Everything about United Kingdom Corporation Tax totally explained
» Throughout this article, the unqualified term "pound" and the £ symbol refer to the United Kingdom pound.
Corporation tax is a
tax levied in the
United Kingdom on the
profits made by
companies and on the profits of
permanent establishments of non-UK resident companies and associations that trade in the EU. Prior to the tax's enactment on
1 April 1965, companies and individuals paid the same
income tax, with an additional
profits tax levied on companies. The
Finance Act 1965 replaced this structure for companies and associations with a single
corporate tax, which borrowed its basic structure and rules from the income tax system. Since 1997, the UK's
Tax Law Rewrite project has been modernising the UK's tax legislation, starting with income tax, while the legislation imposing corporation tax has itself been amended; the rules governing income tax and corporation tax have thus diverged. Corporation tax is governed by the
Income and Corporation Taxes Act 1988 (as amended).
Originally introduced as a classical tax system, in which companies were subject to tax on their profits and companies'
shareholders were also liable to income tax on the
dividends that they received, the first major amendment to corporation tax saw it move to an imputation system in 1973, under which an individual receiving a dividend became entitled to an income tax credit representing the corporation tax already paid by the company paying the dividend. The classical system was reintroduced in 1999, with the abolition of
advance corporation tax and of repayable dividend tax credits. Another change saw the single main rate of tax split into three. Tax competition between jurisdictions has reduced the main rate to 30%, and the main rate is planned to reduce to 28% from April 2008. at the same rate as was levied on individuals. An imputation system existed, whereby the income tax paid by a company was offset against the income tax liability of a shareholder who received dividends from the company. With the standard rate of income tax in 1949 at 50%, a company making £1,000 in profits would pay £500 in tax. If the company then chose to pay a £100 dividend, the recipient would be treated as if he'd earned £200 and had paid £100 in income tax on it — the tax paid by the company fully covered the tax due from the individual on the dividend paid. If, however, the individual was subject to tax at a higher rate (known as "surtax"), he (not the company) would be liable to pay the additional tax.
In addition to income tax, companies were also subject to a profits tax, were introduced in the rates of the distributed profits tax by the post-war Labour government, in an attempt to coerce companies into retaining more of their profits. At the time of
Hugh Gaitskell's 1951 budget, the profits tax was 50% for distributed profits and 10% for undistributed profits.
A series of reductions in the profits tax were brought in from 1951 onwards by the new Conservative government. The tax rates fell to 22.5% on distributed profits and 2.5% on undistributed profits by 1957, although the profits tax was no longer income tax-deductible.
Derick Heathcoat-Amory's Budget of March 1958 replaced the differential profits tax with a single profits tax measure, applicable to both retained and distributed profits. This gradual decrease, and final abolition, of taxes on capital distributions reflected ideological differences between the Conservative and Labour parties: the Conservative approach was to distribute profits to capital holders for investment elsewhere, while Labour sought to force companies to retain profits for reinvestment in the company in the hope this would benefit the company's workforce.
Finance Act 1965
Under the Labour
Chancellor of the Exchequer James Callaghan, the Finance Act 1965 Individuals and companies who received a dividend from a UK company received a
tax credit representing the ACT paid. Individuals could set off the tax credit against their income tax liability.
On introduction, ACT was set at 30% of the gross dividend (the actual amount paid plus the tax credit). If a company made a £70 dividend payment to an individual, the company would pay £30 of advance corporation tax. The shareholder would receive the £70 cash payment, plus a tax credit of £30; thus, the individual would be deemed to have earned £100, and to have already paid tax of £30 on it. The ACT paid by the company would be deductible against its final "mainstream" corporation tax bill. To the extent that the individual's tax on the dividend was less than the tax credit - for example, if his income was too low to pay tax (below £595 in 1973–1974) - he'd be able to reclaim some or all of the £30 tax paid by the company. The set-off was only partial, since the company would pay 52% tax (small companies had lower rates, but still higher than the ACT rate), Also, the recipient company wasn't taxed on that dividend receipt, except for dealers in shares and
life assurance companies in respect of some of their profits. ended the ability of pension funds and other tax-exempt companies to reclaim tax credits with immediate effect, and for individuals from April 1999. with the hypothetical £1.5 m income described above falling to £1.2 m, a fall in income of 20%, because no tax would be reclaimable.
