Introduction
Corporation tax is a direct tax imposed on the taxable profits of companies and certain organizations operating in the United Kingdom. It applies to a company's income derived from trading activities, investments, and capital gains from the disposal of assets. Accurate calculation of taxable profits is necessary to ensure compliance with tax legislation and requires a thorough understanding of the components that contribute to taxable income. This article examines the key elements involved in computing taxable profits for corporation tax purposes, focusing on chargeable receipts, allowable deductions, and capital allowances.
Chargeable Receipts
Chargeable receipts constitute the total income subject to corporation tax. They include various forms of income a company earns, each with specific considerations for tax purposes.
Trading Income
Trading income represents the revenue generated from a company's principal business activities. It includes:
- Proceeds from the sale of goods or services.
- Income from activities closely related to the main trade.
Trading income is recognized on an accruals basis, meaning income is accounted for when it is earned, regardless of when payment is received. This approach ensures that income is matched with the expenses incurred to generate it within the same accounting period.
Non-Trading Income
Non-trading income arises from sources outside the company's core trading activities and may include:
- Interest Received: Income from investments or loans provided to others.
- Rental Income: Earnings from leasing property or equipment to third parties.
- Royalties: Payments received for the use of intellectual property rights.
Each category of non-trading income may be subject to different tax treatments and requires careful consideration to ensure accurate tax computations.
Chargeable Gains
Chargeable gains refer to the profits realized from the disposal of capital assets, such as property, equipment, or shares. The calculation of chargeable gains involves:
- Determining Disposal Proceeds: The amount received from selling the asset.
- Deducting Acquisition Costs: Including the original purchase price and any incidental costs associated with the acquisition and disposal.
- Applying Indexation Allowance: For assets acquired before 1 January 2018, adjusting the cost base for inflation to the date of disposal.
- Considering Available Reliefs: Such as the Substantial Shareholdings Exemption (SSE) for qualifying share disposals.
Understanding the rules surrounding chargeable gains is important for correctly assessing the tax liability arising from the sale of assets.
Exempt Income
Certain types of income are exempt from corporation tax to prevent double taxation or encourage specific economic activities. Exempt income includes:
- Dividends: Received from other UK companies, generally exempt unless specific conditions apply.
- Distributions from Authorized Unit Trusts: And open-ended investment companies.
Identifying exempt income is critical, as it affects the calculation of taxable profits and ensures that companies do not overpay tax.
Deductible Expenditures
Deductible expenditures are expenses that a company can subtract from its chargeable receipts to determine its taxable profits. These expenses must meet specific criteria to qualify as allowable deductions.
General Principles
For an expense to be deductible for corporation tax purposes, it must satisfy the following conditions:
- Wholly and Exclusively Incurred: The expense must be incurred entirely for the purposes of the trade.
- Revenue in Nature: It should not be capital expenditure related to the acquisition or improvement of fixed assets.
- Not Specifically Disallowed: The expense must not be expressly prohibited by tax legislation.
Following these principles is necessary when assessing whether an expense can reduce taxable profits.
Common Deductible Expenses
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Employee Costs
- Salaries and Wages: Remuneration paid to employees for their services.
- Employer's National Insurance Contributions: Statutory payments based on employee earnings.
- Pension Contributions: Payments into employee pension schemes, subject to relevant limits and conditions.
-
Premises Expenses
- Rent: Payments for leasing business premises.
- Business Rates: Local taxes charged on property used for business purposes.
- Utilities: Costs of electricity, gas, water, and other essential services.
- Repairs and Maintenance: Expenses for keeping the premises in good working condition, excluding improvements.
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Administrative Expenses
- Office Supplies: Consumables like stationery and printing materials.
- Professional Fees: Costs for legal advice, accounting services, and consultancy fees.
- Insurance Premiums: Payments for policies covering business risks.
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Finance Costs
- Interest Payments: On business loans and overdrafts used for trading purposes.
- Bank Charges: Fees for banking services and transactions.
- Bad Debts Written Off: Debts considered irrecoverable after reasonable steps to collect have failed.
Illustrative Example: Allowable vs. Disallowed Expenses
A company incurs the following expenses:
- Purchase of Raw Materials: Allowable, as they are directly related to the production of goods.
- Client Entertainment Costs: Generally disallowed, as they are not considered wholly and exclusively for trade purposes.
- Fines for Regulatory Breaches: Disallowed, since penalties are not deductible.
- Staff Training Expenses: Allowable, as they improve the skills of employees and benefit the trade.
Recognizing disallowed expenditures is important to ensure that tax calculations are accurate and comply with HM Revenue & Customs (HMRC) regulations.
Capital Allowances
Capital allowances provide tax relief for capital expenditure on certain assets used in the business. Instead of deducting the cost of such assets directly, companies claim capital allowances to reduce their taxable profits over time.
Annual Investment Allowance (AIA)
The AIA allows companies to claim 100% tax relief on qualifying expenditure on plant and machinery in the year of purchase, up to an annual limit. Key features include:
- AIA Limit: Currently set at £1,000,000 for expenditure incurred until 31 December 2021.
- Qualifying Assets: Most plant and machinery, excluding cars.
