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Corporate Tax Planning – How to reduce Corporation Tax

What is Corporate Tax?

Corporate tax is tax on profits made by companies actively engaging in trade or other commercial activities. Companies, public corporations, unincorporated associations such as clubs, trade associations, industrial and provident societies pay corporation tax on profits. Privatised utilities pay an additional windfall tax on excess profits. Companies extracting oil or gas from the North Sea also pay petroleum revenue tax.

What are the advantages of Corporation Tax Planning?

A thorough understanding of corporation tax rules and its implications would allow reducing the tax burden legally. For instance, UK corporation tax rates are lower than income tax rates for high-income groups. Company owners may also pay themselves dividends, taxed less heavily than other income streams.

What is the rate of corporation tax in UK?

The main rate of corporation tax, applicable to companies that report profit in excess of £150,000, is 26 percent. Companies with profits below £300,000 may claim marginal relief and pay tax at the small profits rate of 20 percent. Companies with profits between £300,001 and £1,500,000 may also avail marginal relief and pay a proportionate lower tax that starts from 20 percent and extends to 26 percent depending on the net profits.

How is Corporation Tax Computed?

The company’s net profits and capital gains attract corporation tax. The computation of profits takes place in the same way as individual income tax and capital gains tax, with the major difference being the absence of the exempt amount, and different relief and allowances for corporation tax.

The law allows deducting most direct expenses from revenues to arrive at the net profit for the purpose of corporation tax. Companies with investment business and life assurance companies may also deduct certain indirect expenses. A notable exclusion from allowable expenses is expense incurred on entertaining clients.

The financial year for the purpose of corporation tax is April to March. Companies may however carry forward trading loss back for one year and set it against the profits of an earlier accounting period. It is also possible to carry forward trading loss and set such loss against any future trade income.

When an accounting period overlaps 31 March, the company may appropriate the profits between the two financial years in question, on a time basis.

Companies qualifying for marginal relief need to calculate corporation tax due at the main rate and then subtract the allowable marginal relief from the tax due.

What are the relief and allowances available for corporation tax?

Apart from marginal relief, the law allows capital allowances, research & development relief or tax credits, loss relief, group relief, dividend relief, expenses relief and credit relief. All these reliefs and allowances reduce corporation lax liability.

  • Capital allowance allows companies to deduct invisible expenses such as depreciation when computing net profits.
  • Research and Development relief allows deducting expenses on certain research and development projects from the net income. Such relief may lead to tax credits.
  • Loss relief, as the name implies, allows set-off of losses against profits
  • Companies belonging to a group may off-set losses among themselves. For instance, one company making a trading loss may off-set such loss against the profits made by another group company in the same accounting period. Such group companies may also transfer assets among themselves without attracting a “chargeable gain” at the time of transfer.
  • Dividend income is excluded when computing corporation tax to avoid double taxation, as the company that disburses the dividend after tax.
  • Companies with an overseas permanent establishment or receiving any foreign income may suffer from having to pay both foreign tax and UK corporation tax. Expense and credit relief provides double taxation relief for such foreign income.

What is capital allowances relief?

The normal computation of corporation tax is gross income or revenues minus direct expenses. This fails to take into account invisible costs such as depreciation. Businesses may avail the provision of capital allowances to gain relief on consumption or depreciation of capital assets that take place during the process of conducting the trade.

Plant and machinery, office equipment, furniture, tools, vehicles, and other common business assets are eligible for capital allowance relief, as are some buildings that require improvement or renovation. Assets taken on lease, however, remain ineligible for capital allowance relief.

Most businesses can claim an annual investment allowance up to £100,000. Certain specific expenditure such as new environment-friendly cars, new zero-emission goods vehicles, designated energy-efficient equipment and others become eligible for 100 percent first year allowance.

The company may claim such deduction in the year of accrual, carry forward any unused capital allowances to later years, or even carry back the unused capital allowances as trading losses.

What is Research and Development Relief?

Research & Development relief grants tax credits to companies, other than subcontractors, for ownership of any intellectual property resultant from the research and development projects conducted in-house, to resolve any scientific or technological uncertainty and enhance knowledge or capability.

Research & Development relief divides into the Small and Medium Sized Enterprise (SME) scheme and Large Company scheme.

  • The Small or Medium-sized Enterprise (SME) Scheme, applicable for companies with not more than 500 employees and either an annual turnover not exceeding €100 million or a balance sheet not exceeding €86 million, provides the tax relief of 200 percent on allowable research and development costs. This means that for each £100 of allowable expenses on research and development, the net income for corporation tax reduces by £200. The rate is set to increase to 225 percent from April 01, 2012.
  • The Large Company Scheme, for companies with more than 500 employees and larger in turnover compared to SMEs, and which incur a minimum research and development expenditure of £10,000 for the year, allows tax relief on allowable research and development costs at 130 percent. This means that for each £100 of allowable expenses on research and development, corporation tax reduces by £130.

This situation may lead to payable tax credits at some times!

What is Loss Relief?

Loss relief is one of the most commonly availed corporation tax reliefs. In a nutshell, it allows a company to set off its losses resultant from trading, disposal of a capital asset, or property losses against income and gains in the same accounting period, income and gains of the previous year, or trading profits of the same trade in future years.

Companies ceasing trading may claim terminal loss relief. This allows set-off of any trading losses in the final accounting period against profits in any or all of the previous three years, provided the company carried out the same trade.

The law treats capital losses differently from trading losses and does not allow offsetting such losses against trading income.

Losses on property income may offset against other profits in the same accounting period, or against property-related profits in the next accounting year. The law however does not allow carrying back such loss to offset against profits from earlier accounting periods.

Group companies may offset losses on property income against profits of other member companies, but only if the company reports an overall loss.

What is Expense and Credit Relief?

UK based companies have to pay corporation tax on all profits from across the globe. However, expense relief allows deducting any overseas tax paid from corporation tax liability. Credit relief allows deduction from corporation tax liability of an amount equivalent to UK tax suffered on the foreign income. Onshore pooling allows setting-off overseas tax suffered in high tax territories against taxable income arising from low tax territories.

At times, moving the headquarters overseas may result in considerable corporation tax savings. For instance, an overseas holding company controlling UK operations allows the UK business to function as a sales and manufacturing service, to which the parent company pays commission. This transfers the tax liability to the overseas country where the corporate tax rate may be lower than the prevailing rates in UK.

What is Petroleum revenue tax?

Companies that earn profits from the extraction of oil and gas from the UK and its continental shelf pay petroleum revenue tax (PRT) in addition to corporation tax. PRT depends on the company’s share of the cash flow from each separate oil field, rather than on profits. The Department of Trade and Industry decides on the fields on geological grounds.

What are the relief and allowances available for Petroleum revenue tax?

Companies may avail various deductions and relief that reduce the PRT liability:

  • When the company is in loss, that is expenditure is greater than income, the loss may be carried forward or backward indefinitely
  • Uplift relief, or past capital expenditure can be given a supplement of 35 per cent to compensate for interest and other finance costs. In normal cases, PRT computation does not allow deducting such expenses.
  • Exploration and Appraisal relief, which allows carry forward or set-off of offshore expenditure on exploration and appraisal against revenues in the same field.
  • Unbelievable Field Loss relief, which allows transferring net losses of an abandoned field to a productive field
  • Research Relief, which allows deducting from the revenue expenditure related to certain research projects

There also exist other allowances such as tariff receipts allowance, oil allowances and cross-field allowance, but only to a select few large companies can hope to avail of such allowance.