Direct taxation of businessesi Corporation tax
UK companies are subject to corporation tax on all worldwide profits, whether such profits are income or capital in nature. Profits for corporation tax purposes must be calculated in accordance with generally accepted accounting principles (GAAP), subject only to any adjustments required or authorised by law. The key adjustments are for losses, allowances and expenditure that, while reflected in the accounting profits, are not allowed for tax purposes so are added back when calculating profits for tax purposes.Calculation of taxable profits
UK-resident companies (see Section IV) are subject to UK corporation tax on their profits, wherever they arise. A non-UK company that trades in the United Kingdom through a PE (branch or agency) is subject to corporation tax on the profits of the branch or agency, which are broadly calculated as if the PE were a stand-alone company in its own right.
Corporation tax is charged on the profits of each financial year, which runs from 1 April (so, for example, the 2016 financial year is the year from 1 April 2016 to 31 March 2017). The tax charged for such financial year is based on the accounts of the company prepared for the accounting period that falls in that financial year (an accounting period is generally 12 months, but while it cannot exceed 12 months, it can be less). Where the company's accounting period and accounts for such period do not coincide with the financial year, the profit shown in the relevant set of accounts is, when required, apportioned, on a time basis, between the financial years that overlap the accounting period.Calculation of income profit
The most common adjustments to accounting (income) profits before they are taxed are as follows.Expenses
Although all expenses incurred by the company will depress accounting profit, not all such expenses will be allowed for tax purposes. To be deductible, an expense must be 'wholly and exclusively' incurred for the purposes of the company's trade. Whether an expense is so incurred is a question of the company's intent in incurring a cost and is thus a question of fact. It is often clear that an item of expenditure was incurred to promote the interests of the trade, such as paying staff salaries or suppliers of raw material used to make products produced by the trade. The position is not always clear, however, and there is a great deal of case law that considers when an item of expenditure, deducted in the accounts, is also deductible for tax purposes; for example, expenditure may be incurred on fees connected with changes to share capital, which would generally be regarded as non-deductible, as such an expense is incurred in connection with the company's capital structure, not its trading activity. In addition, expenditure incurred with a dual purpose, such as the cost of an airfare of an employee who goes on holiday but visits a customer while on the holiday, would generally be disallowed.
In addition to the general rule that expenditure must be wholly and exclusively incurred for the purpose of a trade to be deductible, there are a few important cases provided for in legislation that make specific items of expenditure deductible or non-deductible for corporation tax purposes, irrespective of whether such cost was incurred in the course of trade. The most important example of this is probably expenditure on client business entertainment. Irrespective of the purpose of incurring expenditure on business entertainment or gifts, the general rule is that it is not deductible. Conversely, incidental costs of obtaining loan finance, such as bank fees and commissions, which under the general rule may be regarded as linked to capital rather than trading, are specifically allowed as a deduction.Depreciation (capital allowances)
Accounting depreciation is generally not the basis upon which tax depreciation is based, and tax depreciation is based on a system of capital allowances. There a number of exceptions, where tax broadly follows accounting amortisation, most notably in the case of intangible fixed assets and loan relationships.
'Intangible fixed assets' defined by GAAP include patents, trademark and copyright. Such assets, provided they were acquired or created after 1 April 2002 (internally created goodwill for accounting periods starting after 22 April 2009), will be amortised in accordance with the amortisation in the accounts prepared in accordance with GAAP. However, the Finance Act 2015 introduced measures that denied relief for 'relevant assets', notably goodwill and customer information and unregistered trademarks. This made the UK less generous than many other countries, as well as creating tax differences in the treatment of intangibles that was not consistent with their accounting treatment. In response to these concerns, the 2018 Autumn Statement announced that such relief will be introduced for the cost of goodwill in acquiring businesses with eligible intellectual property from April 2019. The Autumn Statement also announced that de-grouping charge rules, applying when a group sells a company that owns intangibles, will be amended effective from 7 November 2018 to align them with the equivalent rules applying to capital gains.
Although not all capital expenditure qualifies for capital allowances, allowances are normally given for expenditure on things such as plant and machinery, and R&D.
Expenditure on plant and machinery is pooled for capital allowance purposes and generally depreciated for tax purposes at 18 per cent per annum on a reducing balance basis. In the case of long life assets (assets with an anticipated working life of 25 years or more), the rate is reduced to 8 per cent per annum (reducing to 6 per cent per annum from 6 April 2019). If assets are sold at a price above their tax-depreciated value, there may be a clawback of allowances, or if assets have been under-depreciated there may be a balancing allowance.
