Taxation in business - Corporation Tax

Learning Outcomes

This article covers corporation tax as it applies to UK-resident companies and certain non-resident entities with a UK presence, including:

• The basis of charge and scope (UK-resident companies, non-residents with a UK permanent establishment, and UK property disposals by non-resident companies)
• Calculating taxable total profits by aggregating income profits and chargeable gains, and the interaction with capital allowances and disallowable expenditure
• Applying corporation tax rates, the small profits rate, marginal relief, and apportionment where accounting periods straddle financial years (including associated companies adjustments)
• The treatment of distributions (dividends and purchase of own shares) versus deductible remuneration and interest under the loan relationships regime
• Using trading loss reliefs (current year, carry back, carry forward) and terminal loss relief, with claims, caps and time limits
• Group relief for income losses and no gain/no loss intragroup transfers, and key restrictions (including degrouping charges)
• Rules on chargeable gains, indexation allowance for historic costs, connected-party and market value rules, and the intangible fixed assets regime
• Close company rules, including the loans to participators charge and relevant exceptions
• Anti-avoidance measures (GAAR, transfer pricing, thin capitalisation) and their impact on connected-party transactions
• Practical compliance: accounting periods, CT600 filing, payment deadlines, quarterly instalments for large and very large companies, interest and penalties

SQE2 Syllabus

For SQE2, you are required to understand corporation tax as it applies to companies in England and Wales, with a focus on the following syllabus points:

• the basis of charge for corporation tax, including UK-resident companies, non-residents with a UK permanent establishment, and UK property disposals by non-resident companies
• calculation of taxable total profits by aggregating income profits and chargeable gains, and the treatment of capital allowances and disallowable expenditure
• current corporation tax rates, the small profits rate and marginal relief, and apportionment where accounting periods straddle financial years
• reliefs for trading losses (current year set-off, carry back, carry forward, terminal) and conditions, caps and time limits
• group relief for losses and no gain/no loss transfers within 75% groups, and key restrictions and anti-avoidance
• the treatment of company distributions (dividends and purchase of own shares) versus deductible remuneration and interest under the loan relationships regime
• close company rules, including the charge on loans to participators and exceptions
• practical compliance: accounting periods, CT600 returns, payment deadlines, quarterly instalments for large and very large companies, interest and penalties
• relevant anti-avoidance provisions (GAAR, transfer pricing, thin capitalisation) as they affect company scenarios

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.

1. Who pays corporation tax, and what types of profits does it apply to?
2. How is a company's chargeable gain calculated for corporation tax purposes?
3. What is the effect if a company distributes profits by dividend—are these deductible, and how are they taxed?
4. 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 applies to income profits and chargeable gains, and is calculated by reference to each company’s accounting period. You should understand the key features of the regime, how to compute taxable total profits, and the main reliefs and anti-avoidance measures.

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. Since April 2019, non-resident companies disposing of UK property (including indirect disposals of UK property-rich entities) are within the UK corporation tax regime on those gains. 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.

Key Term: permanent establishment
A fixed place of business (or a dependent agent habitually concluding contracts) through which the business of a non-UK company is wholly or partly carried on in the UK. Profits attributable to a UK permanent establishment are chargeable to UK 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 financial years with different rates, profits must be apportioned. Current corporation tax rates operate by reference to taxable total profits: a small profits rate applies to lower levels of profit and a main rate to higher profits, with marginal relief smoothing the transition between the two.

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.

Key Term: accounting period
The period for which a company’s corporation tax is computed, beginning when it starts trading or acquires a source of income and ending when specified by statute (usually up to 12 months, and aligned to the company’s financial year).

How are income profits calculated?

A company's trading income is calculated on broadly similar principles to income tax for unincorporated businesses: 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 and property business income are included if they arise.

Common disallowable items include client entertaining, depreciation (replaced by capital allowances), fines and penalties, and non-business expenditure. Salaries and directors’ fees are deductible as remuneration costs, provided they relate to the business. Interest payable is dealt with under the loan relationships regime and may be deductible subject to the statutory rules.

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. Includes annual investment allowance (AIA) and writing-down allowances on main and special rate pools.

Key Term: loan relationships
The statutory regime for taxing companies on profits and losses from loans and related financial instruments. Interest receivable is taxable and interest payable may be deductible, subject to rules such as transfer pricing and thin capitalisation.

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 basic calculation mirrors CGT: sale proceeds less acquisition cost (including incidental acquisition and disposal costs and enhancement expenditure). Where relevant, gains are adjusted by indexation allowance for qualifying historic expenditure up to December 2017 to allow for inflation; no indexation applies to expenditure incurred after that date. Capital losses are set against chargeable gains and carried forward if not used; they cannot be set against income profits. Intangible fixed assets (such as goodwill and patents) fall under a separate corporation tax regime and are generally taxed within income profits, with their own rollover relief conditions.

