How is my corporation tax bill calculated?
Many small businesses trade as a limited company because of the tax savings available - although these are less now that the new dividend tax has been introduced. And we've covered both the tax savings to be made and the pros and cons of being a limited company in previous blogs.
In this blog we'll cover how your corporation tax bill is calculated - explaining the difference between the profit you see in your accounts and the profit on which you get charged tax. And this blog is for small, owner managed businesses (including freelancers and contractors) and doesn't cover the corporation tax issues for larger companies or groups of companies - these issues can be many and complicated!
The first thing you should have when you start to trade is a 10 digit Unique Taxpayer Reference. This is sent out when you register your company at Companies House. If you haven't received this reference you'll need to contact HMRC's corporation tax helpline.
If you set up your company before you're intending to trade (for example you want to 'claim' the limited company name for yourself) then you can let HMRC know that your company is dormant. A dormant company doesn't have to complete a tax return - it simply has to file dormant accounts with Companies House each year. To find out whether HMRC will consider your company dormant just click here.
So, you've registered your company, have a 10 digit UTR and have now been trading for a year. So how will your corporation tax be calculated?
The company's taxable profit will be different to its accounting profit as some items of expenditure won't be allowable for tax and others will. The main two adjustments you will usually see in your tax computation are shown below. For other allowable and non-allowable expenses, see our blog on what you can and can't claim here.
Depreciation and capital allowances
The main adjustment most companies need to make when calculating their taxable profit and corporation tax bill relates to their capital expenditure.
Capital expenditure relates to money spent on fixed assets - assets which you buy which will last for several years in the business. Examples of fixed assets are computers, office furniture, plant & machinery and, if you've bought them through the company, cars.
Rather than being expensed in your accounts immediately (as, say, any money spent on stationery would be), the cost of these items will be written off in the accounts over a number of years. So, for example, if you buy a new laptop for £600, this won't appear as a cost in the company's profit and loss account. Rather it will appear on your balance sheet as a fixed asset and, if the company feels this will last for 3 years, a 'depreciation' cost of £200 per year will be posted to your profit and loss account for the next 3 years. At the end of the three years, the laptop will appear on your balance sheet with a cost of £600 and accumulated depreciation of £600 - so a net book value of £0.
However for tax purposes depreciation is not an allowable expense. So this will be added back when calculating your taxable profit.
Instead it will be replaced with 'Capital Allowances' - a set of allowances which may be more or less generous than the depreciation charge depending on the asset purchased.
Under the current capital allowance regime (as at June 2016), most assets which will be treated as fixed assets in the accounts of a small business will be eligible for the 'Annual Investment Allowance' - currently allowing a 100% write off for qualifying assets up to a total of £200k.
So there will be a significant cashflow benefit as the company's taxable profit in year 1 will be less than its accounting profit. However, assuming no more assets are bought, this cashflow benefit will reverse during years 2 and 3. (If these timing differences are significant, the company may need to put a deferred tax adjustment through its accounts to 'equalise' these calculations).
You may feel that entertaining your customers and suppliers is a legitimate part of your business – unless you play the game, you won’t get their custom.
Unfortunately the taxman doesn’t feel the same way and any expenditure on entertaining your customers is not be allowable for tax. Again like depreciation this adjustment will affect your corporation tax bill.
So what would that look like?
Your tax computation
Let's assume your profit and loss account looked something like this:
Assuming you'd spent £5,000 during the year on fixed assets, the tax computation would look like this:
Corporation tax is payable 9 months and 1 day after the company's year end - so in this example the corporation tax would be payable by 1st January 2018 in order to avoid any late payment penalties or interest.
However the company has slightly longer to file it corporation tax return as this isn't due for filing until 12 months after the company's year end.
It's also important to factor in the company's corporation tax charge when calculating how much profit is available for distribution as dividends - otherwise you could end up in a situation where you pay too much as dividends and this can lead to a nasty tax trap!