Author: Lucy Mangan, director in the tax team at Menzies
Section 1: Introduction
The UK corporate tax regime applies to incorporated companies (limited by shares or guarantee) and other bodies including clubs and associations. The UK corporation tax regime does NOT apply to trusts, partnerships or individuals.
Currently it also does not apply to non-resident company landlords who receive only rental profits in the UK, these are instead subject to income tax rules however this is under consultation (see here).
The UK corporation tax regime is a self-assessment regime, meaning that the taxpayer is responsible for calculating its taxable profits including whether any reliefs apply, tax adjustments are required or whether any anti-avoidance rules apply.
Although there are some tax benefits and specific rules for “group” companies, each separate entity is required to prepare a tax return and calculate its tax liability, it is not possible to submit “group” tax returns.
Well established but under reform
Whilst the regime is well established, it has also seen continuous reform over recent years with more on the horizon.
Reforms aimed at strengthening the UK corporate tax regime
The Coalition Government published the Corporation Tax Roadmap in 2010 with the objective of creating the most competitive corporate tax regime in the G20, achieving fiscal stability, attracting investment into the UK and providing a simpler and more stable tax system. This has given rise to a number of changes.
International reforms
While the 2013 OECD’s Base Erosion and Profit Shifting (BEPS) report and action plan is more likely to have an impact on larger businesses, depending on how these recommendations are enacted into the UK tax legislation, they are likely to result in radical changes to the international tax landscape for all companies. The introduction of the Diverted Profits tax in the UK is a result of recommendations made in this report.
For more information, see here.
Devolved taxes
Certain taxes have already been devolved to Scotland, and are in the process of being devolved to Wales and Northern Ireland (from 1 April 2018), giving the powers to set and administer these taxes to the relevant administrations rather than Westminster.
To date, the devolved taxes are fairly minimal and largely only concern stamp duty land tax and landfill tax, with the exception of Scotland which has some powers in respect of Air Passenger Duty, Aggregates Levy and setting income tax rates and bands.
There are currently no proposals for Scotland or Wales to obtain any powers over corporation tax.
Northern Ireland however is to be given the power to set the corporation tax rate applying to the profit or losses arising from certain activities. The reason for this is that Northern Ireland needs to remain competitive with the Republic of Ireland which has a much lower corporation tax rate of 12.5%. Details of how this will work in practice are not yet available.
Read more: Tax planning – Don’t count on the status quo
Section 2: Who falls within the UK corporation tax regime?
A company will fall within the UK corporate tax regime if it is regarded as tax resident in the UK or if it has a permanent establishment in the UK.
Tax resident
A company is regarded as UK tax resident if:
1. It is incorporated in the UK
This remains the case unless a double tax treaty grants precedence to treat the company as resident in another jurisdiction. If this may be relevant, specific tax advice should be sought as this is a complex area.
2. If central management and control is in the UK
This rule has developed from case law and is more complex to determine. There is no statutory definition of central management and control, only guidance from the decided cases involving different situations.
As it is usual to assume that central management and control resides with the directors who take these decisions at board meetings, their location is often taken as the starting point, although it is important to note that this is not conclusive.
A UK resident company is generally subject to UK corporation tax on the company’s worldwide profits[WS1] , although it may be possible to exempt some overseas branch profits.
Permanent establishments
Non-UK resident companies are subject to UK corporation tax if they have activities in the UK which amount to a UK permanent establishment (i.e. a branch) under UK rules and taking into account any double tax treaty.
A UK permanent establishment is subject to UK corporation tax only on the profits derived by the UK permanent establishment’s activities.
The rest of the guide below relates to companies which are UK tax resident however the majority of the comments would equally also apply to a UK permanent establishment of a non-resident company.
Section 3: Basis of UK corporation tax calculation
Period for which tax returns are prepared
Corporation tax is usually charged for accounting periods in line with the company’s financial statements.
These are usually for one year, except for the periods when a company starts and ceases, or if there is a change of accounting date. For accounting periods in excess of 12 months, more than one tax return will be required as a tax return cannot span a period of more than 12 months.
UK scheduler system
A tax resident company’s worldwide profits or losses are subject to UK corporation tax. Tax relief may be available for all or part of any foreign income tax applied.
Total taxable profits are the aggregate of a company’s net income from each “source” and its net chargeable gains from the sale of capital assets.
The current tax system identifies a number of different “sources” of income and the tax rules that apply to each “source” may differ subtly but sometimes importantly.
