UK Business Information / Corporation Tax

Corporation tax rates in the UK are still relatively low compared to other EU member states as a whole. It is a tax on a company’s profits and applies equally to both resident companies on their worldwide income and non-resident companies carrying on a trade through a permanent establishment in the UK.

Below, you will find information on:

Resident / Non-Resident Companies

Groups of Companies

Calculation of Taxable Profits and Losses

Compliance

Tax Payments

Double Taxation Relief

Repatriation of Profits

 

1. Resident / Non-Resident Companies

A company might be resident in the UK under two circumstances;

a. it is incorporated in the UK; or

b. it is not incorporated in the UK but its central management and control is in the UK.

Taxation of non-resident companies will vary depending on whether or not they have a permanent establishment in the UK. This is based on the OECD Model Tax Convention and broadly arises where there is a fixed place of business in the UK or a dependent agent conducting contracts in the UK on behalf of the principal company. This may be eliminated using one of the UK’s many double taxation conventions, however, it is a complex area and specific professional advice  is required.   Non-resident companies will generally be chargeable to UK corporation tax if they are carrying on a trade in the UK trough a permanent establishment.

 

2. Groups of Companies

UK tax legislation broadly has the effect of neutralising intra group transactions and allowing loss relief between the group entities. The definition of a group company for tax purposes is different from one provided under company law.

Whether a group exists depends on which relief is being claimed under which part of the tax legislation. For example, in order for a UK company to claim  relief for another UK group member’s trading losses and non-trading deficits (e.g. some types of interest payment)  one company must own at least 75% of the ordinary share capital of the other company or another company (which does not have to be a UK company) must own at least 75% of the ordinary share capital (directly or indirectly) of both companies. Trading losses and non-trading deficits can generally only be group relieved against a fellow group member’s profits of the same accounting period. Following a European Court decision, there is now also relief for losses of a EU group company against a UK group company’s profits of the same period, but only if the non-UK company can never get loss relief in its own country, for example, because it has ceased trading. However, conditions to be fulfilled by EU companies for the loss relief still remain onerous.

Companies might be in the same capital gains group when a company is a 75% subsidiary of another. This is broadly similar to the definition above of a group  although is more complicated where a company is not an effective 51% subsidiary of the principal company. Group companies for these purposes are entitled to transfer assets between them on no gain no loss basis as well as re-allocate third party gains and losses between them.

 

3. Calculation of Taxable Profits and Losses

The starting point for a company’s taxable profits is its accounts profit under UK GAAP or IAS as appropriate. Adjustments then have to be made for items for which there is a special treatment under the tax legislation. The main such items are:

• Capital expenditure, including any related expenditure such as legal fees on the acquisition or disposal of capital assets, for which there is no trade deduction allowed although a capital gains deduction may be allowed on the disposal of the relevant asset;
• Expenditure on entertaining, for which there is no deduction allowed, save for staff entertaining;
• Depreciation for which no deduction is allowed.

Profits and losses on sales of assets for which no profit/loss is recognised (except  broadly for assets held under a finance lease). Capital gains rules generally apply in this case;

•  A deduction is available for “Capital allowances” on certain fixed assets (which effectively replaces depreciation);
• Expenditure on Research and Development and other special reliefs for which additional tax relief can be claimed;
• Transfer pricing adjustments where the company’s profits are lower as a result of goods or services received from (or provided to) another group company at a price that is not at a normal market rate;
• Interest received or paid and amounts written off on loan relationships including trading debts particularly between “connected” companies for which there are special rules to arrive at the amount to be included in taxable profits;
• Capital gains and losses on the disposal of assets, for which the assessable amounts are calculated under special rules.

Losses on trading activity can be set against other income and gains of the same accounting period or the previous period. They can also be carried forward without time limit but are only available against trading profits of the same trade and not for example investment income or capital gains.

Some of these points are considered below;  

a. Capital allowances

Capital allowances take the place of depreciation to provide relief for capital expenditure on items that are used in the day-to-day running of the company.

Capital allowances cannot be claimed on assets purchased with the intention to sell as these would usually be recognised as trading stock in the accounts. Normally, companies can claim capital allowances on the cost of motor vehicles, equipment, furniture, plant and machinery, and many other items that are purchased for use in the business.

The main exception is expenditure on fixed items in buildings that provide the setting in which the business is carried on, such as walls, ceilings and doors for which allowances are not generally available.

UK businesses are generally entitled to an annual investment allowance (AIA) which allows a 100% deduction for up to £100,000 of qualifying expenditure broadly on all plant and machinery except cars. There are rules which mean only one investment allowance is available to a group of companies or companies under common control and which are “related” to each other. Where the cost of plant and machinery exceeds the AIA in a year the balance of expenditure is available for writing down allowances.

