How is Corporation Tax Assessed in England?

As a business owner, you might wonder how Her Majesty’s Revenue and Customs (HMRC) assesses the amount of corporation tax you owe. This assessment differs from the tax rules HMRC applies to individuals and other business entities. For example, corporations (and other incorporated entities) must account for income, chargeable gains, and loss relief when determining their taxable income. This article will explain the rules that govern the corporation tax system so that you can get a better sense of what your company’s tax liability may be. 

The Subject of Corporation Tax 

Corporation tax only applies to companies (and certain other incorporated entities). Thus, it does not apply to you as a business owner. Instead, HMRC will look at your income profits and capital gains to determine your yearly tax liability. 

The Company’s Accounting Period 

Your company is liable to account for any taxable income profits and chargeable gains that arise during its accounting period. The accounting period is a twelve-month period that the company is free to set for itself. For instance, it might be from 1 July to 31 June the following year. Any money it makes during this period is taxed as a single tax year.

Importantly, your company’s accounting period does not have to align with the financial year, which runs from 1 April to 31 March of the following year. However, where it does not align, your company may have to pay different tax rates, as the government might change these rates over separate financial years. The current corporate tax rate is 19%. 

Total Taxable Profits 

You probably know that profit generally refers to all the money you receive less any expenses. However, “taxable profits” has a specific definition regarding corporation tax. 

The amount of money HMRC assesses for tax is your company’s total taxable profits (TTP). In other words, you only pay tax on your company’s TTP. 

Calculating TTP: Basics

At the most basic level, TTP is the sum of:

• your business income profits; and 
• your chargeable business gains. 

You can think of your income profits as all the money your business regularly receives. This includes: 

• the money it routinely brings in through selling goods and services; and
• regular payments arising from ancillary income, such as rental and interest payments received. 

‘Chargeable gains’ refers to the taxable sum of any gains you make selling a capital asset, calculated as the sale price less the price you paid for the capital asset. A capital asset is any asset used in the course of your business but which does not contribute to any business income. 

Below, we discuss the specific factors that affect your TTP and how to account for these when calculating. These include your: 

• income;
• chargeable gains; and
• loss relief. 

Income 

Income includes all money your business receives from the following sources:

• trading income (the sale of goods produced or services provided); 
• rental income; and 
• interest paid on loans by your debtors. 

Note that dividends, though technically a form of income, rarely attract any tax liability. This means that if your company receives a dividend payment, HMRC is unlikely to include it in your taxable income. 

Trading income is the income your business brings in through its core business activities. It does not include non-core income, like incidental interest, dividends, or rental receipts. 

Deductible Expenditure 

Deductible expenditures are any and all tax-deductible expenses you incur while trading. To determine if an expense is deductible, HMRC asks if the expense is:

• wholly and exclusively incurred for the purposes of trading; 
• not an expense prohibited by statute; and 
• an expense of an income nature. 

In practice, this includes:

• money spent on raw materials used to manufacture goods or provide services;
• ancillary bills for things like heating, electricity, wifi, and rent; and 
• employee wages and salaries. 

It does not include:

• business entertainment expense; and 
• provisions made for doubtful debts. 
  

Capital Allowances 

The general rule in tax law is that you cannot offset income gains from capital losses. Capital allowances are an exception. 

Provided your company spends money on qualifying capital assets, you can deduct certain amounts from your pre-tax income, thereby reducing your overall tax liability. 

The most common types of qualifying assets include:

• plant and machinery; 
• long-life assets; 
• research and development expenditure; and 
• certain costs related to the construction and renovation of commercial buildings. 
  

Other Income 

Before assessing your company’s total liability for income, it will add all other sources of income. Therefore, if your business collects money from rent or interest payments, these will be factored in. There are additional deductions your company may be eligible to claim from its other income. 

Total Income Profits

From the total trading income, the following items are deducted:

• deductible expenses; 
• capital allowances; and 
• trading losses (see below).

This figure is your total taxable trading income. 

Additionally, if you have made any gains from other sources of income, these sums (less any allowable expenditures) are added to the taxable trading income to arrive at the total taxable income. 

Chargeable Gains 

Separately, HMRC will also assess all gains you have made from selling capital assets. 

Net Gains

First, HMRC will assess net gains, which is the difference between the price you sold the asset for and the price you paid for it. 

Allowable Expenditure

HMRC then allows you to deduct certain expenses from the net gains, such as those arising from the purchase and sale of the asset. In practice, this includes legal and brokerage fees and money spent enhancing the asset’s value. 

Index Allowances

Additionally, certain allowances, called index allowances, permit your company to offset the effects of inflation from the gains you made selling the asset. The current figures have been frozen since 2017.

Rollover Relief 

In certain cases, you can defer any tax arising from the sale of a capital asset. To do so, you must sell a qualifying asset and use the proceeds to purchase a replacement asset. The effect of rollover relief is that you do not pay any chargeable gains until you sell the replacement asset without purchasing a subsequent one. 

An example of a qualifying asset is plant and machinery. 

Total Chargeable Gains 

From the net gains, the following sums are deducted:

• allowable expenditures; 
• index allowances; and 
• rollover relief. 

This amount is your total chargeable gains. 

Loss Relief: Income and Chargeable Gains 

There are specific rules that govern how you can apply losses in the current, previous, or subsequent accounting period to the taxable portions of income and capital gains. These rules are called loss relief. As a general rule, you can only offset trading losses from the income portion of your TTP and capital losses from the portion of the chargeable gain. 

In general, if you have made any losses in the current tax year, you first apply these losses to any gains. If your losses exceed your gains, in some cases, you can apply them to previous years to recover tax you have already paid. Alternatively, you may be able to carry the losses forward to subsequent years and reduce your future tax liability. 

Applying Loss Relief to your TTP

You would typically assess loss relief for each accounting period after determining your total income profit and chargeable gains. The next step is to consider which form, if any, of loss relief is available. You then apply loss relief most efficiently by subtracting the amount from the income and chargeable gains portion of the corporation tax proforma.

Key Takeaways 

The rules governing the corporate tax system are very detailed. Only companies pay corporation tax. In general, the law distinguishes between profit from income and profit from the gains your company has made from the sale of capital assets. Different rules apply, depending on if the gains are of an income or capital nature. Various deductible expenditures are available for you under capital and income profits. It is worth clarifying your tax obligations with a lawyer, so you are not liable for unlawful tax avoidance.

If you need help with your business or tax obligations, our experienced commercial lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us on 0808 196 8584 or visit our membership page today!

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