Corporation tax definition
Corporation tax is a business tax a limited company has to pay on any profits it makes. It also has to be paid on any gains made when a company sells shares or any assets such as property or land.
The rate of corporation tax, also sometimes called corporate income tax, is 19% for companies with profits under £50K. It is 25% for companies with profits of more than £250K. Companies whose taxable profits fall between those two amounts may be entitled to claim marginal relief on the standard rate of 25%.
Example of corporation tax
John and Jane Smith decide to form a limited company together. They call it J & J Smith. In its first year, J & J Smith Ltd makes a pre-tax profit of £49K. They will pay a corporation tax rate of 19% as they’re under the £50k threshold, which equates to a bill of £9,310. The remaining net profit once their tax bill is settled, which is £39,690, belongs to the company J & J Smith, not John and Jane directly.
John and Jane are, however, J & J Smith’s sole directors and owners. What happens with this profit is, therefore, entirely up to them to decide. They can choose to leave it in the company (perhaps to finance investment for future growth). Alternatively, they can withdraw some or all of it to increase their private income. If they withdraw it, they will be taxed on the income as private individuals.
For example, if they pay themselves a salary and/or award themselves bonuses, they will pay income tax and national insurance on this income. If they pay themselves dividends, these will be subject to dividend tax. The tax bill they pay will be calculated via self-assessment.
Who pays corporation tax and when is the deadline?
The company directors are responsible for paying their corporation tax bill to HMRC. The deadline depends on the level of taxable profits.
Up to £1.5 million and it must be paid nine months and one day after the end of a company’s accounting period. If a company has taxable profits in excess of £1.5 million it can be paid in instalments and there are further rules that apply depending on the level of profits.
Note, the deadline for corporation tax comes before the deadline for filing your company tax return which is 12 months after the end of your accounting period.
Registering and paying corporation tax
Most companies register for corporation tax and PAYE at the same time when they register with Companies House. If you haven’t done it this way you’ll need to register within three months of starting a limited company.
Once you’re registered you can sign into HMRC online services to file your company tax return and make a payment.
How to calculate corporation tax and available reliefs
The tax you owe is based on your pre-tax profits and you may be eligible for tax relief.
Corporation tax allowances and reductions
If your taxable profits are below £50K you pay at the small profit rate of 19%. If you have profits of between £50K and £250K then you may be able to reduce your rate from the main 25% rate. Visit the HMRC website to calculate your rate of relief.
Minimising corporation tax: strategies and tips
You can reduce the corporation tax you owe by making sure you claim for all allowable expenses. These are expenses that can be deducted before corporation tax is calculated and are generally known as tax-deductible expenses (or just tax-deductibles).
As a rule of thumb, any expenses that relate to essential purchases are likely to be tax-deductible.
Understanding what is and isn’t legally considered an essential purchase can, however, be complicated. For this reason, it’s generally best to have company accounts prepared by a qualified accountant. This ensures that you pay your tax liability in full but do not overpay.
Corporation tax rates
As we’ve mentioned there are currently two rates in the UK. The 25% standard rate and the 19% small profit rate depending on how much taxable profit a company makes. The 25% rate came into effect on April 1, 2023. It is likely to stay at this rate for the foreseeable future as the UK government has no plans to reduce it.
Corporation tax and other taxes: exploring connection
Corporation tax is separate from other taxes but it can influence them. Here is a quick guide to what this can mean in practice.
Corporation tax and income tax
Corporation tax is paid by the company itself. If company funds are used to pay employees/workers and/or service providers (e.g. freelancers), it will lower the company’s pre-tax profits. This will mean that the company pays less tax. The people paid by the company, however, will need to pay income tax and national insurance on the money they receive.
Regular employees (and service providers) will typically need to be paid the going market rate for their services. Directors who are also employees are mandated to pay themselves at least the minimum wage. They can choose to pay themselves more but not less.
Directors who are employees also have the option to divert regular income into pension contributions. These are counted as part of their pay but are not liable for income tax or national insurance (subject to certain limits).
Corporation tax and dividend tax
Dividends are paid out of a company’s post-tax profits. This means that, in itself, paying dividends will not reduce the amount of corporation tax a company pays. If, however, directors who are employees take payment in dividends rather than a salary, it will reduce the company’s liability for employers’ national insurance. This may increase the company’s profits and hence its liability for corporation tax.
The shareholders who receive the dividends will be liable for dividend tax. This may, however, be more economical for them than paying income tax and national insurance on a salary and/or a bonus.
Frequently asked questions about corporation tax
Do sole traders pay corporation tax?
No, sole traders need to register with HMRC as self-employed and pay income tax on money they earn after they deduct any allowable expenses. This is their taxable income.
What is the impact of dormant business on corporation tax?
If you notify the revenue service that your company is dormant or they deem it to be dormant you don’t need to pay corporation tax or file a company tax return unless you receive a notice to file.
Key takeaways: understanding the basics
If you have a limited company you will need to register for corporation tax and pay it on any taxable profits.
There are two rates - 19% for companies with taxable profits of under £50K and 25% for companies with taxable profits in excess of £250K. If your company has profits in between those two figures you may be eligible for marginal relief.
Corporation tax must be paid nine months and one day after the end of your accounting period. This is shorter than the 12 months you have to file your company tax return.