Learning Outcomes
After reading this article, you will be able to explain how corporation tax applies to UK companies, including the basis on which it is charged, how to calculate taxable profits (income and capital gains), the key reliefs available, the rules for group companies, and the interaction between corporation tax, distributions, and business structures. This understanding will help you assess tax consequences accurately for company clients in the SQE2 exam.
SQE2 Syllabus
For SQE2, you are required to understand corporation tax as it applies to companies in England and Wales. Focus your revision on the following:
- the basis of charge for corporation tax and what entities are liable
- calculation of a company’s corporation tax liability, including chargeable income and capital gains
- key statutory reliefs for trading losses and groups
- the treatment of company distributions, such as dividends and buybacks
- interaction with business structure and practical issues for clients (such as filing, payment, and statutory deadlines)
- anti-avoidance provisions relevant to corporation tax
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- Who pays corporation tax, and what types of profits does it apply to?
- How is a company's chargeable gain calculated for corporation tax purposes?
- What is the effect if a company distributes profits by dividend—are these deductible, and how are they taxed?
- Name two statutory reliefs available to companies for trading losses in the UK.
Introduction
Corporation tax is the tax charged on the taxable profits of companies and some other entities incorporated in the UK, as well as certain non-UK companies with sufficient UK presence. It is important for the SQE2 that you understand the key features of corporation tax, the profits that are taxable, the basic calculation of the tax due, and the main reliefs and anti-avoidance measures. You should be able to apply this knowledge to give practical tax consequences of typical business scenarios.
What is corporation tax and who pays it?
Corporation tax is charged on the worldwide income and capital gains of UK-resident companies, and on certain UK-source profits of non-UK companies with a permanent establishment here. Only companies and certain other bodies corporate pay corporation tax; individuals, partners in partnerships, and LLP members pay income tax and capital gains tax instead.
Key Term: corporation tax
A tax charged on the taxable profits of companies and some other bodies corporate, including both trading and investment profits and capital gains.Key Term: corporation tax financial year
The period running from 1 April to 31 March each year, used to set rates and rules for corporation tax.
What profits are taxed and when?
A company's taxable profits include all income (trading, investment, and property) and its chargeable gains (capital profits) after deducting allowable expenses and reliefs. The calculation is made for each accounting period, which is typically aligned with the company's financial year. If an accounting period straddles two tax years with different rates, profits must be apportioned.
Key Term: income profits
Profits from a company’s trading, investment, and property activities, as calculated under tax rules.Key Term: chargeable gains
Taxable profits from the sale of company assets, calculated in line with capital gains tax principles, but taxed within corporation tax.
How are income profits calculated?
A company's trading income is calculated on the same broad principles as for income tax: start with gross trading receipts, and deduct allowable trading expenses that are incurred wholly and exclusively for the trade, and capital allowances for investment in plant and machinery. Investment income is included if it is part of the company’s profit, and property income is also included.
Key Term: deductible expenses
Costs wholly and exclusively incurred for the trade, business, or profession, or as otherwise allowed under corporation tax rules.Key Term: capital allowances
Tax deductions for qualifying capital expenditure on plant and machinery, replacing depreciation for tax purposes.
How are capital gains taxed within corporation tax?
Companies are subject to corporation tax on chargeable gains when they dispose of assets such as land, premises, or shares. The calculation is as follows: sale proceeds less acquisition cost (and improvement costs and sale costs). There is an indexation allowance for historic expenditure up to December 2017, to allow for inflation.
Key Term: indexation allowance
An adjustment increasing the acquisition cost of an asset for inflation (up to December 2017) when calculating a company’s chargeable gain.
Main steps in a corporation tax calculation
The key steps for a company's annual corporation tax calculation are:
- Identify sources of income: trading, investment, property.
- Deduct allowable expenses, capital allowances, and reliefs.
- Calculate any chargeable gains and deduct allowable losses and indexation, if applicable.
- Add together income profits and net chargeable gains to give taxable total profits.
- Apply any appropriate reliefs against profits (such as loss relief).
- Apply the correct corporation tax rate(s) to taxable total profits.
- Deduct any available tax credits.
Worked Example 1.1
ABC Ltd makes trading profits of £120,000 and sells a building for £50,000, which it bought for £25,000 in 2016. Allowable expenses are £60,000, capital allowances are £10,000, and non-trading investment income is £5,000.
