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How to calculate tax

How to calculate tax

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Contents

How to calculate Corporation Tax

To work out your company's taxable profits, start with your pre-tax profit figure (sometimes known as 'profit before tax') in your financial accounts for a financial year.

Once you've done that, you must:

  • Add back any depreciation charges included in the accounts.
  • Deduct any capital allowances - they take the place of depreciation charges. Capital Allowances for a company are the same as those for a sole trader (see 'Capital allowances' under Income Tax for sole traders). You can get further information on capital allowances on the HMRC website.
  • Add any other relevant income or chargeable gains.
  • Deduct any other relevant deductions, reliefs, allowances or losses.

Then:

  • Apply the relevant tax rate(s) to calculate the gross Corporation Tax payable.
  • Deduct any relevant tax credits and any Income Tax already deducted from interest income the company received (for example, the tax deducted by a bank before it paid the company interest).

Finally:

  • Deduct any Corporation Tax already paid, e.g. tax paid early, to find the amount of Corporation Tax that you need to be pay, or the amount of Corporation Tax that you can claim back as an overpayment.

Chargeable gains

If your company has made a profit from selling a chargeable asset, e.g. a building used for its trade, this profit (called a 'chargeable gain') is added to the trading profits. You should include it in the Company Tax Return. Corporation Tax is paid on this profit instead of Capital Gains Tax. Your company will also have to pay Corporation Tax if it gives away or otherwise disposes of the asset. To work out the chargeable gain:

  • Start with sale proceeds and deduct any costs of sale, such as solicitor's or surveyor's fees.
  • To get the unindexed gain, which is the gain before inflation is taken into account, deduct:
    • the original cost of the asset;
    • incidental costs of purchase, such as solicitor's fees and Stamp Duty Land Tax; and
    • any money spent on permanent improvements (e.g. an extension)
  • Calculate the indexation allowance.

The indexation allowance is an allowance for inflation. It's based on the movement in the Retail Prices Index (RPI) between:

  • the date of acquisition of the asset and the date of sale; and/or
  • the date the money was spent improving the premises and the date of sale.

Deducting the indexation allowance strips away the gain due to inflation, leaving the real gain in the value of the asset. You can find tables of the indexation factors on the HMRC website.

To calculate the indexation allowance for the original expenditure, the original cost of the asset and incidental costs of purchase are multiplied by the indexation factor for the date of purchase.

If you spent money on improving the asset, the indexation allowance for the improvements is calculated by multiplying the cost of the improvements by the indexation factor for the date of this expenditure. The indexation allowances for the original expenditure and for the improvements are added to give the total indexation allowance.

Deduct the total indexation allowance from the unindexed gain. You'll then be left with the indexed gain, which represents the real gain when the effect of inflation is stripped away.

Example calculation of indexed gain

The company bought premises to be used for the trade in September 2005 for £250,000. Incidental costs of purchase were £4,000. It sold the premises in September 2013 for £420,000. Costs of sale were £3,000. In May 2007, it had spent £25,000 on a small extension. The relevant indexation factors for an asset sold in September 2013 are:

  • September 2005 - 0.305
  • May 2007 – 0.222

To calculate the chargeable gain:

Sale proceeds

£420,000

Deduct costs of sale

£(3,000)

Net proceeds of sale£417,000

Deduct purchase price

£(250,000

Deduct costs of purchase

£(4,000

Deduct improvement cost

£(25,000)

Unindexed gain£138,000

Deduct indexation allowance:

  • On cost of purchase £250,000 x 0.305 = 76,250
  • On incidental costs of purchase £4,000 x 0.305 = 1,220
  • On cost of improvements £25,000 x 0.222 = 5,550

Total Indexation allowance

(83,020)

Indexed gain54,980

Capital losses

If the company has sold more than one asset in its accounting period, and it has made a capital loss on one of them and chargeable gains on the others, it can deduct this loss from the chargeable gains made on the sale of the other assets. The net chargeable gain is included in the calculation of corporation tax.

If, in an accounting period, you deduct all the chargeable gains of your company from the capital loss and still have some loss left (an 'unabsorbed loss'), your company can carry this unabsorbed loss forward. The unabsorbed loss can be set against chargeable gains made in future accounting periods. It can't, however, be set against income profits.

Reliefs for chargeable gains

Business Asset Rollover relief

Your company may be able to claim Business Asset Rollover relief if it buys a new qualifying asset to be used in the business within a specified timeframe of selling an old qualifying business asset.

This relief will allow your company to postpone payment of corporation tax on its chargeable gain made on the old asset until it sells the new asset. Apart from the fact that goodwill isn't a qualifying business asset for corporation tax, this relief works in the same way for companies as it does for unincorporated businesses such as sole traders and partnerships (see 'Capital Gains Tax' under Relief from Tax for sole traders for more information).