- Shared Allowance: The limit must be apportioned among group companies or those under common control.
Example: A manufacturing company invests £800,000 in new production equipment. Under the AIA, it can deduct the full £800,000 from its taxable profits in the year of purchase, significantly reducing its corporation tax liability.
Writing Down Allowances (WDA)
For qualifying expenditure that exceeds the AIA limit or on assets not eligible for AIA, companies can claim WDAs. There are different rates depending on the type of asset:
-
Main Pool
- WDA Rate: 18% per annum on a reducing balance basis.
- Assets Included: General plant and machinery not requiring special rate treatment.
-
Special Rate Pool
- WDA Rate: 6% per annum on a reducing balance basis.
- Assets Included: Long-life assets, core features of buildings (e.g., electrical systems), thermal insulation, and cars with high CO₂ emissions.
Example: A company has a special rate pool asset with a value of £200,000. The WDA claimed for the year would be £12,000 (6% of £200,000).
Structures and Buildings Allowance (SBA)
The SBA provides relief for capital expenditure on the construction or renovation of non-residential structures and buildings. Key points include:
- Annual Relief Rate: 3% on a straight-line basis over 33 1/3 years.
- Qualifying Expenditure: Construction, renovation, or conversion costs incurred on or after 29 October 2018.
- Commencement of Allowance: Relief begins when the building is brought into qualifying use.
Understanding capital allowances is important for effective tax planning, as it allows companies to optimize the timing and amount of tax relief on significant capital investments.
Complex Tax Scenario
Calculating corporation tax can become complicated when multiple elements interact. The following example illustrates the application of the principles discussed.
Example: Comprehensive Corporation Tax Calculation
Company Profile: TechDynamics Ltd is a company specializing in electronic equipment manufacturing for the year ended 31 March 2021.
Financial Information:
- Trading Income: £3,000,000
- Non-Trading Income:
- Interest Received: £75,000
- Rental Income: £125,000
- Chargeable Gains:
- Disposal of Machinery: Gain of £50,000
- Exempt Income:
- Dividends from UK Subsidiary: £40,000
- Allowable Trading Expenses: £1,800,000
- Capital Expenditure:
- Purchase of New Machinery: £1,200,000 (qualifies for AIA)
- Purchase of Special Rate Asset: £300,000
- Written-Down Value:
- Main Pool: £500,000
- Special Rate Pool: £200,000
Tax Computation:
-
Trading Profit
Trading income: £3,000,000
Less: Allowable trading expenses: £1,800,000
Initial trading profit: £1,200,000
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Capital Allowances
-
AIA on New Machinery: £1,000,000 (maximum AIA limit)
-
Remaining Expenditure on Machinery: £200,000 added to the main pool.
-
WDA on Main Pool:
-
Additions: £200,000 (excess over AIA)
-
Written-down value brought forward: £500,000
-
Total: £700,000
-
WDA at 18%: £126,000
-
-
Additions to Special Rate Pool: £300,000
-
Written-down value brought forward: £200,000
-
Total: £500,000
-
WDA at 6%: £30,000
Total capital allowances:
-
AIA: £1,000,000
-
WDA (Main Pool): £126,000
-
WDA (Special Rate Pool): £30,000
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Total: £1,156,000
Adjusted trading profit after capital allowances:
£1,200,000 - £1,156,000 = £44,000
-
-
Non-Trading Income
-
Interest received: £75,000
-
Rental income: £125,000
Total non-trading income: £200,000
-
-
Chargeable Gains
- Gain on disposal of machinery: £50,000
-
Total Profits Before Deductions
Adjusted trading profit: £44,000
Non-trading income: £200,000
Chargeable gains: £50,000
Total profits: £294,000
-
Deduct Exempt Income
- Dividends received from UK subsidiary: Exempt and not included in total profits.
-
Taxable Total Profits
Taxable total profits: £294,000
-
Corporation Tax Liability
Corporation tax rate for the year: 19%
Corporation tax due: £294,000 x 19% = £55,860
This example demonstrates how various components—trading profits, capital allowances, non-trading income, and chargeable gains—are combined to determine the corporation tax liability.
Conclusion
Calculating taxable profits for corporation tax purposes requires meticulous consideration of multiple factors. The accurate identification and categorization of chargeable receipts—including trading income, non-trading income, and chargeable gains—form the basis of the computation process. Detailed knowledge of deductible expenditures, aligned with the principles that govern allowable expenses, ensures that companies maximize legitimate deductions while remaining compliant with tax regulations.
Capital allowances play a significant role in providing tax relief for capital investments. Understanding the distinctions between the Annual Investment Allowance, Writing Down Allowances, and other specific allowances like the Structures and Buildings Allowance allows companies to plan effectively and comply with tax requirements.
The calculation process becomes more complicated when these elements interact, as illustrated in the comprehensive example provided. Companies must apply the tax rules meticulously to each component to determine the correct tax liability. An understanding of how chargeable receipts interact with allowable deductions and capital allowances is fundamental for accurate tax calculations.
By thoroughly understanding these principles, companies can not only ensure compliance with HMRC requirements but also make informed financial decisions that optimize their tax position within the legal framework.
