What is corporation tax ?

For many freelancers, contractors and small businesses it is beneficial to trade as a limited company for a combination of tax and non-tax reasons and the profits of limited companies are taxed through corporation tax – this article explains what is corporation tax.

We have posted some previous articles which explain the tax savings of limited companies and the non-tax issues.

What is corporation tax

We are going to keep the article simple and focus on micro businesses, freelancers and contractor who make up the vast majority of limited companies in the UK.

Corporation tax for bigger companies that might have multiple divisions or are multi-national are a lot more complicated but for most of the UK corporation tax is pretty simple to understand so we’ll focus on them when it comes to the question of what is corporation tax.

When you register your company with Companies House usually within a few weeks HMRC will write to you to tell you what your first corporation tax period is and what your companies tax reference is (unique tax reference ‘utr’) – this will be ten digits long preceded by a three digit number which indicates what your companies corporation tax office is. If you don’t receive this from HMRC you’ll need to call them on the corporation tax helpline to ask them to post it to you.

In some circumstances you might have setup a company but might not have started trading yet and you might be able treat the company as “dormant” for corporation tax  – have a read of HMRC’s guidance here to see if this applies to you.

For the 14-15 and 15-16 tax years the corporation tax rate is 20%. For bigger businesses there is a slightly higher rate of 21% for 14-15 but this won’t apply to most people.

The 20% corporation tax is applied to the businesses taxable profits and must be paid within 9 months and 1 day of the companies financial year end.

UPDATE – for 2017/18 the corporation tax rate has reduced to 19%

For most small businesses the profit and loss will look something like the below.

Screenshot 2015-03-22 08.51.06For corporation tax there are a few adjustments that need to be made for the typical freelancer, contractor and small business:

  • Client entertaining – this is not an allowable expense for corporation tax purposes so needs to be added back in our tax calculation.
  • Capital expenditure – bigger purchases of equipment will be treated as a fixed assets and their cost will be “depreciated” to the profit and loss account over a relevant period of time in relation to it’s “useful economic life” (for example it is quite common to depreciate a new laptop over a 3 year period). For corporation tax we ignore the depreciation and can usually claim the entire cost of the purchase in the year of purchase under something called the “Annual Investment Allowance”. For this reason it is a good tax planning strategy to buy computer and office equipment before your companies year end to accelerate the corporation ax savings.

There are some other potential adjustments but these two are the most common ones.

Below shows the corporation tax calculation of our example profit and loss account where we have assumed £5,000 has been spent on fixed assets.

Screenshot 2015-03-22 08.55.34

So the corporation tax due on this example is £17,070 and would need to be paid to HMRC no later than 9 months and 1 day from the accounting year end which is 31 March 2015 for this example.

Information on how to pay your corporation tax can be found here.

TOP TIP : It is important to factor in your running corporation tax position when it comes to assessing your profits available for dividends – if you want to super charge your businesses book-keeping you should consider FreeAgent which estimates your corporation tax bill as you go along so you will always know what your corporation tax is.