Corporation tax is a percentage levy paid to HMRC on the profits generated by your business. The charge applies to all the money remaining after spending on “permissible expenses.”
How Does Corporation Tax Work?
Let’s say, for instance, that your icecream business takes £100,000 in sales for the tax year (which runs from April 6th to April 5th in the UK). That figure looks pretty good on paper, but when you factor in the money you had to spend to make it – your expenses – it adds up to a lot less. Summing the costs of running your business, such as wages, fuel for the ice cream van, and stock purchases, you get a figure of £75,000. Subtracting that from your revenue gives you profits for the year of £25,000. Thus, corporation tax applies to the £25,000 you have left after expenses.
HMRC calculates corporation tax as a percentage of your net profits. The actual rates tend to change from year to year in the UK. In the tax year starting April 2020, HMRC will charge 18 per cent (down from 20 per cent in 2016). So, returning to the above example and using the rate from April 2020, the tax bill for the ice cream van will be £4,500 – 18 per cent of £25,000.
As you can see, the more money you make, the more tax you pay. Interestingly, though, corporation tax is not progressive like, say income tax. That is, you don’t pay a higher percentage the more profits you make. The 18 per cent rate applies whether you make £1,000 or £1 billion.
If you run a small limited liability company, you usually have several months before you need to file your accounts with HMRC and several more months before you have to pay any taxes you owe. Most small businesses lose money during their first few years and so don’t generate any profits for the government to tax. For mature companies, however, it is a different story. The moment firms start making money; they are liable to pay corporation tax, a direct hit on their profitability (and the returns they can pay to shareholders).
What Is The Difference Between Corporation Tax And VAT?
Corporate tax is different from VAT or “value-added-tax.” Value-added-tax is a levy paid by the customers of firms in the form of higher prices. Companies set their non-VAT price according to supply and demand and then add the VAT rate (which is currently 20 per cent) as an additional charge. The customer pays this tax (often without even realising it), and the company collects the revenue and then sends it to HMRC, separate from the corporation tax bill. Importantly, companies pay VAT regardless of whether they are profitable or not.
Going back to our ice cream van company example, suppose that it costs the owner £1.40 to serve each icecream. The company wants to make a profit of every cone, so it adds 20 pence to the base price, bringing the cost of each ice cream to £1.60, before VAT. If VAT is 20 per cent, then the customer pays £2.00 flat. The icecream van takes £1.60 in revenue and 20 pence in profit, and the government gets the remaining 40 pence.
Just for context, the ice cream van owner still needs to pay corporation tax on the 20 pence profit they made on the ice cream (so long as the business is profitable overall). At a rate of 18 per cent, that’s an additional 4 pence that goes to the government following the sale of each ice cream.
To complicate matters slightly, not all companies have to pay VAT. Businesses that turnover less than £85,000 per year on a rolling 12-month basis, for example, are exempt. Likewise, certain products are exempt from VAT or command a much lower rate.
If, however, your company makes more than £85,000 per year, you must charge customers VAT and then pass this onto the HMRC. While technically, you’re not paying it, it can sometimes feel like you are. The best way to compensate is to add 20 per cent VAT to your fees, though you might lose sales.
Who Pays Corporation Tax?
In the UK (and most other developed countries for that matter), all limited liability companies have to pay corporation tax. There are, however, some exemptions.
New businesses, for instance, can avoid paying corporation tax by changing their year-end accounting date (if they incorporate but do not actively trade). Other companies can file to get their corporate tax repaid if they qualify for tax credits. Most, however, have to take the hit.
Don’t forget, corporation tax is owed on all profits your business makes, not just those from your operations. So if you make money from investments in other companies, you have to declare these and include them in your final summary of accounts.
If you base your company in the UK but receive revenues from overseas, you’ll still need to include these in your final corporate tax calculation too. The UK has “double taxation” arrangements with practically all countries around the world. So, as long as you’re based in the UK, you won’t have to pay additional corporation tax in foreign jurisdictions.
How To Pay Corporation Tax
If you register a business with Companies House, you have three months to register for corporation tax with HMRC (if you begin trading immediately).
To pay corporation tax, you’ll need something called a Unique Taxpayer Reference or UTR for short – a code that HMRC generates for your business. You can either get an agent to open an account with HMRC for you or do it yourself.
Just be warned that if you do decide to adopt the DIY approach, you need to know what you’re doing. As part of calculating how much corporation tax you owe, you’ll need to file either full or abridged company accounts. HMRC’s online portal tries to make this as friendly as possible by providing tooltips and doing some calculations for you. Still, unless you have experience in accounting, you’ll find it a challenge. There’s a lot of financial jargon.
Current rules state that corporation tax is due within nine months of the end of your firm’s financial year. HMRC will regularly send reminders in the post to your business address, telling you precisely when you need to pay your tax. You’ll also get reminders telling you that you need to complete your Company Annual Return, showing HMRC how you calculated your tax bill. You have twelve months following the end of the respective financial year to do this.
Know Your Financial Year
In general, it is not a good idea to leave it until the last minute. Things can and do go wrong when filing, so leave a couple of months before the deadline to be safe. Additionally, pay close attention to your financial year – it is not the same as the tax year for regular income tax. Your firm’s fiscal year runs from the date you incorporated it until a day before the same date the following year – for instance, January 31st to January 30th. The amount of corporation tax you pay depends on your profits during your financial year.
If your business is successful and you earn more than £1.5 million per year, HMRC forces you to pay in instalments every quarter. If you find that you have underpaid tax, speak with your agent. They will arrange catch-up payments with HRMC, although you may owe interest on any unpaid tax in the interim.