The main sources identified include:
- Trading activities
- Property business activities (e.g. rental income)
- Non-trading profits or losses from loan relationships (e.g. bank interest received)
- Management expenses
- Dividends
Calculation of taxable profits/loss arising
The starting point for the calculation of a company’s taxable profit is the profit or loss per the company’s accounts (where prepared under UK or International GAAP).
Unless there is a specific tax rule to the contrary, all costs incurred by the company which are included in the P&L account will be allowable for corporation tax purposes as long as they have been incurred “wholly and exclusively” for the purposes of the company’s activities. Likewise, all income will be taxable unless there is a specific rule to the contrary. Unlike many other jurisdictions, dividends received by UK companies are usually exempt from tax irrespective of where they are received from, although there are exceptions to this.
There are a number of specific tax rules which require the accounting profits to be adjusted for tax purposes. Most notably, depreciation charged in the accounts is replaced by capital allowances which are available on qualifying assets.
Capital allowances
The UK does not allow for capital allowances in respect of the cost of buildings or improvements to the building itself. Capital allowances should be available on most other assets acquired by, and used in, a company’s activities.
The specific rules would need to be considered but in summary the current rates of capital allowances are:
Annual investment allowance (AIA) – 100%
100% deduction for qualifying assets up to £200,000 in a year (note cars are not qualifying assets for AIA )
(the £200,000 applies from 1 January 2016 prior to this the AIA amount varied)
Low emission cars – 100%
100% deduction is available for the cost of new and unused electric cars or cars where the CO2 emissions are 75g/km or less. This is reducing to 50g/km from April 2018.
Plant and machinery – 18% writing down allowance (reducing balance basis)
Available for qualifying assets that do not fall into a special rate pool (see below)
Special rate pool – 8% writing down allowance (reducing balance basis)
Applies to:
- Parts of a building considered to be integral (known as ‘integral features’) including for example; air conditioning, lifts, water heating systems, lighting systems
- Items with a long life (broadly items with a life over 25 years when new and if all such assets cost more than £100k in a year)
- Cars with CO2 emissions of more than 130g/km (this is reducing to 110g/km from April 2018)
Loss utilisation
Position at time of writing
The table below shows how losses from different sources and capital losses can currently be offset.
At the date of writing there is no time limit by which any carried forward losses must be used and for most types of company there is no restriction on the level of losses that can be offset in any one future year, however, this is set to change (see below).
Changes to the utilisation of tax losses
Two major changes in respect of loss utilisation were to be enacted in the Finance Bill 2017, to have effect from 1 April 2017. These are briefly summarised below as it is expected that these will be reintroduced.
Change 1 – restriction of offset of brought forward losses
The offset of losses brought forward is expected to be restricted to 50% of the taxable profits arising in the later year but only in respect of profits over £5 million.
These rules will apply to ALL unutilised historic losses (except capital losses), not only losses that arise after the rules are introduced.
Change 2 – more flexibility in respect of brought forward losses (excluding capital losses)
Brought forward losses will be available to be surrendered to group companies and against any profits in the later year. These changes will remove the distinction between what types of profit different types of brought forward loss can be used against but will not apply to historic losses – only those arising after the date the rules are introduced. The treatment of historic losses remains as per the table above.
Section 4: Tax rates
The UK’s corporate tax year runs to 31 March each year and the financial year (FY) is referred to by the start of the year. For example the tax year 1 April 2017 – 31 March 2018 is referred to as FY2017.
Since 1 April 2015 the UK has had only one general rate of corporation tax irrespective of the size of the company’s taxable profits (prior to this date the UK had a main and small companies rate) . The rate below applies to the total profits and gains arising in the company. There is no separate rate for capital gains.
The tax rates since 1 April 2015 are as follows:
FY2017: 19%
FY2016: 20%
FY2015: 20%
The corporation tax rate is currently set to reduce to 17% from 1 April 2020.
Section 5: Particular industries
The UK has specific tax rules/regimes which apply to or are available to specific industries only.
The rules are often complex and therefore this guide cannot cover these in any detail. Specific rules include the following (please note that this is not an exhaustive list):
1. Tonnage tax regime – This is applicable to qualifying ship owners and operators who have elected into the regime. See Schedule 22 Finance Act 2000 and HMRC manuals.
2. Ring Fence Corporation Tax (RFCT) – Applicable to companies involved in the exploration for, and production of, oil and gas in the UK and on the UK Continental Shelf. See HMRC manuals.