The annual writing down allowance is usually 20% of the cost of the item in the year of purchase (to the extent it is not covered by the AIA)  and then 20% of the written down value in subsequent years. The allowances for motor vehicles are generally based on their CO2 emissions. For example, low emission cars (< 110 gm/km) will benefit from 100% allowance in year of acquisition.

Two recent categories have been added as an exception to the 20% writing down allowance, namely integral features and assets qualifying for enhanced capital allowances.

Integral features include electrical, cold water system, a space and water heating systems, lifts, escalators, and external solar shading. The annual writing down allowance is 10% of the cost of those items.

Enhanced capital allowances are available at 100% of the cost of specific items, such as energy saving plant and machinery, low emission cars (emits not more than 110 g/km CO2) and designated plant and machinery to reduce water use and improve water quality.

There can also be enhanced allowances in the year of purchase for buildings in certain areas designated as enterprise zones although these will be withdrawn from April 2011.

Small and medium-sized enterprises that are not part of a large group, are sometimes entitled to enhanced allowances in the year the asset is purchased. These are set each year by the Government and can be restricted to certain types of asset and are intended to encourage capital investment.

Industrial buildings, such as factories, could historically qualify for an allowance of 4% of the original cost of the building, depending on the type of activity carried on by the company. These allowances are being phased out however and will not be available from 1 April 2011.  

b. Research and Development Expenditure

This relief is only available to limited companies. Qualifying Research and Development activities are defined under government guidelines which are broadly concerned with advances in science or technology through the resolution of scientific or technological uncertainties. These are uncertainties which can not be easily resolved by a competent professional working in that particular field of expertise.  Small/medium sized companies are able to claim an enhanced deduction equal to 175% of qualifying expenditure and large companies 130% of qualifying costs.

Expenditure must be revenue (not capital) in nature and be directly related to the company’s R&D activities. The categories of qualifying expenditure include staff costs, software, relevant payments to the subjects of clinical trials, consumable or transferable materials, subcontracted research and developments costs, and externally provided workers.

A small/medium sized company which realises net trading losses for an accounting period can surrender all or part of the loss (subject to certain restrictions) so far as it relates to R&D expenditure for a repayable 14% tax credit from HMRC.    

c. Transfer pricing

Normally, trade occurs between different companies that have no direct link. However, related companies can trade goods and services between themselves – a common example is a multinational group, which trades in goods and services between its operations in different countries. If this is the case, then companies must follow various transfer pricing rules. Transfer pricing can pose a problem for tax authorities due to the fact that the prices agreed between the related companies can be set in such a way as to minimise the taxable profits in a particular  country and thus decrease the tax burden of the multinational overall. UK rules generally state that any transfer of goods or services between related companies must pass the ‘arms length’ test – that is, the price paid must be the price that would be paid if the companies were completely unrelated.

If this test is passed, then it is more likely that each related company will pay the correct tax in each country.

A transfer pricing adjustment for tax purposes is only required where there is a UK tax advantage conferred as a result of the non-arm’s length provision. Companies can enter into Advance Pricing Agreements with HMRC to provide certainty that the prices they charge meet their approval and therefore no transfer pricing adjustments are required  to their tax returns.

Previously, UK rules regarding transfer pricing were only applicable to UK companies trading with related overseas firms. However, from 1 April 2004, this rule was extended to related companies that are based in the UK. However, small and medium-sized enterprises are now normally exempt from the transfer pricing rules.

 

4. Compliance

Companies must register with HMRC within 3 months of starting to trade. They are then  responsible for calculating the tax payable and filing  their own tax returns within twelve months of the end of  the accounting period to which it refers. Failure to do so results in penalties. The tax return must include a  separate set of tax computations (usually running to  several pages) showing the adjustments made to the  accounting profits in accordance with the tax legislation.  Much of this legislation is complex and there can be penalties for getting it wrong.

HMRC has 12 months from the time of filing the tax return to make enquiries (or longer if the return is filed late), which can lead to adjustments to the tax payable. If however they discover something that affects the  company’s tax affairs for an earlier period that was not properly disclosed at the time, they can adjust earlier years. In addition to normal accounting records, which must be kept for at least six years, companies in groups must keep documentation regarding transfer pricing of transactions between group companies. With effect from 1 April 2010 the normal discovery window is reduced from 6 years to 4 years but where HMRC discover a loss of tax due to carelessness by the company or a person acting on behalf of a company the 6 year window still remains.

 

5. Tax Payments

Companies are also responsible for calculating and paying their corporation tax without assessment from HMRC. In general, the normal due date for the tax to be paid is nine months and a day after the end of the accounting period. The exception is for large companies, large being defined broadly as those having profits in excess of £1,500,000, thus, paying tax at 28%.

