Understanding corporation tax is essential for businesses operating in the UK. Whether you’re running a small company or a larger organisation, it’s key to know how to calculate and manage this tax. In this guide, we’ll explore what corporation tax is, how to calculate it, and steps to avoid common mistakes.
What is corporation tax?
Corporation tax is a tax that UK-based businesses pay on their profits. It applies to both limited companies and certain other organisations like clubs, societies, and associations. Unlike income tax, which applies to individuals, corporation tax is paid on company earnings. Typically, you’ll need to register for corporation tax within three months of incorporating a limited company.
💡Editor’s insight: “Incorporation just means the legal process of forming a company. You’ll need a few documents to do this, including a memorandum of association, articles of association and a form IN01 from Companies House.”
What do you pay corporation tax on?
Corporation tax applies to various forms of income, including:
Trading profits: The earnings from the business after you have removed allowable expenses.
Investment income: Profits from investments, such as interest or dividends.
Chargeable gains: Profits from selling assets like property, shares, or equipment.
💡Editor's insight: “I find a lot of people think all income is subject to corporation tax. It’s important to know this is not always the case. There are exemptions or allowances where corporation tax is not needed such as sole traders and charities. It’s also worth noting that if a business is running at a loss, you will not need to pay until you make a profit."
How to work out corporation tax
Calculating corporation tax can seem daunting, but it doesn't have to be. Here's a step-by-step guide to help you navigate the calculation with confidence:
1. Determine your accounting period
You pay corporation tax on your company’s accounting period, which is the 12 months of your financial statements. If your accounting period is shorter or longer, you will need to work out corporation tax for these different timeframes. For example:
If your financial year runs from April 1 to March 31, your corporation tax applies to profits during this period.
If you have a shorter period due to starting or closing your business, HMRC requires two separate tax calculations.
2. Calculate total income
You need to work out what your company has earned from all sources of income during the accounting period. This includes:
Trading profits: You need to work out your trading profits from your business activities. You need to remove the costs linked to generating this income.
Investment income: Earnings from interest, dividends, or property rental.
Chargeable gains: You need to work out the profit from selling business assets. For example, property or equipment when above the purchase price.
💡Editor's insight: “I speak to many business owners who do not keep accurate financial records. I’ve found this has led to problems down the line. It’s so important to do so to make sure your total income is correct. If there are inaccuracies, be aware this can lead to penalties.”
3. Deduct allowable expenses
You can remove business expenses that are only run up for business purposes. Allowable expenses include:
Employee salaries and wages
Rent for office or retail space
Utility bills (electricity, water, internet)
Office supplies and equipment
Marketing and advertising costs
Example: If your trading profits were £200,000 and you had £50,000 in allowable expenses, your taxable trading profit would be £150,000. You do not include penalties and personal expenses in expenses.
4. Apply reliefs and allowances
Reliefs and allowances can reduce your taxable profits. Common examples include:
Capital allowances: You can claim capital allowances. The Annual Investment Allowance (AIA) allows you to deduct the cost of qualifying purchases up to £1 million. This could be vehicles, machinery or IT equipment.
Research and Development (R&D) tax credits: R&D tax relief aims to help companies that work on innovative projects in science and technology. If you qualify, these R&D tax credits can lower your tax bill.
Loss relief: If your company had a loss in previous accounting periods, you can carry these forward to balance future profits.
Example: If your taxable profit is £150,000, but you have £20,000 in capital allowances, your adjusted taxable profit becomes £130,000.
5. Calculate taxable profits
After taking away expenses and applying reliefs, the result is your company’s profit. This figure is what you’ll use to work out your corporation tax liability.
Example calculation:
Total income: £300,000
Allowable expenses: £50,000
Reliefs and allowances: £30,000
Taxable profit: £220,000
6. Apply the corporation tax rate
The next step is to multiply your taxable profits by the corporation tax rate. As of 2024/25, the corporation tax rate in the UK depends on your company’s profit:
19% for profits under £50,000 (Small Profits Rate)
25% for profits over £250,000 (Main Rate)
For profits between £50,000 and £250,000, a tapered rate applies
7. File your corporation tax return and pay
Once you’ve worked out your tax liability, the final steps are to:
File your CT600 return: You need to submit your corporation tax return online via HMRC’s system. This will give you a breakdown of your taxable profits and deductions.
Pay your tax bill: You then need to pay the corporation tax payments by nine months and one day after the end of your accounting period.
Are there ways to reduce your corporation tax bill?
Yes, there are a few ways to lower your corporation tax bill while staying fully compliant with tax laws. Common business practices include:
Claim capital allowances: You can cut the cost of assets like equipment or vehicles from your taxable profits.
Make pension contributions: Contributions to employee pension schemes can be tax-deductible.
Making charitable donations: Some tax reliefs are offered when you donate to charity. Companies often can pay less corporation tax if they donate money, equipment, or even land to charity.
Common mistakes when calculating corporation tax
Even small errors in your corporation tax calculations can lead to penalties or paying over the odds. Here are some common pitfalls to avoid:
Not claiming for allowable expenses: If you don’t deduct your allowable expenses, the taxable profits could likely be higher.
Having incorrect capital allowances: Be sure to check your capital allowances are correct. Any miscalculations could mean over or underpaying corporation tax.
Missing deadlines: You’ll usually get a company tax notice. However, late filings or payments can often lead to penalties and interest charges.
Having the incorrect accounting period: This is one of the most common reasons HMRC might query your corporation tax. Always double check your accounting period is correct.
Not seeking professional advice: Tax issues can be undeniably complex. When in doubt, seek help or advice from an accountant or tax advisor.
FAQs
Should I use online corporation tax calculators?
Online calculators can be useful for estimating your corporation tax liability. However, they may not account for all the reliefs and allowances of your specific business. We always recommend to consult with an accountant or tax professional.
What documents do I need to calculate corporation tax?
To calculate corporation tax, you’ll need:
Profit and loss statements
Records of allowable expenses
Details of capital expenditures
Documentation for any reliefs or allowances claimed
Final thoughts
Calculating corporation tax is a fundamental part of running a business in the UK. We have looked at the steps involved in how is corporation tax calculated, including potential tax reliefs and common mistakes. Need legal advice for your business? Our team of small business lawyers are on hand to help. Get in touch today for a free quote and see how we can help.
References
Pay your corporation tax bill from Gov.UK
Corporation tax rates from Gov.UK
Disclaimer: This article only provides general information and does not constitute professional advice. For any specific questions, consult a qualified accountant or business advisor. Bear in mind that tax rules can change and will differ based on your circumstances.