Abolition of Advance Corporation Tax
From
6 April 1999 ACT was abolished, This was another stealth tax increase by Gordon Brown: it meant that the deemed gross income of a basic-rate taxpayer was reduced, and there was no overall change in liability for a higher-rate taxpayer, but a non-taxpayer could no longer reclaim any tax at all.
ACT that had been incurred prior to 1999 could still be set off against a company's tax liability, provided it would have been able to set it off under the old imputation system. In order to keep the stream of payments associated with advance corporation tax payment, 'large' companies (comprising the majority of corporation tax receipts) were subjected to a quarterly instalments scheme for tax payment. This apparent increase was negated by the fact that under the ACT scheme, dividends were no longer subject to income tax.
The 1979 Conservative Budget of
Geoffrey Howe cut the small companies' rate to 40%, followed by a further cut in the 1982 Budget to 38%. introduced a 10% starting rate for profits from £0 to £10,000, effective from April 2000. cut the starting rate to zero, with marginal relief applying in the same way. Previously self-employed individuals could now distribute profits as
dividend payments rather than salaries. For companies with profits under £50,000 the corporation tax rate varied between 0% and 19%. Because dividend payments come with a
basic rate tax credit, provided the recipient didn't earn more than the
basic rate allowance, no further tax would be paid. The number of new companies being formed in 2002–2003 reached 325,900, an increase of 45% on 2001–2002.
The fact that individuals operating in this manner could potentially pay no tax at all was felt by the government to be unfair tax avoidance, introduced a Non-Corporate Distribution Rate. This ensured that where a company paid below the small companies' rate (19% in 2004), dividend payments made to non-corporates (for example, individuals, trusts and personal representatives of deceased persons) would be subject to additional corporation tax, bringing the corporation tax paid up to 19%. For example, a company making £10,000 profit, and making a £6,000 dividend distribution to an individual and £4,000 to another company would pay 19% corporation tax on the £6,000. Although this measure substantially reduced the number of small businesses incorporating, the Chancellor in the 2006 Budget said tax avoidance by small businesses through incorporation was still a major issue, and scrapped the starting rate entirely.
Taxable profits and accounting profits
The starting point for computing taxable profits is profits before tax (except for a
life assurance company). The rules for calculating corporation tax generally ran in parallel with income tax until 1993, when the first statutory rule to move profit reporting into line with
generally accepted accounting practice was introduced, although the courts were already moving towards requiring trading profits to be computed using general
accountancy rules.
The Finance Act 1993 introduced rules to make tax on exchange gains and losses mimic their treatment in a company's
financial statements in most instances. The Finance Act 1994 saw similar rules for financial instruments, and in the Finance Act 1996 the treatment of most loan relationships was also brought into line with the accounting treatment. The Finance Act 1997 saw something similar with rental premiums. A year later, the Finance Act 1998 went even further, making it clear that taxable trading profits (apart from those accruing to a
Lloyd's corporate name or to a
life assurance company) and profits from a rental business are equal to profits calculated under
generally accepted accounting practice ("GAAP") unless there's a specific statutory or case law rule to the contrary. This was followed up by the Finance Act 2004, which ruled that where a company with investment business could make deductions for management expenses, they were calculated by reference to figures in the
financial statements.
International Financial Reporting Standards
From 2005, all
European Union listed companies have to prepare their financial statements using the "
International Financial Reporting Standards" ("IFRSs"), as modified by the EU. Other UK companies may choose to adopt IFRSs. Corporation tax law is changing so that, in the future, IFRSs accounting profits are largely respected. The exception is for certain financial instruments and certain other measures to prevent tax
arbitrage between companies applying IFRSs and companies applying UK GAAP.
Avoidance
Tax avoidance is the legitimate reduction of tax through tax planning and/or usage of legal provisions. Unlike most other countries, most UK tax professionals are accountants rather than lawyers by training. The main promoters of tax avoidance schemes are the large
accountancy and law firms, and large financial services groups, who market tax-efficient investments.
There has never been a
general anti-avoidance rule ("GAAR") for corporation tax. However, it inherited an anti-avoidance rule from income tax relating to transactions in securities, and since then has had various "mini-GAARs" added to it. The best known "mini-GAAR" prevents a deduction for interest paid when the loan to which it relates is made for an "unallowable purpose".
The Finance Act 2004 This is the first provision of its kind in the UK, and the Finance Act 2005 has shown a number of tax avoidance schemes being blocked earlier than would have been expected prior to the disclosure rules.