Large companies have to pay tax on a quarterly basis, the first payment being due six months and 14 days from the start of their accounting period. Should there be any underpayment of tax, then the company may have to pay interest on the outstanding amount not paid; similarly, if there is an overpayment of tax, HMRC may pay interest on the amount due back to the company. There are special rules where a company’s the accounting period is more or less than 12 months.

The corporation tax rates in the UK vary according to the level of profits and there are marginal rates in order to ease the transition between tax bands. The rates are set out in the table below:

	Profits	Rate
Small companies	Up to £300,000	21%
Marginal relief companies	Between £300,000 to £1,500,000	28% (marginal relief applies)
Large companies	Above £1,500,000	28%

Note that if a company is part of a group or if there are other companies under common control, then these rate bands must be divided by the relevant number of companies in the group (including companies outside the UK).

The rate bands are proportionately reduced if the accounting period is less than 12 months.

 

6. Double Taxation Relief

When a UK resident company operates overseas it may pay both overseas taxes and the UK taxes on the same activities. Double taxation relief is designed to alleviate this double charge on the same source of income. There are two different double taxation relief systems applicable in the UK tax system, namely unilateral relief given by the UK legislation and double tax treaty relief given by bilateral tax treaties signed by the UK government.

The unilateral relief is calculated on a source by source basis. In essence, the relief is the lower of the UK corporation tax due on that source of income and the foreign tax suffered. In order to calculate the UK corporation tax foreign income must be grossed up. If the foreign tax is less than the UK tax, the company will pay the difference to HMRC. Where a foreign tax is higher, no repayment will be claimable by the company.

There have been recent changes regarding the way that foreign profits are taxed in the UK. With a few exceptions, dividends now are exempt from UK taxation regardless of received from a UK company or an overseas company. Therefore, wherever withholding tax paid on foreign dividend is going to be a final liability of the company and no additional liability will be incurred in the UK.

Double taxation treaties relief varies on each treaty provisions. Double taxation treaties contains a provision regarding which country is entitled to tax the relevant source.

 

7. Repatriation of Profits

A UK subsidiary company commonly repatriates part of its profits to its parent company commonly by way of a dividend, royalty, management charges, or interest on loans, depending for example on how the UK subsidiary is financed and the extent to which administration and support services are centralised within the group. Two particular issues arise in respect of the repatriation of profits withholding taxes and transfer pricing.

The UK does not currently withhold tax on dividends and so a UK subsidiary does not need to withhold tax on any distributions aide to its parent company regardless of where the parent company is tax resident

Withholding tax at a rate of 20% (2010/2011) generally applies to payments of interest made to a non UK resident company unless the interest is received as part of the business carried on by a UK permanent establishment of that overseas company. If the UK has a double tax treaty with the tax jurisdiction in which the parent company is tax resident, this may allow a lower rate of withholding tax or gross payment subject to the UK subsidiary making a successful treaty relief claim to HMRC. 

Unlike interest payments,  for royalty payments there is no requirement under the UK legislation to make a specific treaty relief claim provided that the person paying the royalties to pay EU companies without deduction if they have a reasonable belief that the recipient will be entitled to the exemption.

When non-resident individuals or companies receive income from a property situated in the UK a payer who will be either a letting agent or a tenant has to deduct tax at the basic rate (%20). However, landlords can apply to Charities Assets and Residency for approval to receive the income of their rental business with no tax deducted provided that they satisfy the conditions and file a tax return including their property income.

The UK does not generally withhold tax on other services. 

In addition to transfer pricing and thin capitalisation rules, for accounting periods commencing after 1 January 2010 ‘debt cap’ rules will also apply to companies which form part of a large group. The rules effectively restrict the UK tax deduction for interest costs of UK companies. The aim of the rules is to ensure that the aggregate UK corporation tax deductions for financing costs do not exceed the group's external financing costs on a worldwide basis. It is a very complex area and professional advice must be sought. There are two steps test before applying the UK debt cap rules. At first stage which is only applicable standalone UK companies, the company needs to check whether it meets with conditions of the “gateway test”, if so, it is outside the “debt cap” rules. The 'gateway test' works by comparing the sum of the UK net debt of each relevant group company (that have net liabilities) with the worldwide gross debt (relevant liabilities) of the group as whole. Secondly, if the UK net debt exceeds 75 per cent of the worldwide gross debt, then the group is within the debt cap rules.

Lastly, there are anti-avoidance provisions in relation to Controlled Foreign Companies (“CFC”). The controlled foreign companies' provisions are directed at

companies which make use of low tax territories or other favourable overseas tax regimes to reduce their United Kingdom tax liabilities. Substantial changes are expected from July 2011.