Many companies claim an annual investment allowance that gives tax relief (broadly a 100 per cent offset for cost in the year in which it is incurred) for qualifying business capital expenditure up to a maximum annual sum (currently £200,000 per annum but temporarily increasing to £1 million per annum for expenditure incurred between 1 January 2019 and 31 December 2020).Trading and income losses
If there is a trading loss in any year, the loss can be offset against total profits (income or capital) for the current accounting period of the company. The trading loss can be set against all profits (including chargeable gains) and not just the profits arising from the same trade as that in which the loss was incurred.
Excess trading losses can also be surrendered to another UK company in the same group or consortium (see below for a description of the taxation of groups), or carried back to set off against the company's total profits (income or capital) of the preceding year.
Income and trading losses realised prior to April 2017 can also be carried forward indefinitely and offset but only against income profits arising from the same trade. However, the Finance (No. 2) Act 2017 allows companies to set certain carried-forward losses (notably trading losses) made after April 2017 against total profits, rather than be restricted to set-off against profits of the same trade. However, the Finance (No. 2) Act 2017 imposes a new restriction on the amount of profits that can be reduced by carried-forward losses. Losses made prior to April 2017 can be carried forward and fully offset against a future accounting period's profits, but under the new regime only 50 per cent of profits can be reduced by post-April 2017 losses. Companies are entitled to a £5 million allowance against which carried-forward losses can be fully offset before the restriction applies.R&D tax credit
Relief is available for expenditure on revenue on R&D. The nature and rate of relief depends on whether the company is a large company or a small or medium-sized enterprise (SME).
The relief for SMEs provides a greater than 100 per cent deduction for all qualifying R&D expenditure in computing profits for corporation tax purposes. Relief is given at 230 per cent for SMEs in relation to expenditure incurred on or after 1 April 2015. The enhanced tax benefits used to apply only to small companies but now extend to medium-sized companies (companies with fewer than 500 employees, with an annual turnover not exceeding €100 million or a balance sheet not exceeding €86 million, or both and meets certain independence and going concern tests). If an SME is loss-making after deducting the R&D relief, it can elect to surrender the loss relating to the R&D expenditure and SME R&D relief and take credit in cash from the HMRC, worth up to 14.5 per cent of the surrendered loss. A separate relief, similar to that available to an SME with some modification, existed for large companies but was phased out and replaced by an R&D expenditure credit (RDEC, also known as the 'above the line' tax credit) for R&D expenditure incurred on or after 1 April 2016. Large companies may make an irrevocable election to use the R&D expenditure credit for expenditure incurred on or after 1 April 2013.
Under the RDEC regime, large companies work out the eligible costs directly attributable to R&D, reduce relevant subcontractor or external staff payments to 65 per cent of the original costs, and then multiply the figure by 12 per cent (from 1 January 2018) to obtain the expenditure credit. This credit can then be used to settle the company's corporation tax liability for the accounting period with any excess being reduced by applying a notional tax charge to it based on the main rate of corporation tax for the accounting period. The remaining amount can be used for various purposes including paying outstanding corporation tax for other accounting periods or surrendered to any group member.
An added attraction of this new regime is the way in which it appears in the company's accounts. The credit is recognised as part of the company's profit before tax (hence the reason it is called an 'above the line credit') and so will have a favourable impact on a company's accounting profits.
Expenditure that qualifies for R&D credit is defined by reference to expenditure that qualifies under GAAP, subject to certain exclusions. Most notably, in order to qualify the R&D must seek to achieve a general advance in knowledge or capability in a field of science or technology, not just a company's own knowledge or capability; furthermore, the research does not have to be successful for the revenue expenditure to qualify for R&D credit.Calculation of capital (chargeable gains)
A company is potentially liable for corporation tax on any chargeable gains arising from the disposal of a capital asset. The gain is taxed at the same rate as an income trading profit, and is the difference between the original acquisition cost and the disposal value minus designated allowable expenses (e.g., the costs of improvements and an allowance for inflation).
If a capital asset qualifies for capital allowances, these are deducted from the acquisition cost, but only to eliminate or reduce a loss so that if, for example, the asset is sold at a gain, capital allowances are ignored.
Unlike trading losses, capital losses can only be set off against chargeable gains in the same or future accounting periods. Capital losses can be carried forward indefinitely, but not back. Under proposals announced in the 2018 Autumn Statement, from 1 April 2020, the proportion of annual capital gains over a £5 million allowance that can be relieved by brought-forward capital losses will be limited to 50 per cent.
Anti-avoidance rules exist that restrict the ability to buy loss-making companies in order to use their capital losses, and the use of capital losses made on transactions with related parties.
Rollover relief is available to companies that reinvest the proceeds from disposals of certain types of capital assets into new capital assets. This allows any gains on such assets to be deferred until the new asset is sold, unless the proceeds of that sale are also reinvested.