Connected party and market value rules apply: if a company gives an asset away or sells to a connected person at undervalue, the disposal is treated at market value.

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. It cannot create or increase a loss.

Corporation tax rates: small profits, main rate and marginal relief

From financial year 2023 onwards, a small profits rate applies to companies with taxable total profits up to a lower threshold, and the main rate applies above an upper threshold. Profits between the thresholds attract marginal relief, reducing the effective rate below the main rate. The thresholds are adjusted where a company has associated companies. If an accounting period straddles 31 March, profits are apportioned between the two corporation tax financial years and the relevant rates applied to each portion.

Key Term: small profits rate
The lower corporation tax rate applying to companies with taxable total profits at or below the lower threshold for the financial year.

Key Term: marginal relief
A reduction to the main rate calculation to taper the effective corporation tax rate for profits between the lower and upper thresholds.

Key Term: associated company
A company is associated with another if one controls the other or both are under common control; the number of associated companies adjusts the thresholds for the small profits rate and marginal relief.

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 within income profits (including loan relationship debits where applicable)
• calculate any chargeable gains and deduct allowable losses and indexation where applicable
• add together income profits and net chargeable gains to give taxable total profits
• apply any appropriate reliefs against taxable total profits (such as trading loss reliefs and qualifying charitable donations)
• apply the correct corporation tax rate(s) to taxable total profits (including small profits rate, main rate, and marginal relief as appropriate)
• consider any tax credits or other adjustments arising (for example, certain R&D credits), then compute the final liability

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 (ignoring any indexation as the cost is post-1982, and indexation applies only up to December 2017). 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 purchase of own shares (buyback/redemption) 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 or shareholder loans) may be deductible, if it meets the conditions under the loan relationships regime and any transfer pricing arm’s length requirement. Directors’ remuneration is ordinarily deductible.

For purchase of own shares, tax treatment for the seller (outside the scope of corporation tax) may be income (distribution) or capital depending on statutory conditions such as substantial reduction of shareholding, minimum ownership period, and benefit of trade; but for the company, the payment remains a non-deductible distribution.

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 income losses or certain expenses and surrender them within the group. The surrendering (transferor) and receiving (transferee) companies must have overlapping accounting periods for the surrendered item to be used. Capital losses are not surrenderable under group relief. For chargeable gains, assets can be transferred between group companies on a no gain/no loss basis (so the transferee takes the transferor’s base cost), subject to anti-avoidance (including degrouping charges if the transferee leaves the group within a prescribed period).

Key Term: group relief
The ability for certain group companies to surrender current income losses or other permitted amounts to other group members, reducing total group corporation tax.

Key Term: no gain, no loss
Intragroup asset transfers treated as neither creating a chargeable gain nor a loss; the transferee inherits the transferor’s base cost and acquisition history.

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 current trading loss to Brown Ltd as group relief, lowering Brown Ltd’s taxable total profits to £80,000 for corporation tax. The accounting periods must overlap for the surrendered loss to be used.

How are trading losses relieved?

A company may offset trading losses against other profits in the same accounting period (carry across), carry them back one year (in most cases) against total profits of the preceding 12 months, or carry them forward to set against profits in future periods, subject to conditions and restrictions. Terminal loss relief applies on cessation of trade: losses from the final 12 months may be carried back and set against profits of the same trade in the three years before the start of that final 12 months, taking later periods first. Carry-forward relief is generally available against total profits (subject to post-2017 conditions), with an annual cap for large accumulated losses.

Claims must be made within statutory time limits. Where reliefs overlap, companies can choose the order that best meets cash-flow and rate considerations; however, the same loss cannot be relieved twice.

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.

Corporation tax on intangible fixed assets

Goodwill and intellectual property (trademarks, patents, designs and copyright) are intangible fixed assets. Receipts and debits from transactions in such assets are generally treated within income profits. Subject to conditions, gains on disposal of intangible fixed assets can be rolled into the acquisition cost of replacement intangible assets, deferring tax within this regime.

Practical issues: payment, filing, and penalties

Corporation tax self-assessment applies. Companies must notify chargeability, file a CT600 tax return, and pay tax by the due dates. For most companies, payment is due nine months and one day after the end of the accounting period; the return is due 12 months after the period end. Large and very large companies must pay by instalments:

• large companies generally pay four quarterly instalments within the accounting period, starting six months and 14 days after the period begins
• very large companies pay even earlier instalments, typically beginning two months and 13 days into the period

Whether a company is large or very large depends on its level of profits and the number of associated companies. Late filing and payment attract penalties and interest, and HMRC may open enquiries; companies can appeal assessments to the First-tier Tribunal (Tax).

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 limiting excessive debt, and specific rules for close companies. Apply these where relevant to scenarios; detailed computational rules are beyond scope, but the principles must be understood.