3. Charities – UK charities in a corporate form are subject to UK corporation tax in the same way as any other company however there are many exemptions that result in no tax being payable.
See HMRC manuals.
4. Specific tax rules also apply to several other industries, including banks and insurance companies, farms, Real Estate Investment Trusts, or certain other investment companies.
Section 6: Tax Incentives and deductions
The UK has many tax incentives, particularly in the creative industries. Some of the main ones include:
Research & development (R&D)
The UK has two R&D schemes. The way relief is claimed depends on the size of the company.
The small or medium enterprise (SME) scheme essentially allows an extra tax deduction equal to 130% of the qualifying R&D costs. So, for every £100 spent the company would receive £230 tax relief. If the company is making a loss it can choose to receive R&D credits instead of carrying forward the increased loss. This is a CASH sum paid to the company by HMRC. The R&D tax credit is currently calculated at 14.5% of the surrenderable losses, meaning that the total R&D credit can be up to 33.35% of the qualifying R&D costs.
A company should qualify for the SME scheme if it has no more than 500 employees and either less than €100m of turnover or €86m of total assets, although certain exclusions apply if the R&D in question is subsidised or subcontracted. If part of a group the above limits apply to the group as a whole, the definition of group is wide so should be confirmed in individual cases.
For companies that do not fall into the SME scheme there are separate large company schemes. Prior to April 2016 there were two possible schemes for large companies but for periods from April 2016 the only relevant scheme is the Research & Development Expenditure Credit (RDEC) scheme.
The RDEC scheme is more complicated but it allows for a taxable credit of 11% (net 8.8 %) of total qualifying R&D expenditure. This credit can be offset against a company’s tax liability, group relieved or surrendered for cash.
More information can be found here.
Patent box
This allows companies to apply a lower rate of corporation tax to profits arising from exploiting its patented inventions. The rules were phased in from 2013 and are fully phased in from 1 April 2017 after which the relevant tax rate is 10%. The definition of patent related profits is widely drawn and so this is potentially a very generous relief.
Creative industry tax reliefs
These reliefs are a group of seven corporation tax reliefs for the creative industries and allow qualifying companies to claim a larger deduction or possibly a tax repayment in a way similar to the R&D relief above.
The seven reliefs are:
- Film Tax Relief
- Animation Tax Relief
- High-end Television Tax Relief
- Children’s Television Tax Relief
- Video Games Tax Relief
- Theatre Tax Relief
- Orchestra tax Relief
See here for government guidance.
Substantial Shareholdings Exemption (SSE)
The gain arising from the disposal of shares in a trading company wherever located, may also be exempt from corporation tax if certain requirements are met as to the size and length of the shareholding.
Section 7: Filing and payment deadlines
Submission deadline
Corporation tax returns are required to be submitted to HMRC within 12 months of the end of the relevant accounting period together with a copy of the company’s accounts in an iXBRL format.
ALL tax returns and accounts are required to be submitted to HMRC electronically.
Tax payment deadlines
The deadline to settle a company’s corporation tax liability for the accounting period will depend on the size of the company.
Small companies will pay their corporation tax 9 months and 1 day after the end of the accounting period.
Large companies will be required to pay their corporation tax liability for a year in advance in four quarterly instalments once its taxable profits for the current period are expected to be more than £10 million (reduced if there are more than one group company) or from the second year in succession in which it is not a small company. This does not however apply if the company’s tax liability is less than £10,000 for the current period.
If the company has a 12 month accounting period instalments would be payable as follows:
– 6 months and 13 days after the first day of the accounting period
– 3 months after the first instalment payment
– 3 months after the second instalment payment (14 days after the accounting period end)
– 3 months after the third instalment payment
A small company is a company which has taxable profits in an accounting period of less than £1.5m.
For periods ending after 1 April 2015, the £1.5m limit is reduced by dividing by the number of worldwide “51% group companies” that a company is deemed to have plus one. 51% refers to share capital. A company will be regarded as a “51% group company” if:
– One is a 51% subsidiary of the other
– Both are 51% subsidiaries of the another company
The £10m limit for large companies is also reduced by dividing by the number of ‘51%’ group companies when relevant.
Note: all of the above limits are pro-rated for short accounting periods and the payment dates will also change if the period is less than 12 months.
How to pay corporation tax
A company must settle its corporation tax liability electronically but there are number of options in a e.g. direct debit, BAC’s, CHAPS.
For more details on how to make corporation tax payments see HMRC website information here.
Read more: Making Tax Digital – What might HMRC’s penalties model look like?