Reliefs for trading losses

Carry-across and carry-back relief

Your company can claim to set off a trading loss:

  • against total profits of the accounting period in which the loss was incurred (carry-across relief); and
  • if there is still an unabsorbed loss, against its total profits of the preceding 12 months (carry-back relief). A company must set its loss against profits of the current period first, before setting them off against profits of the previous 12 months.

If your company is claiming carry-across/back relief, it must set the loss against total profits, i.e. income profits plus chargeable gains. It can't choose to set off its loss only against particular items of income or gains.

Losses may be only carried back against profits of the preceding 12 months if the company was carrying on the same trade in part of that period. However, it isn't necessary for the trade to have been carried on for the whole of the preceding 12 month period.

Example

A company makes a trading loss of £40,000 in its 12-month accounting period ending 31 December 2013. It made a chargeable gain in that year of £10,000. It had made a total profit of £50,000 in the previous 12-month accounting period which ending 31 December 2012.

It can set its loss against the chargeable gain in the year of the loss (year ending 31 December 2013) so that it pays no Corporation Tax in respect of that gain. £10,000 of the loss would be set against the chargeable gain leaving a loss of £30,000, which the company could then carry back and set against the profit of £50,000 in the previous year. That would reduce the total profit in the previous year on which Corporation Tax is calculated to £20,000.

Relief givenLoss usedTotal profits remaining

Against chargeable gain for year ending 31/12/13

£10,000

Against total profits for year ending 31/12/12

£30,000

£20,000

Total loss used

£40,000

This is a simple example, but you may need professional advice if your situation is more complex.

Carry-forward relief

Relief for trading losses is available by carrying forward trading losses and setting them against future trading income from the same trade.

The loss available for carry-forward is the loss sustained, less any part of that loss already used on Carry-across or carry-back relief (see 'Carry-across and carry-back relief' above).

You can't pick and choose the subsequent years in which you use the relief. You must set the loss against the profits of each subsequent year in chronological order until the loss is used up.

Example

A company makes a trading loss of £40,000 in its 12-month accounting period ending 31 December 2013. It projects it will make trading profits of £30,000 in the next accounting period ending 31 December 2014, and £60,000 in the accounting period ending 31 December 2015. It could elect to use carry-forward relief to set the loss against future profits of the same trade.

Relief givenLoss usedTotal profits remaining

Against trading profits year ended 31/12/14

£30,000

£0

Against total profits for year ended 31/12/15

£10,000

£50,000

Total loss used

£40,000

The disadvantage of carry forward relief is that the company has to wait until future profits are made in order to benefit from the relief. Also, the trading loss can only be set against future trading profits and not any other income or chargeable gains.

Corporation Tax rates

Until Financial Year 2015 (starting 1 April 2015), there were 2 rates of Corporation Tax, depending on your company's taxable profits:

  • The lower rate - known as the 'small profits' rate,
  • The upper rate - known as the 'full' rate or 'main' rate

There was also a sliding scale between the lower and upper rates known as 'marginal rate relief'.

In Financial Year 2015, the main rate was brought down to the small profits rate of 20%, and the small profits rate was abolished. The main rate now applies to all companies. This will remain at 20% for Financial Year 2016, fall to 19% for the Financial Years 2017, 2018 and 2019 and then to 17% for the Financial Year 2020.

Franked investment income

If your company receives dividends from shares it holds in another company, and it's entitled to a tax credit in respect of these dividends, the total of the dividend income plus the tax credit is called 'franked investment income'. Franked investment income is added to the taxable profits to determine the rate of tax applicable to the company. However, the franked investment income isn't generally taxed.

Example

A company has taxable profits of £250,000 and franked investment income of £100,000. The rate of tax applied will be the rate for a company with profits of £350,000. However, this rate will be applied when calculating tax on the taxable profits of £250,000. The franked investment income won't be taxed.

How the rates of corporation tax apply

Information on Corporation Tax rates and fractions is contained in the table below.

Rates for Financial Years starting on 1 April (2011-2014)

2011

2012

2013

2014

Small profits rate

20%

20%

20%

20%

Small Companies Rate can be claimed by qualifying companies with profits at a rate not exceeding

£300,000

£300,000

£300,000

£300,000

Marginal Relief Lower Limit

£300,000

£300,000

£300,000

£300,000

Marginal Relief Upper Limit

£1,500,000

£1,500,000

£1,500,000

£1,500,000

Standard Fraction

3/200

1/100

3/400

1/400

Main rate of Corporation Tax

26%

24%

23%

21%

Special rate for unit trusts and open-ended investment companies

20%

20%

20%

20%

Corporation Tax 'marginal rate relief' for taxable profits from £300,001 to £1,500,000

There is a marginal rate calculator and instructions available on the HMRC website.

Note that marginal relief was no longer relevant after the main rate of corporation tax became the same as the small profits rate in financial year 2015.

Rates for Financial Years starting on 1 April (2015-2020)

The main rate of corporation tax for all companies is

  • 20% for Financial Years 2015 and 2016,
  • 19% for 2017, 2018 and 2019, and
  • 17% for the Financial Year 2020.