Need for greater revenues
Recently, the Government has sought to raise more revenues from corporation tax. In 2002 it introduced a separate 10% supplementary charge on profits from oil and gas extraction businesses, continued measures specifically relating to
life assurance companies. When originally announced (as the Finance (No.3) Bill 2005)
Legal & General told the Stock Exchange that £300 m had been wiped off their value, and Aviva (Norwich Union) announced that the tax changes would cost its policy holders £150 m.
Method of charge
Corporation tax must be passed annually by
Parliament, otherwise there's no authority to collect it. The charge for the
financial year (beginning
1 April each year) was imposed by the Finance Act passed in that calendar year. The Finance Act 1998 changed this, imposing the charge for the 1998 and 1999 financial years, with the Finance Act 1999 then imposing the charge for the 2000 financial year, and so on. The tax is charged in respect of the company's
accounting period, which is normally the 12-month period for which the company prepares its
accounts.
Corporation tax is administered by
Her Majesty's Revenue and Customs (HMRC), which was formed from a merger of the
Inland Revenue (which previously administered corporation tax) and
Her Majesty's Customs and Excise on
18 April 2005.
Assessment
Corporation tax is levied on the net profits of a company. it's borne by the company as a
direct tax.
Up until 1999 no corporation tax was due unless
HM Revenue & Customs (HMRC) raised an assessment on a company. Companies were, however, obliged to report certain details to HMRC so that the right amount could be assessed. This changed for accounting periods ending on or after
1 July 1999, when self-assessment was introduced.
The self-assessment tax return needs to be delivered to HMRC 12 months after the end of the period of account in which the accounting period falls (although the tax must be paid before this date). If a company fails to submit a return by then, it's liable to penalties. which can't be appealed — however, in practice they wait until a further six months have elapsed. Also, the most common claims and elections that may be made by a company have to be part of its tax return, with a time limit of two years after the end of the accounting period. This means that a company submitting its return more than one year late suffers not only from the late filing penalties, but also from the inability to make these claims and elections.
From 2004 there has been a requirement for new companies to notify HM Revenue & Customs of their
formation, although HMRC receives notifications of new company registrations from
Companies House.
Schedular system
In the
United Kingdom the
source rule applies. This means that something is taxed only if there's a specific provision bringing it within the charge to tax. Accordingly, profits are only charged to corporation tax if they fall within one of the following, and are not otherwise exempted by an explicit provision of the Taxes Acts:
|-
||
Schedule D||Taxable income not falling within another Schedule
|-
||
Schedule F||Income from UK dividends
|-
||
Chargeable gains||Gains as defined by legislation that are not taxed as income
|-
||
CFC charge||Profits made by controlled foreign companies where no exemption applies
|}
Notes:
- In practice companies don't get taxed under Schedule F. Most companies are exempted from Schedule F and there's a provision for those companies which are taxed on UK dividends (ie dealers in shares (stock)) that removes the charge from Schedule F to Schedule D.
- A Controlled Foreign Company ("CFC") is a company controlled by a UK resident that isn't itself UK resident and is subject to a lower rate of tax in the territory in which it's resident. very few companies suffer a CFC charge.
- Schedules B, C and E used to, but no longer, exist.
- Authorised unit trusts and OEICs are not liable to tax on their chargeable gains.
Schedule D is itself divided into a number of cases:
|
Scope |
| Case I |
Profits from a UK trade |
| Case III |
Interest-type income and gains/losses on loans, derivatives, financial instruments and intangibles |
| Case V |
Overseas income |
| Case VI |
Annual income not falling within Cases I, III and V, and other income/gains specifically taxed under Case VI |
Notes:
Cases II and IV only apply to income tax and not corporation tax.
Relief for expenses
Most direct expenses are deductible when calculating taxable income and chargeable gains. Notable exceptions include any costs of entertaining clients. Companies with investment business may deduct certain indirect expenses known as "expenses of management" when calculating their taxable profits. A similar relief is available for expenses of a life assurance company taxed on the I minus E basis which relate to the company's basic life assurance and general annuity business.
Rates and payment
The 2007 Budget announced a main rate cut from 30% to 28%, effective from April 2008.
The rate of corporation tax is determined by the financial year, which runs from 1 April to the following 31 March. Financial year FY05 started on 1 April 2005 and will end on 31 March 2006. Where a company's accounting period straddles a financial year in which the corporation tax rate has changed, the company's profits for that period are split.