Section 8: Penalties and interest
HMRC has the power to raise penalties on a company for a number of offences. These fall into two types of offences, failure or error.
The most common “failure” offences are:
– Failure to notify liability
– Failure to submit a tax return by the due date
Error offences are more serious. The most common example would be fraudulently or negligently submitting an incorrect tax return.
The penalties raised will depend on: whether the company had a reasonable excuse (no penalty), or whether the company has been found to have acted carelessly (the lowest penalty), deliberately but has not concealed or deliberately and concealed (highest penalties). If an error has been made, penalties may be reduced if the company notifies HMRC without prompting and offers full cooperation.
As an example: Failure to submit a return on time gives rise to an initial penalty of £100, increasing to a further £100 after three months. After six months a further penalty equal to 10% of the estimated tax is raised and after 12 months a further 10%.
If errors are identified in a return then the penalties can range from 0% (careless and disclosed to HMRC without prompting) to 100% if deliberate (and not disclosed by the company).
Further details of penalties can be found here.
Late or underpaid tax does not generally result in a penalty but HMRC will charge interest from the date the tax should have been paid until the date it is settled. At the time of writing, the interest rate charged by HMRC on late paid corporation tax is 2.75%.
See here for full information regarding interest charged by HMRC.
Section 9: Anti-avoidance regulations
The UK corporation tax regime has a number of pieces of anti-avoidance legislation. The main ones are set out below.
GAAR (General Anti Abuse Rule)
The GAAR took effect from 17 March 2013 and was strengthened in the Finance Act 2016. Its purpose is to deter taxpayers from entering into abusive arrangements and deter would-be promoters from promoting them. If an arrangement is not regarded as abusive it cannot fall within the GAAR. Although potentially quite wide reaching to date the GAAR has not been applied.
TAARs (Targeted Anti Avoidance rules)
As well as the GAAR the UK corporate tax regime includes a number of TAAR’s. These are introduced as and when HMRC become aware of specific deemed abuses. These numerous, and in many cases highly specific, and so are not set out here.
DOTAS (Disclosure of Tax Avoidance Schemes)
Introduced in 2004 this requires taxpayers to include details of potential tax avoidance schemes on their tax returns and therefore has given HMRC early warnings of some arrangements.
International aspects
CFC (Controlled Foreign Company) rules
The CFC rules have been around for some time but were revised as part of the Corporation Tax Roadmap reforms, applying for periods 1 January 2013 onwards.
A CFC is a non-resident company controlled by a UK resident company. If the rules apply the profits (in part or full) of the CFC can be included as part of the taxable profits of the UK company and therefore subject to UK tax.
The revised rules remain complex but a number of exemptions apply. In essence, the rules are intended to catch only profits where there has been an attempt to divert profits to obtain a tax advantage and not to catch genuine commercial arrangements.
Diverted profits tax
Introduced from April 2015, this is in fact a separate tax to corporation tax but is mentioned here as relevant. These rules were brought into effect as a direct result of BEPS recommendation.
The rules intend to prevent the diverting of profits from the UK and are aimed at two scenarios:
– Arrangements which are specifically structured to avoid the establishment of a UK permanent establishment. In this case there is an exemption if UK sales are less than £10 million in any year.
– Arrangements which are artificial and which are structured to move profits offshore.
If applicable, the profits arising are calculated under UK tax principals and a tax charge of 25% is applied. Double tax relief is unlikely to be available for this tax in the non-UK resident jurisdiction.
Transfer pricing and thin capitalisation rules
The UK does not have separate thin capitalisation rules. These fall within the transfer pricing rules.
The UK’s transfer pricing legislation applies to transactions between connected persons and requires the profit or losses on these transactions to be calculated on arm’s length terms. If the transaction is not at arm’s length and a company has received a potential UK tax advantage (i.e. reduced profits or increased losses) then the rules require a tax adjustment to be included in the UK corporation tax calculations to counter this benefit.
The UK transfer pricing rules differ from regimes of other countries in that:
– They also applies to transactions between two or more connected UK tax resident entities.
– There is an exemption from the rules that will apply to most small and medium enterprises.
For definition, see here.
The UK transfer pricing rules cannot be used to increase losses or reduce profits, however, if the two connected companies are both UK tax resident then an “opposite tax adjustment” is allowed so that an increase in profits in one company is matched by a reduction in the other.
The relevant legislation is set out in Part 4 Taxation (International and Other Provisions) Act 2010.
For more information, see HMRC manuals.