Subject to the selling company and company being sold meeting certain trading company criteria, broadly a company that holds at least 10 per cent of the share capital of another, and has held such interest for 12 months, may qualify for SSE on a disposal of those shares so that any gain arising on disposal is completely exempt from tax on the capital gain. The Finance (No 2) Act 2017 introduced certain changes that relax the trading requirements, notably for institutional investors.Rates of corporation tax
The rates of corporation tax are set for each financial year, and if the rate changes during a company's accounting period, the profits are generally split between the two financial years on a time-apportioned basis and the different rates applied to the relevant part. The corporation tax rate for the financial year commencing on 1 April 2017 is 19 per cent and reduced to 17 per cent on 1 April 2020.Groups
Unlike the position in some other jurisdictions, a group is not taxed as a single entity in the United Kingdom, and members of a group are taxed on an entity-by-entity basis but with rules to allow sharing of tax reliefs and movements of assets between group members on a tax-neutral basis. The definition of a group for UK tax purposes differs according to the context, but as a broad rule a company will be grouped with another if 75 per cent of a company's ordinary share capital (which gives proportionate economic rights, broadly 75 per cent of the right to any dividend paid and assets distributed on a winding-up) is owned by that other company.
Subject to certain exclusions, UK companies within a capital gains tax group may transfer assets between them without triggering a capital gain or UK stamp duty.
Current year trading losses (not carried-forward losses or capital losses) and certain other deductions such as debits on loans can be surrendered between group members.Administration and payment
UK companies self-assess by submitting a tax return generally within 12 months of the end of their accounting period. If the return is filed late there is a small fixed penalty, which increases to 10 per cent of the unpaid tax if the return is submitted more than 18 months after the end of the accounting period (over six months late), and then to 20 per cent if the return is more than two years late (over 12 months late). Companies (other than small companies) pay their corporation tax by quarterly instalments: two in the current year and two after it has finished. The first payment is due six months and 14 days after the start of the accounting period; the second three months after the first payment; the third three months after the second payment; and the final payment three months after the third payment. However, for accounting periods starting on or after 1 April 2019 (originally proposed for periods after 1 April 2017) this will change to quarterly payments in the third, sixth, ninth and 12th months of the accounting period.Compliance and reporting
As part of increased compliance and reporting requirements, companies are required to take action outside of the normal requirements to submit accurate tax returns on a timely basis. Among the most noteworthy of these requirements are: the obligation to publish tax strategy, the obligation to take proactive steps to prevent tax evasion and country-by-country reporting. These are all discussed in more detail below.
Under the UK Finance Act 2016, all large businesses operating in the UK are required (in respect of all financial years commencing on or after 15 September 2016) to publish, before the end of the first relevant accounting period, their UK tax strategy online. This applies not only to UK companies, UK permanent establishments and UK partnerships with turnover exceeding £200 million and having a balance sheet total of over £2 million, but also to multinational groups with a global turnover exceeding €750 million that have any UK presence no matter how small.
The strategy is restricted to UK strategy and need not divulge how much UK tax is paid or commercially sensitive information but must set out the following relation to UK tax:
- the company's approach to risk management and governance arrangements;
- the company's attitude to tax planning;
- the level of risk the company is willing to accept;
- the company's approach towards dealings with HMRC; and
- a statement that the company regards the publication as complying with its duty under the Finance Act 2016.
The strategy must be accessible free of charge on the internet and be republished every subsequent year.
The Criminal Finances Act 2017 introduces new strict liability offences with potentially hefty fines for failing to prevent facilitation of UK and non-UK tax evasion. Businesses in the financial services, legal and accounting sectors are likely to be most affected, but it applies to all companies and partnerships. There is a statutory defence where there are reasonable preventative procedures in place to prevent its associated persons from committing tax evasion facilitation offences. In practice, this will mean that businesses will probably start to introduce policing procedures and start including provisions in commercial contracts, employment contracts, etc., to protect against financial and reputational risk.
The UK country-by-country reporting obligations apply to accounting periods beginning on or after 1 January 2016. UK-parented multinationals with revenues above €750 million or entities with a non-UK parent in a country that has no country-by-country reporting or effective exchange of information mechanism with the UK will need to submit a report (following the OECD template) in respect of the global group or UK subgroup, as appropriate, to HMRC within 12 months of the year end. Following OECD recommendations, a multinational group can file in the UK on a group-wide 'surrogate' basis.ii Other relevant taxesStamp duties
The United Kingdom has no capital duties but does levy stamp duties. Stamp duty land tax (SDLT) is charged on the execution of some documents that transfer land in England and Northern Ireland generally at rates of up to 5 per cent on commercial property and 12 per cent on residential property, unless the purchaser is a non-natural person (see below). If the residential property is leasehold and the total rent over the life of the lease is more than £250,000 you also pay 1 per cent on the portion over 1 per cent. SDLT does not apply in Scotland, where land and buildings transaction tax applies, or in Wales, when from April 2018 a land transaction tax will apply. Stamp duty is charged on instruments that transfer UK company shares or securities (usually at 0.5 per cent). Securities generally exclude ordinary commercial loan capital, provided such loan capital has no equity-type characteristics, such as a yield linked to profit. Higher rates of SDLT apply to the purchase of additional residential properties (such as second homes and buy-to-let properties) for chargeable consideration exceeding £40,000. The higher rates are 3 per cent above the current SDLT rates for residential property.
