Corporation Tax

Introduction to Taxation, ch. 10

Business Law, chs. 15 and 16

Company Tax

• Corporation tax• Directors salaries and fees

• Dividends• Comparison

Corporation tax

• Companies do not pay– Income tax– Capital gains tax– Inheritance tax

• Companies pay corporation tax on their– Income profits, and– Capital gains

Income profits

• Assessed by reference to the categories of income tax– Trading income (business profits)– Savings income (interest/dividends)– Property income (rent)

• Capital gains assessed by CGT rules– use same process to calculate gain

Differences

• No personal allowances- No equivalent of IT personal allowance- No CGT allowance

• Capital Gains- Indexation not frozen in 1998- Tapering relief not available to companies

• Different basis of assessment- CT assessed on the company’s accounting

reference period - payable 9 months later• Different tax rates

Corporation tax rates

Profit up to £300,000 all at 20 %

Eg profit £70,000 – tax is 20% of £70,000 = £14,000

Profits between £300,000 and £1,500,000– 20% on first £300,000– 32.5% above that

Profit over £1,500,000 all at 30%Eg profit £1.6m – tax is 30% of £1.6m = £480,000

Example of the marginal rate

• Profits = £950,000• First 300,000 taxed at 20% =

60,000• Next 650,000 taxed at 32.5%• 650,000 x 32.5% =

211,250• Total tax = 271,250

Corporation tax – rates cont’d

• Important issue is to ascertain which band the taxable profit falls within ie is it:

• - up to £300,000 or• - between £300,000 and £1.5m or• - over £1.5m• This then determines the applicable

rate

Losses

• Trading losses– can be set off against other income or

capital gains in the same accounting period,

– or carried back one year– or carried forward

• Capital losses– cannot set against income– can be set against capital gains in

future periods (indefinitely)

Groups of companies

• Many companies are groups of companies• Typically, a holding company owns the

shares in the other companies in the group• Tax planning issues about whether to create

a group like that or just have separate companies

• Generally, the losses of one company in the group can be set against the profits of other companies

Close companies

• One controlled by five or fewer ‘participators’ or by participators who are directors

• ‘Participator’ is widely defined, but includes shareholders and others who share profits

• ‘Associates’ are treated as one participator(eg close family, partners and trustees of family settlements)

• In practice, most smaller private companies are close companies

Special rules• Company lends over £15,000 to participator

– Company liable to tax of 25% of loan value (repayable when loan paid off)

• Company gives benefits in kind to participator or associate– Treated as a distribution (dividend)– Taxable as investment income

• Company makes gift to participator– Can be treated as gift by other

participators to the recipient - inheritance tax implications

Taking money out of the company

• 1. Pay fees and salaries to directors

• 2. Pay dividends to shareholders

Directors’ salaries

• An expense for the company• Director has to pay income tax under

ITEPA 2003 (employment income)• Company deducts tax under the

P.A.Y.E. system• National insurance contributions

payable by both the company and the director

Dividends

• Not an expense for the company• No tax effect on the company• Investment income for the

shareholder• Taxed at special rates:

– 10% standard rate (tax credit !)– 32.5% higher rate

Compare partnership & company

• Partners pay tax at IT rates• Higher rate (40%) on income over £39,825• Paid on all profits (including retained)• Companies pay much lower rates, higher

rate is 30% and that is re profits over £1.5m

• Dividends have tax advantage (especially when recipient is not higher rate tax payer)

Example

• Business with three individuals• Total profits = £120,000 • Take out £32,000 each

• Compare partnership tax and company tax

As a partnership• Profits per partner = £40,000(NB all taxable even if some (£8k) left in

business)• Less personal allowance 5,225• Taxable 34,775• 10% on 2,230 223• 22% on 32,370 7,121• 40% on 175 70• Total tax per partner 7,414(Total retained funds is 3 x £8k = £24,000)

As a company

• Company pays corporation tax• Pays small salaries to directors

– e.g. £6,000

• Directors are also shareholders so rest paid to them as dividends

- ie £26,000

Company’s corporation tax

• Company’s profits 120,000 (after all other expenses)• Less salaries (3 x 6,000) 18,000• Taxable profits 102,000• Tax at 20% 20,400• Distributable profits 81,600• Dividends (3 x 26,000)

78,000• Retained profit 3,600

Each individual gets £32,000

• Director’s salary 6,000• Less personal allowance 5,225• Taxable income 775• Taxed at 10% starting rate £77.50• Rest (26,000) is taken as dividend• Still less than 34,600 basic rate so 10%• But covered by tax credit 0

• Total tax paid by indv = £77.50

Comparison

• As partners, each pays 7,414• Total tax (x3)

22,242

• Company pays 20,400• Each director pays 77 (x3) 231• Total 20,631• Total saving re whole business

1,611

Cont’d

• BUT Total saving for individuals £7,414 – £77 = £7,337(There would also be NI contributions as well,

which would work out more for the partners)

• Note also the difference in retained profits:Partnership - £24,000Company - £3,600