Key Term: close company
A company controlled by five or fewer participators, or any number of participators who are also directors or shadow directors.

Close companies face a charge when making loans to participators or their associates. Broadly, the company must pay a sum to HMRC equal to a percentage of the loan (refunded when the loan is repaid or written off). This prevents extraction of value via untaxed loans. No charge arises for loans made in the ordinary course of a money-lending business or certain small loans to full-time employees with minimal shareholdings.

Key Term: loans to participators charge
The corporation tax charge payable by a close company when it makes a loan to a participator or their associate, refundable when the loan is repaid or released.

Transfer pricing requires connected-party transactions to be on arm’s length terms. If excessive interest is paid to a connected party, HMRC may disallow a portion of the deduction. Thin capitalisation ensures the company’s level of debt (and related interest) is not excessive compared to equity, by reference to arm’s length standards.

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. Thin capitalisation principles may also apply to restrict excessive debt.

Worked Example 1.4

Delta Ltd has taxable total profits of £200,000 in financial year 2023. It has no associated companies.

Question: Compute corporation tax using the main rate with marginal relief.

Answer:
Apply the main rate then marginal relief. Main rate calculation: 25% × £200,000 = £50,000. Marginal relief reduces tax for profits between the thresholds (lower £50,000; upper £250,000, adjusted for associated companies). Using the statutory fraction for marginal relief, the reduction is 0.015 × (upper threshold − profits) = 0.015 × (£250,000 − £200,000) = £750. Corporation tax = £50,000 − £750 = £49,250 (an effective rate of 24.625%).

Worked Example 1.5

Echo Ltd’s accounting period runs from 1 January to 30 June 2023. Tax rates changed on 1 April 2023. Echo Ltd’s taxable total profits for the six-month period are £90,000.

Question: How are profits taxed when an accounting period straddles 31 March?

Answer:
Apportion profits on a time basis between the two corporation tax financial years. Three months fall in financial year 2022 and three months in financial year 2023. Profits apportioned: £90,000 × 3/6 = £45,000 to FY 2022; £45,000 to FY 2023. Apply FY 2022 rate (single rate) to £45,000. Apply FY 2023 rates to £45,000 (considering thresholds and marginal relief as appropriate). Add the two amounts to obtain total corporation tax for the accounting period.

Worked Example 1.6

Foxtrot Ltd is a close company. It lends £60,000 to its controlling shareholder. The loan is not repaid within nine months of the year end.

Question: What corporation tax consequence arises for Foxtrot Ltd?

Answer:
Foxtrot Ltd must pay the loans to participators charge equal to the relevant percentage of the loan to HMRC. The company can reclaim this amount when the shareholder repays the loan or if the loan is written off. Certain exceptions may apply (for example, loans made in the ordinary course of a money-lending business), but they do not apply here.

Exam Warning

Do not confuse corporation tax with income tax rules when assessing unincorporated businesses. Partnerships and LLPs do not pay corporation tax—members and partners are taxed individually (save that corporate partners pay corporation tax on their own profits).

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). Be precise about loss relief time limits and whether a loss can be relieved against total profits or must be restricted.

Key Point Checklist

This article has covered the following key knowledge points:

• Corporation tax applies to the taxable profits (income and chargeable gains) of UK-resident companies and certain UK-source profits of non-UK companies (including UK property disposals).
• The main calculation aggregates trading and investment profits, after deducting allowable expenses and capital allowances, with net chargeable gains to produce taxable total profits.
• Corporation tax rates may include a small profits rate and a main rate; marginal relief applies between thresholds, and profits must be apportioned if an accounting period straddles financial years.
• Most distributions to shareholders (dividends and purchase of own shares payments) are not deductible expenses for corporation tax; directors’ remuneration and arm’s length interest generally are.
• Key statutory reliefs include loss relief (current year, carry back, carry forward), terminal loss relief, group relief for income losses, and indexation for historic capital gains up to December 2017.
• Groups can surrender certain losses between group companies and transfer assets on a no gain/no loss basis, but capital losses cannot be surrendered; degrouping charges may apply.
• Intangible fixed assets are taxed in an income regime with potential rollover relief on replacement intangible assets.
• Close companies are subject to the loans to participators charge; transfer pricing and thin capitalisation can restrict deductions on connected-party transactions.
• Practical compliance includes CT600 filing, payment deadlines (including quarterly instalments for large and very large companies), interest on late payment, and penalties for late filing.

Key Terms and Concepts

• corporation tax
• corporation tax financial year
• permanent establishment
• income profits
• chargeable gains
• accounting period
• deductible expenses
• capital allowances
• loan relationships
• indexation allowance
• distribution
• group relief
• no gain, no loss
• trading loss relief
• terminal loss relief
• small profits rate
• marginal relief
• associated company
• close company
• loans to participators charge