What is Corporation Tax and How do I Calculate it?

What is Corporation Tax?

Corporation tax is a tax which is charge on taxable profits generated by a Limited Company.

Often after a company's year-end has passed, there are common topics that arise such as ‘how much tax do I need to pay?’, ‘when is the deadline for paying the taxes?’ & ‘ how can I plan the cash flow impact of paying the taxes?’. The stem of the issue here is that many business leaders don’t think (or know how) to estimate their liabilities. This may be due to the intimidating nature of the corporation tax legislation. Within this blog, we will give you some tools to calculate your estimated corporation tax bill. Due to the nature of corporation tax, it is worth noting that when you generate an estimate, it may be slightly different from the final calculations, however you can at least get a ballpark figure. It is important to estimate your taxes as it can provide you with the ability to plan your cash flow more effectively. It can also (if you do it before your financial year ends) give you the ability to consider tax planning strategies to reduce your liabilities.

This blog has been written based on the corporation tax rules introduced as of April 2023, and are subject to change. Please note if your year end is before the 31^st March 2024, your company will be taxed over 2 different taxation rule periods. For further guidance, please contact us at Stryde and we will see if we can help you.

Who is Subject to Corporation Tax?

Every limited company is subject to this tax (noting Limited Liability Partnerships are excluded from this list). With this, the company makes a declaration in line with the fiscal period. This is normally once a year, and in line with your company year end. The deadline to pay Corporation Tax, or report if you have nothing to pay is usually 9 months and 1 day after the end of your ‘accounting period’. Similarly, the deadline to file your Company Tax Return is usually 12 months after the end of your accounting period, however it is usually submitted in line with your company accounts.

Understanding the Corporation Tax rules in the UK is crucial for businesses. It’s important to keep accurate accounting records, prepare a Company Tax Return, and meet the deadlines for payment and filing. The rates vary depending on the profits, so businesses need to be aware of the current rates and allowances.

Calculating Your Company’s Corporation Tax

The common method used for calculating estimated corporation tax bills is to take your net profit, and multiply by 19% (with some using 20% to give them room for add backs). This, however, has its limitations. With slightly larger businesses, under the new regulations, this method may no longer give you a good enough estimate. Here’s how you should do it…

Within a company’s profit and loss are several items. They can be broken down into three main categories: 

• Sales Income 
• Cost of Sales
• Overheads (also known as expenses)

Most of the costs incurred by a company to generate sales income are known as deductible expenses. There are, however, some exceptions. These include (but are not limited to) Entertainment, Depreciation & Amortisation. This is important to note, as your Taxable Profits exclude these items. 

If you therefore run your Profit & Loss, you can then take the Net Profit Number (which some software note as ‘Net Income’ or ‘Profits before taxation’), add back the Entertainment, Depreciation and Amortisation you then have your estimated taxable profits. 

Capital Allowances

Now you are ready to consider capital allowances. The purchase of certain fixed assets will provide you with a capital allowance. At the time of writing this blog, each company has what’s known as an Annual Investment Allowance of up to £1 million. This means the first £1 million of expenditure on certain fixed assets will generate a 100% allowance. This means if you spend £5,000 on a computer, you can deduct £5,000 from your taxable profits. 

We are now ready to calculate your estimated taxes. To summarise, take the following steps:

1. Take your Net Profit
2. Add back Entertainment, Depreciation and Amortisation
3. Deduct your capital expenditure
4. The resulting number is your Estimated Taxable Profit

Once we have that number, we are ready to calculate the taxes. Now, please note that the rate of tax you are charged depends on whether your Taxable Profits fall within the following bands (noting these are for a full year’s profits):

1. Loss making you will not be charged any taxes.
2. £0 to £50K you will be charged corporation tax at 19%.
3. £250K + you will be charged tax at 25%.
4. £50K to £250K you will be charged tax at 25%, and then claim a marginal relief

Marginal Relief

The new corporation tax rules mean that should your company generate taxable profits of between £50K and £250K, the rate of tax you are charged will vary. For a 12 month accounting period, where you are in this band, you will be taxed 25% on all profits and then claim the Marginal Relief reducing your bill. In essence, this means the rate of tax you are charged tapers up from 19% up to 25% within this band. To calculate your marginal relief, use the below:

Marginal Relief: (£250,000 – Taxable Profits) X (3/200)

As an example, a company which generates £100,000 in taxable profits will use the following formula to calculate marginal relief:

(£100,000 x 25%) – (£250,000-£100,000 x 3/200) = £25,000 – (£150,000 x 3/200) = £25,000 - £2,250 = £22,750.

For more specific guidance to your own organisation, please consult your tax advisor.

Finally, how is the above affected by Associated Company Rules? It must be noted that these bands are altered when Associated Companies are involved. The aforementioned numbers are divided equally between each Associated Company. For example, if you had 5 associated companies, the table changes to the below: 

1. Loss making you will not be charged any taxes.
2. £0 to £10K you will be charged corporation tax at 19%.
3. £50K + you will be charged tax at 25%.
4. £10K to £50K you will be charged tax at 25%, and then claim a marginal relief

Conclusion

The earlier you calculate your estimates (especially if you do them regularly during the year) the more time you will have to cash flow plan any potential liabilities. The ability to identify what your bill is likely to be during the year further enables you to make key tactical decisions such as investing in   capital expenditure. 

Whilst it may feel like there are a lot of steps involved in the above, if you take your time and work through it slowly, you’ll get to where you need to be. Doing this exercise regularly will hopefully provide you with decent financial clarity.  Please feel free to contact us if you’d like any further guidance on the above. 

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