What is adjusted profit for corporation tax?

I run my own small limited company and I have just received my draft accounts and corporation tax return from my accountant for the year ended 31 Dec 2017. I have noticed that my corporation tax doesn’t seem to be working out at 19% of my profits, why could this be the case?

 

Corporation tax adjusted profit

 

Answer March 2018:

The headline rate of corporation tax for 2017/18 and 2018/19 is 19%.

However, the calculation of corporation tax is, in many cases, not as simple as taking the profit and multiplying this by 19%, there are a number of adjustments that need to be made when taking company profits per the accounts and calculating taxable profits.

We look at some of the more common adjustments for small companies below:

 

Disallowable expenses

When calculating company profits there are a number of costs that the company suffers in any given year which, although should be deducted when calculating profits for accounting purposes, need to be added back to determine taxable profits.

We look at four major categories below:

 

Client entertaining

As a general rule entertaining clients (or potential clients), as well as general business contacts, is not an allowable expense for corporation tax purposes and needs to be added back to the accounting profits to calculate taxable profits of a company.

If, for example, accounting profits were £10,000 in a given accounting period, with £1,000 of client entertaining, the taxable profits for that period would be calculated at £11,000 – assuming no other adjustments were required.

 

Costs of incorporation

You cannot claim the costs of setting up a company for corporation tax purposes.

Although these costs can be brought into the first-year accounts there will need to be an adjustment for these before calculating the corporation tax liability.

 

Fines and penalties

Any fines or penalties incurred where a company has fallen foul of rules are not allowable costs for corporation tax purposes. As such these need to be added back to company profits when computing taxable profits.

Most common types of fines a company could suffer would be parking fines and late filing or payment fines.

 

Depreciation charge

Where a company buys an asset which is considered to have a life longer than one year, this asset is normally capitalised for accounting purposes and taken to the balance sheet.

This asset is then written off against the profit figure by a process of depreciation over the life of the asset.

For example, a laptop costing £3,000 may be considered to have a life of 3 years at the time of purchase, as such in the accounts the depreciation charge will be £1,000 per year. After the 3 years the value of the laptop on the balance sheet would be nil.

The £1,000 annual depreciation would be a disallowable cost for corporation tax purposes in each of the 3 years.

The company would instead receive tax relief for the laptop by virtue of the annual investment allowance, discussed next.

 

Annual Investment Allowance / Capital Allowances

The Annual Investment Allowance is a type of Capital Allowance – Capital Allowances are the mechanism by which capital assets attract tax relief.

For corporation tax purposes you would take the accounting profit then deduct the Annual Investment Allowance in order to arrive at taxable profits.

Taking the example of the laptop discussed above, this would usually qualify for the Annual Investment Allowance and as such the full cost would be allowable for corporation tax purposes in the year of purchase.

Therefore, if the profits of the company were £10,000 after adding back depreciation, then £3,000 would be deducted to produce taxable profits of £7,000.

There is more on the Annual Investment Allowance and Capital Allowances here.

 

Losses

Where a company has made a loss in the previous period (or potentially even the preceding period) this may be carried forward to the current accounting period in computing the taxable profits.

For example, if the company had made a taxable loss of £2,000 in the previous period which was carried forward and £10,000 of taxable profits in the current period, the overall taxable profits would be £8,000 – this would then be the figure that was multiplied by the prevailing corporation tax rate (currently 19%) to determine the corporation tax payable.

 

Change in corporation tax rate

For the example of a year ending 31 December 2017 there may be an alternative reason (before any of the above-mentioned adjustments) as to why corporation tax does not work out as 19% of profits.

The corporation tax rate changed from 20% to 19% on 1 April 2017.

As such where a company tax year straddles this date the profits get apportioned between these two rates on a pro-rata basis.

If the total taxable profit for the year to 31st December 2017 was £10,000, £2,466 (90/365 days x £10,000) would be apportioned to the period 1st January 2017 to 31st March 2017 and taxed at 20% with the remainder taxed at 19%.

 

Summary of corporation tax adjusted profits

The above examples are in no way exhaustive even for small companies but are illustrative in nature to show that calculating corporation tax is not as simple as taking the profits per the accounts and charging 19%.