How Your Corporation Tax is Calculated

The Tax – Collection and Administration
At the end of each of your financial years you submit your accounts to HMRC (Her Majesty’s Revenue and Customs) who assess them for calculating your corporation tax liability. This starts but does not end with your published net profit. This article explains how this is done.

Note that when you are entering your figures for a report, Figurewizard performs all of these calculations for you automatically.

The Fiscal Year
The fiscal or tax year on which HMRC bases its calculations runs from the 1st April to 31st March. This is an important point if your own financial year does not end on the 31st March. If tax rates or allowances against profits change from one fiscal year to the next then your tax is calculated on part of your profit using the first fiscal year’s rates and allowances and the second year’s rates and allowances on the balance of the profit.

Example:
1). Your financial year runs from 1st August 2008 to 30th June 2009.
2). This means that the first 243 days of your year are assessed as in fiscal year 2008/2009
3). And the last 122 days are assessed as in fiscal year 2009/2010
4). Therefore 243 days of your profits (i.e. 66.6%) are taxed by the rules of 2008/2009
5). And 122 days (i.e. 33.4%) are taxed by the rules of 2009/2010

VAT
With the sole exception of company cars you never include VAT when entering your figures into Figurewizard: Our system calculates all VAT values and transactions for you automatically.

Equally this means that VAT is never taken into consideration by HMRC when calculating the values of your tax liabilities and / or any tax reliefs you may be entitled to.

The Rules
There are four steps HMRC take to work out how much tax you must pay. These are:

1). Establish your Taxable Profit by adding back the depreciation you have deducted in your accounts.
2). Calculate the value of Capital Allowances, which they use in place of depreciation.
3). Multiply the Taxable Profit thus created by the applicable % rate of tax.
4). Deduct what Marginal Relief (if any) should be allowed against the value of that tax.

The Taxable Profit
Your taxable profit is not necessarily the same as the pre-tax profit shown on your accounts. This is because HMRC does not accept your depreciation charges against fixed assets as they substitute their own specific allowances for these, known as ‘capital allowances’.

There are exceptions to this, principally goodwill and property which are treated as special cases. Generally your own estimates of depreciation will be accepted where these are concerned if they are considered to be reasonable. It is always advisable to seek the advice of your accountant when dealing with the treatment of goodwill and property.

Capital allowances can very often be more generous than your own depreciation charges, especially in the first year of ownership of assets.

Capital Allowances – Sundry Operating Assets (other than Company Cars)
With exception of company cars - plant; fixtures & fittings; commercial vehicles and computers etc. all fall into the same category for capital allowances. They are referred to here as sundry operating assets. Remember VAT is not part of the value of these assets when allowances are calculated.

Capital allowances are always made against the reducing balance after the first year:

Example:
1). You acquire operating assets in the year of £70,000 excl. VAT.
2). In year 1 an allowance of 100% of this cost up to the maximum allowance of £50,000 is set against profits.
3). An allowance of 20% of the balance of £20,000 (£4,000) is also set off against profits.
4). This balance of this £20,000 less the allowance of £4,000 (i.e. £16,000) is c/fwd into the next year.
5). And a further 20% allowance (i.e. £3,200) is set off against profits in that year.
6). And so on ...............

Capital Allowances – Company Cars
Company cars are treated differently in your accounts and by HMRC in that they are the sole items that are entered including VAT. This is because VAT is not recoverable for cars. Note that this rule does not apply to vans or trucks.

There is no larger allowance for the first year of ownership of Company Cars; the rate is always set at 20%. In addition this allowance is only given up to a maximum value of £12,000 per car.

This means that the capital allowance you get for a BMW with leather upholstery at a cost of say £60,000 in any year can be no more than £2,400; the same that you could claim for a mini at a valuation of £12,000.

Marginal Relief
At this point HMRC has taken your pre-tax profit as reported in your accounts, added back the depreciation you have charged and substituted their capital allowances. There is one last step however before your corporation tax charge can be established and that is whether you qualify for what is known as marginal relief or not.

The following explains how to assess if you do qualify and if so, how much marginal relief you are entitled to. The secret here is to understand how the table is to be used. A working example at the end of this paragraph should make this clear.

What HMRC then does is to check which taxable profit band you fall into once capital allowances have been taken into account. If this is in the band £0 - £50,000 or £1,500,000 + in fiscal year 2008 / 2009 there is no marginal relief available but if you are in band £3000,001 - £1,500,000 that same year you do get relief (i.e. divide by 400 & multiply by 7).

Assuming a taxable profit of £400,000 in a financial year beginning 1st. April 2008, marginal relief at 400/7 would apply.

First the tax before marginal relief is worked out. In the case of £400,000 this is £112,000, (i.e. £400,000 x Tax Rate of 28%).

What happens then is that the taxable profit is deducted from the upper limit of it's taxable profit range.This figure is then divided by 400 and multiplied by 7 and deducted from the tax charge.

Example:
1). Your Taxable Profit after Capital Allowances is £400,000
2). Tax before marginal relief is therefore £112,000 (i.e. £400,000 x 28%)
3). The upper limit of your Taxable Profit range is £1,500,000
4). Deduct the Taxable Profit from the upper limit (i.e. £1,500,000 - £400,000)
5). This leaves £1,100,000
6). Divide the £1,100,000 by 400 = £2,750
7). Multiply this by 7 = £19,250, which is your amount of marginal relief

Your corporation tax payable is therefore £92,750 (i.e. tax of £112,000 less marginal relief of £19,250).

Tax Losses
You only have to pay corporation tax if you have made a profit, but what if you have made losses in previous years?

This is taken into account when calculating your tax liabilities in successive years when you will have made profits. For example if last year, once depreciation had been written back and capital allowances had been substituted you showed a loss, that figure would be deducted from any profit that you made this year.

Example:
1). In your financial year ending 31st March 2008 you made a Taxable loss of £10,000.
2). In your financial year ending 31st March 2009 you made a Taxable Profit of £55,000.
3). The £10,000 loss is deducted from the £55,000 profit
4). And tax for year 2009 is calculated on the balance of £45,000 only.

If you had made a loss of £5,000 in 2009 instead of a profit then that would be added to the previous year's loss of £10,000 and a new total for tax losses of £15,000 would then be carried forward to be deducted from profits you would make in 2010.

Mitigating Your Tax Bill
This is not the end of the story where tax is concerned. Tax law affords a number of concessions beyond the simple matters of capital allowances and marginal relief. These can help to reduce your company’s or indeed your personal tax burden, especially if there is an element of research and development in your business.

The rules can be complex though and may involve changing the way your business is structured, how and when you acquire fixed assets or whether or not to pay yourself dividends instead of salary. This is where both figurewizard and your accountants come in.

No one is better qualified to advise you on these than your accountant but he or she needs tangible figures in front of them to be able to form a correct judgement. By producing a realistic set of forecasts through figurewizard you can enable them to do so. If you wish you can produce and save two or more sets to be advised on your likely options on each.

One meeting early on covering tax planning can leave you better informed and the better informed you are the less tax your business could end up paying.

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