The reduced rates don't apply to close investment holding companies (companies controlled by fewer than 5 people (plus associates) or by their directors/managers, whose main activity is the holding of investments). Nor do they apply to companies in liquidation after the first 12 months.
Authorised unit trusts and open-ended investment companies are taxed at the basic rate of income tax
Life assurance companies are taxed using the above rates on shareholder profits and 20% on policy holder profits
Companies active in the oil and gas extraction industry in the UK or on the UK continental shelf are subject to an additional 10% charge on their profits from those activities
Most companies are required to pay tax nine months and a day after the end of an accounting period. Larger companies are required to pay quarterly instalments, in the seventh, tenth, thirteenth and sixteenth months after a full accounting period starts. These times are modified where an accounting period lasts for less than twelve months. From 2005 onwards, for tax payable on oil and gas extraction profits, the third and fourth quarterly instalments are merged, including the supplementary 10% charge. The total revenue was £41.9bn from 831,885 companies.
HM Revenue and Customs audit
HM Revenue and Customs (HMRC) has one year from the normal filing date, which is itself one year after the end of the period of account, to open an enquiry into the return. This period is extended if the return is filed late. The enquiry continues until all issues that HMRC wish to enquire about a return are dealt with. However, a company can appeal to the Commissioners of Income Tax to close an enquiry if they feel there's undue delay.
If either side disputes the amount of tax that's payable, they may appeal to either the General or Special Commissioners of Income Tax. Appeals on points of law may be made to the High Court (Court of Session in Scotland), then the Court of Appeal, and finally, with leave, to the House of Lords. However, decisions of fact are binding and can only be appealed if no reasonable Commissioner could have made that decision.
Once an enquiry is closed, or the time for opening an enquiry has passed, HMRC can only re-open a prior year if they become aware of an issue which they couldn't reasonably have known about at the time, or in instances of fraud or negligence. In fraud or negligence cases, they can re-open cases from up to 20 years ago.
After an HMRC enquiry closes, or after final determination of an issue by the courts, the taxpayer has 30 days to amend their return, and make additional claims and elections, if appropriate, before the assessment becomes final and conclusive. If there's no enquiry, the assessment becomes final and conclusive once the period in which the Revenue may open an enquiry passes.
Relief from double taxation
There is a risk of double taxation whenever a company receives income that has already been taxed. This could be dividend income, which will have been paid out of the post-tax profits of another company and which may have suffered withholding tax. Or it could be because the company itself has suffered foreign tax, perhaps because it conducts part of its trade through an overseas permanent establishment, or because it receives other types of foreign income.
Double taxation is avoided for UK dividends by exempting them from tax for most companies: only dealers in shares suffer tax on them. Where double taxation arises because of overseas tax suffered, relief is available either in the form of expense or credit relief. Expense relief allows the overseas tax to be treated as a deductible expense in the tax computation. Credit relief is given as a deduction from the UK tax liability, but is restricted to the amount of UK tax suffered on the foreign income. There is a system of onshore pooling, so that overseas tax suffered in high tax territories may be set off against taxable income arising from low tax territories.
Loss relief
Detailed and separate rules apply to how all the different types of losses may be set off within a company. A detailed explanation of these can be found in: United Kingdom corporation tax loss relief.
Group relief
The UK doesn't permit tax consolidation, where companies in a group are treated as though they're a single entity for tax purposes. One of the main benefits of tax consolidation is that tax losses in one entity in a group are automatically relievable against the tax profits of another. Instead, the UK permits a form of loss relief called "group relief".
Where a company has losses arising in an accounting period (other than capital losses, or losses arising under Case V or VI of Schedule D) in excess of its other taxable profits for the period, it may surrender these losses to a group member with sufficient taxable profits in the same accounting period.
The company receiving the losses may offset them against their own taxable profits. Exceptions include that a company in the oil and gas extraction industry may not accept group relief against the profits arising on its oil and gas extraction business,
Consortium relief is permitted where a company subject to UK corporation tax is owned by a consortium of companies that each own at least 5% of the shares and together own at least 75% of the shares. A consortium company can only surrender or accept losses in proportion to how much of that company is owned by each consortium group.
