You can take advantage of the legitimate ways to reduce your corporation tax such as claiming expenses, paying yourself a salary, and spending profits. We explain each step with examples and show how you could reduce the tax you owe more than by half.
Let us do some accounting magic!
What is corporation tax?
Corporation tax, also known as company tax, is the key tax on business in the UK. As a small business owner, you have to calculate your taxable profit, apply the corporate tax rate, pay, and report on it (all by yourself). If your business is based in the UK, the profits from anywhere in the world are taxable. If you only have a branch here, you are only taxed on your profit from the local operations.
How much is corporation tax for a limited company?
The UK's corporation tax is currently at 19% for the years starting 1 April 2020 and 2021. For the year starting April 2023, the tax will increase to 25% in as the government looks to restore public finances in the aftermath of the Covid-19 pandemic. However, for small businesses with profits of £50,000 or less, the corporation tax will be maintained at the current rate of 19%, at a Small Profits Rate. Only companies with profits of more than £250,000 will be taxed at the full 25% rate.
Here’s how to calculate corporation tax for your limited company — you need to add up all the profits:
- ‘Trading profits’ — the ones from your business operations,
- Investment profits
- ‘Chargeable gains’, when you sell assets for more than they cost you.
Jane is a sole director in HotDogsRockBox, Ltd. and has a hot dog stand. She made £20,000 selling food and drinks. She invested in London stock exchange and made £50 . She also sold her smoothie machine, because no one had bought detox drinks from her. She managed to sell it for £150 more than it was worth according to her records in the books.
She made a total of £20,200 and now needs to pay 19% Corporation tax off that sum. That’s £3,838 she owes in tax.
How to reduce company tax for my limited company?
The definition of corporation tax is that you are taxed on your profits. So your profits have to get smaller and your expenses bigger. It doesn’t mean you should run a business less efficiently, quite the opposite. Tax regulations allow you to take advantage of different ways to optimize your taxable profit. These rules are there to help you spend your money to fuel your business performance. Here are 3 ways to do so:
- Claim all business expenses
- Pay yourself a salary
- Spend your profits
Bonus track: pay HRMC early and get interest.
Let’s examine them closely.
Basically, any expense that is related to your business ‘wholly and exclusively’ can be claimed. Most of us remember to include salaries, contractors’ costs and advertising. Here are a few examples of expenses entrepreneurs forget to add to their losses:
- Office stationery, like paper or markers
- Mobile phone expenses
- Taxi, bus, or tube fares, parking fees
Remember to save the check any time you buy something your business urgently needs.
Jane analyzed her expenses to see if she could claim anything. She found £60 she spent on the mobile plan over the year, £23 she had to pay for parking in London, and £1,900 her Oyster card cost. After deducting all that, her profit shrank to £18,217.
That means she has to pay £3,461 in tax instead of the original £3,838.
Pay yourself a salary
As an entrepreneur, you have 2 options to get money from your business: pay yourself a salary or distribute dividends. These are taxed very differently and have a different impact on your financials.
A salary is a part of your expenses, so it reduces your profits. This helps reduce corporation tax, however, you need to pay income tax on your salary, and National Insurance (NIC) fee on top of that.
Now, dividends are paid from profits, so you need to be profitable in the first place. They are subject to tax on dividends, which depends on your income bracket.
When you decide whether you should take a salary or dividends, there are several factors to consider. For example, paying NIC can entitle you for statutory benefits, and finding the right balance between salary and dividends can reduce your overall tax, not only Corporation tax.
If you want to be tax-efficient, you need to find the ‘break-even’ level of income. That’s a number that would be taxed the same whether you pay yourself a salary or dividends. That’s your salary. Anything on top of that you should distribute as dividends.
Jane sits down to figure out the break-even point between salary and dividends. It turns out that £13,810 ‘costs’ her roughly the same. If she pays herself a salary of £13,810, her tax+NIC will be £883. If she distributes £13,810 as dividends, she’ll pay £886.
This is the maximum annual salary it makes sense to pay herself. Anything beyond that she should distribute as dividends if there’s enough profit.
Jane used to pay herself a salary of £12,500. She adds up the difference between £13,810 and £12,500, which is £1,310. After deducting this expense, her profit is now £16,907.
She owes £3,212 in tax instead of the original £3,838.
! Finding the right balance between salary and dividends is a complicated matter. This one example does not give a full picture, just a general understanding of the topic. We are preparing a separate article on it, so stay tuned.
Spend your profits
You can invest your profits into your business development. If you buy ‘plant and machinery’, you can claim capital allowance. It allows you to spend up to £1,000,000 on equipment, fixtures, or vans and lorries. You then deduct these expenses from your profits and don’t have to pay corporation tax on them.
Jane goes shopping: she gets a soft-serve ice cream machine for £3,995 to replace the smoothie maker. She then gets air conditioning installed inside the stand (thank goodness!), which costs her £1,260. Her remaining profit stands at £11,652.
She now owes £2,214 in Corporation tax instead of the original £3,838.
Throw a party
Staff parties can be accepted as allowable expenses since they aim to increase staff motivation and corporate culture and therefore, make your team and your business more productive. To make sure your parties are tax-deductible, they have to be annual and open to all your employees. Note that if you throw a party for your directors and friends only, it will not be tax-deductible. So either invite everyone who works for you or the party will have little tax optimization effect.
You can claim a maximum of £150 per head.
Jane invited all her employees, which there are five, to celebrate Christmas. Everyone came, and the six of them spent £597 (it was a hell of a party!). The profit that is subject to tax now stands at £11,050.
She has reduced the Corporation tax to £2,100. Remember, she started at £3,838, so it’s less than half of what she owed! She also has made renovations, invested in new equipment, increased her salary and achieved some team building.
Jane is smart! Be like Jane.
Bonus Track: Pay HMRC early
HRMC pays interest they call ‘credit interest’ to limited companies that pay their Corporation tax early. They pay 0.5% from the date you submitted your tax till the day it was due. The earliest you can pay is 6 months 13 days after your Accounting period started.
Jane paid her £2,100 in tax 2 months in advance, so she got £21 back from HRMC. Not that much, but hey, it’s quite a few hot dogs!
That's it. Hope you have a clear picture now of what corporate tax is and how to pay it smarter!
Osome knows not only how to guide you through accounting and bookkeeping. We can help you open your company in the UK.