Investment Allowance (AIA) is a type of capital allowance that allows expenditure on specific equipment and machinery to be deducted from taxable profits. The idea is to help businesses invest further in equipment that will help them generate more potential profit in the future, which is ultimately good for the UK economy.  

Other types of capital allowance include the Writing Down Allowance (WDA) and First-year Allowance (FYA).

Another benefit of capital allowances is you can claim for capital expenditure previously not claimed and incurred in previous periods.

• Research & Development (R&D)

Companies that focus on advancing the UK’s science and technology excellence can also benefit from tax reliefs. R&D tax relief can be applied in two ways, either as a deduction from taxable profits if the business is making a profit, or as a cash payment from HMRC if the business is making a loss.

• The Patent Box Tax Regime

This works by reducing the tax rate to 10% on profits that are generated from patents. This means if a business makes some, or all, of its profits because of patented products, services, or processes the Patent Box may be a very useful tool for reducing Corporation Tax contributions. However, it can be a complicated process as it can only be applied to profits made directly from products or services with a patent, not company profits as a whole. So, it’s wise to work with a professional.

• Employee-related schemes

Relief is also available from business activities relating to its employees. For example, some employee share schemes qualify for a Corporation Tax reduction, so offering employees shares isn’t just beneficial from a recruitment and retention perspective, but may also be tax advantageous too.

Elsewhere, costs relating to training and subscriptions that are paid for are also likely to be tax deductible. Additionally, business owners can claim up to £150 per head for an annual staff party.

• Tracking losses

Where relevant, businesses can also offset their previous years’ losses against current profits to reduce Corporation Tax liability.

To summarise

Corporation Tax is something that all limited businesses are likely to need to pay, and the repercussions of making errors are quite severe. As the Corporation Tax system has got more complicated over the years, more businesses are running into bother with HMRC. To avoid tax troubles the best approach is likely to be to consult an accountant.

Find out more about Wellers’ knowledge and skills as to how we help small businesses in our corporate tax planning page.