Example computation
This is an example computation involving a company that has one associate from which it receives £50,000 group relief.
| Example Company Ltd |
| |
£ |
£ |
| Schedule A (UK land) |
|
100,000 |
| Schedule D |
|
|
| — Case I (UK trade) |
200,000 |
|
| — Case I losses brought forward 1 |
(100,000) |
100,000 |
| — Case III (loan relationships, derivatives, financial instruments) |
|
100,000 |
| — Case V (overseas) |
|
300,000 |
| — Case VI (other annual profits) |
|
10,000 |
|
150,000 |
|
|
(50,000) |
100,000 |
|
|
(50,000) |
|
|
(20,000) |
|
|
(10,000) |
|
|
(50,000) |
|
|
580,000 |
|
|
174,000 |
|
|
(46,750) |
|
|
(30,000) |
|
|
97,250 |
Notes:
1 UK trading losses brought forward from previous accounting periods must be relieved as fully as possible against any trading profits in the current accounting period. They can't be relieved against non-trading profits.
² Brought forward non-trading debits can be utilised against non-trading profits; they can't reduce the trading profits
³ The management expense deduction is in relation to expenses incurred on managing the company's investments.
4 The marginal relief computation is as follows: » Marginal relief fraction x (Upper limit/ (Number of associates plus one) - Profit)
11/40 x (1,500,000/2 - 580,000)
5 The £30,000 overseas tax has been included in the taxable Schedule D Case V figure. Double tax relief is available on the lower of overseas tax suffered and UK corporation tax suffered on the overseas income.
Interaction with European law
Although there are no European Union directives dealing with direct taxes, UK laws must comply with European legislation. In particular, legislation shouldn't be discriminatory under the EC treaty.
A number of cases where UK tax laws are believed to be discriminatory have been bought to the European Court of Justice, usually with respect to freedom of establishment and freedom of movement of capital. Key cases which have been decided include:
Hoescht — where the Court found that the way the partial imputation system operated prior to its abolition in 1999 was discriminatory;
Lankhorst-Hohorst — a German case which implied that the UK's transfer pricing and thin capitalisation legislation may have been contrary to EU legislation (the 2004 Finance Act made changes to counter this threat);
Marks and Spencer — where it was claimed that UK parents should be able to relieve the losses of overseas subsidiaries against the tax profits of their UK subgroup (On 7 April 2005, the Advocate-General gave an opinion supporting the claim of a UK parent to offset losses of its EU subsidiaries, where no effective loss relief was available in the EU Member States the subsidiaries were resident in). However, in the final judgment, a compromise agreement was reached in which the national interest to prevent excessive loss of tax was held to outweigh in most circumstances the restriction on the freedom of movement of capital. Accordingly, although no specific new legislation has been introduced, relief for overseas losses will only be available where they may not be utilised in the overseas jurisdiction;
Cadbury Schweppes — where it was ruled that CFC rules are only acceptable if they relate to wholly artificial arrangements intended to escape the UK tax normally payable.
Also, the case of ICI v Colmer led to the UK amending its definition of a group, for group relief purposes. Previously, the definition required that all companies and intermediate parent companies in a group to be UK resident.
There are also a number of other cases making their way, slowly, up to the European Court. In particular:
A Group Litigation Order arguing that dividends received from overseas companies should be exempt from tax in the same way as dividends received from UK companies are exempted from tax;
Claims that the UK CFC legislation is contrary to EU law (notably Vodafone).
Recent developments
Corporation tax reform
There have been a number of proposals for corporation tax reform, although only a few have been enacted. In March 2001, the Government published a technical note A Review of Small Business Taxation, which considered simplification of corporation tax for small companies through the closer alignment of their profits for tax purposes with those reported in their accounts. In July of that year, the Government also published a consultation document, Large Business Taxation: the Government's strategy and corporate tax reforms. It set out the strategy for modernising corporate taxes and proposals for relief for capital gains on substantial shareholdings held by companies.
In August 2002, Reform of corporation tax — A consultation document was published, outlining initial proposals for the abolition of the Schedular system. This was followed up in August 2003 by Corporation tax reform — A consultation document, which further discussed the possible abolition of the Schedular system, and also whether the capital allowances (tax depreciation) system should be abolished. It also made proposals that were ultimately enacted in the Finance Act 2004.
Other enactments
Other main reforms enacted, include:
Relief from tax on chargeable gains on disposals of substantial shareholdings in trading companies and groups (enacted by the Finance Act 2002).
Introduction of UK to UK transfer pricing rules, coupled with the merging of the thin capitalisation rules with the transfer pricing rules (enacted by the Finance Act 2004).
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