Question: What are the corporation tax profits for the year before applying reliefs or tax credits?
Answer:
Trading profits: £120,000 – £60,000 expenses – £10,000 capital allowances = £50,000. Chargeable gain: £50,000 (disposal) – £25,000 (acquisition) = £25,000. Investment income: £5,000. Total taxable profits: £50,000 + £25,000 + £5,000 = £80,000.
When are company distributions deductible?
Payments to shareholders as dividends or as part of a share buyback are generally not deductible for corporation tax purposes. These are distributions from profits, not an allowable expense, and the company pays tax before such payments are made. Interest paid on debt (such as debentures) may be deductible, if it meets the conditions for trading or non-trading loan relationships.
Key Term: distribution
A payment (such as a dividend) made by a company to its shareholders out of profits, not deductible for corporation tax.
How are group companies treated?
Groups of companies (parent and at least 75% subsidiaries) may claim group relief for current trading losses or certain gains and transfer them within the group. Groups may also transfer assets between companies on a no-gain, no-loss basis for capital gains purposes, subject to anti-avoidance rules.
Key Term: group relief
The ability for certain group companies to surrender current trading losses or other permitted reliefs to other group members, reducing total group corporation tax.
Worked Example 1.2
Brown Ltd and Green Ltd are in a 100% group. Brown Ltd makes a trading profit of £100,000 and Green Ltd makes a trading loss of £20,000.
Question: How could the companies reduce Brown Ltd’s taxable profit in the current year?
Answer:
Green Ltd can surrender the £20,000 trading loss to Brown Ltd as group relief, lowering Brown Ltd’s taxable profit to £80,000 for corporation tax.
How are trading losses relieved?
A company may offset trading losses against other profits in the same accounting period, carry them back one year (in most cases), or carry them forward to set against profits in future periods, subject to conditions and restrictions. Additional reliefs may apply for terminal losses (final 12 months of trading), and the Covid-19 regime introduced temporary extensions.
Key Term: trading loss relief
Loss relief rules that allow a company to offset current or future trading losses against taxable profits, subject to statutory restrictions.Key Term: terminal loss relief
Special relief for companies ceasing to trade, allowing trading losses from the last 12 months to be offset against profits in the three preceding accounting periods.
Practical issues: payment, filing, and penalties
Corporation tax self-assessment applies. Companies must file a tax return and pay tax due by the normal due date—usually nine months and one day after the end of their accounting period (unless they are large or very large, in which case quarterly payments may be due). Late filing and payment attract penalties and interest.
How do anti-avoidance rules affect companies?
Corporation tax contains numerous anti-avoidance provisions, including a general anti-abuse rule (GAAR), transfer pricing rules for transactions between connected companies, thin capitalisation rules for excessive debt, and rules on distributions. Apply these where relevant to exam scenarios, but you are not required to know minor detail.
Worked Example 1.3
XYZ Ltd makes deductible interest payments on a loan to a parent company based overseas. On enquiry, HMRC finds that the amount is higher than an arm’s length rate for similar loans between independent borrowers and lenders.
Question: What is the likely tax effect?
Answer:
HMRC may disallow an appropriate portion of the interest deduction under transfer pricing rules, increasing XYZ Ltd’s taxable profits.
Exam Warning
If faced with a partnership or individual trader scenario, do not confuse corporation tax with income tax rules. Partnerships and LLPs do not pay corporation tax—members and partners are taxed individually.
Revision Tip
Always distinguish between the treatment of distributions (usually not deductible) and trading or investment expenses (which may be deductible if they meet statutory criteria).
Key Point Checklist
This article has covered the following key knowledge points:
- Corporation tax applies to the taxable profits (income and chargeable gains) of companies resident in the UK.
- The main calculation involves aggregating trading and investment profits, after deducting allowable expenses and capital allowances, with chargeable gains.
- Most distributions to shareholders are not deductible expenses for corporation tax.
- Key statutory reliefs include loss relief (current, carry back, carry forward), group relief, and indexation for historic capital gains.
- Groups can surrender certain losses between group companies.
- Detailed anti-avoidance rules exist and must be considered in scenarios involving connected parties or cross-border transactions.
Key Terms and Concepts
- corporation tax
- corporation tax financial year
- income profits
- chargeable gains
- deductible expenses
- capital allowances
- indexation allowance
- distribution
- group relief
- trading loss relief
- terminal loss relief