To discourage the practice of buying residential property in an offshore company then transferring shares in such company without paying SDLT, SDLT is charged at 15 per cent on interests in residential dwellings costing more than £500,000 purchased by certain non-natural persons such as companies, collective investment schemes, and partnerships with one or more members who are either a body corporate or a collective investment scheme. In addition, any such non-natural person that owns a residential dwelling will be subject to an annual tax on enveloped dwellings (ATED). The amount of ATED is worked out using a banding system based on the value of the residential property. Properties on which ATED is paid and that were owned on 1 April 2017 need to be revalued to that date for the purposes of the ATED charge. Currently, there are six valuation bands and six corresponding levels of charge from £3,600 per annum for properties worth between £500,000 and £1 million up to an annual charge of £226,950 for a residential property worth more than £20 million. Capital gains tax applies on a sale of properties in this regime, even for non-UK resident entities. In respect of both the SDLT charge and ATED, there are exclusions notably for companies acting in their capacity as trustees for a settlement and property developers or property rental businesses that meet certain conditions.
Agreements to transfer UK company shares or securities, or shares of a non-UK company that maintains a UK register of such shares or securities, may attract stamp duty reserve tax (SDRT) (usually at 0.5 per cent). If stamp duty is paid on the instrument of transfer within prescribed time limits, the SDRT charge on the contract predating the formal transfer document need not be paid.Value added tax
VAT is a tax on non-business consumers, and for most business is an administrative burden rather than a tax cost. VAT is charged on goods and services supplied in the course of business. If the customer is itself a business, is registered for VAT and uses the supplies it receives for business purposes, the business will receive credit for the VAT it pays (input tax), which it can offset against the VAT it charges (output tax). If a business is charged more VAT than it charges its own customers, it can reclaim the difference, but if it charges more than it is charged, it pays the difference to HMRC. Thus, generally the burden is passed down the supply chain until it reaches the ultimate non-business consumer who bears the cost.
Certain supplies are exempt from VAT, notably supplies of shares and securities (including loans) and certain supplies of land and buildings. Other supplies are zero-rated, such as books, food, transport, children's clothing and supplies of goods and services outside the United Kingdom. In cash terms, a zero-rated supply (where VAT is charged at zero per cent) is the same as an exempt supply (where no VAT is chargeable), but the difference is that a business can generally recover VAT incurred on costs incurred in connection with a zero-rated supply but may not recover VAT on costs incurred in respect of exempt supplies.
Currently, UK businesses with a taxable turnover greater than £85,000 in the preceding 12 months (it is proposed that the £85,000 limit will apply to April 2020), or where there are reasonable grounds for expecting that turnover in the next 30 days will exceed this limit, must register for VAT. Businesses may also choose to register if they anticipate being able to reclaim material amounts on VAT charged by their suppliers.
VAT has been generally charged at 20 per cent, with some exceptions such as a rate of 5 per cent on home energy. Taxpayers are required to maintain detailed records of output and input tax. Large taxpayers pay tax monthly, as do those who regularly reclaim; others may pay quarterly.Income tax and social security contributions
Unlike corporate tax rates, the United Kingdom's income tax rates are relatively high and higher still in Scotland; this is a factor that a business thinking of moving into the United Kingdom and relocating staff will need to take into account. In the current tax year (to 6 April 2019), individuals pay tax on total chargeable income at 20 per cent (the basic rate) on the first £34,500 of their income, then at 40 per cent (the higher rate) on income above that figure up to £150,000, then at 45 per cent (the additional rate) on income above £150,000. In Scotland there is a five-band structure with the top two bands charging tax at 41 per cent above £31,850 and 46 per cent above £150,000.
There are personal (tax-free) allowances on the first slice of income (generally £11,850 in the current tax year with different allowances in Scotland). Dividend income above £2,000 is taxed at slightly lower rates and interest is tax free up to £1,000 then taxed above this, although those with incomes in excess of £150,000 pay tax on all of their savings income.
Employers are required to deduct income tax from their employees at source and account to HMRC under a system known as pay-as-you-earn (PAYE).
In addition to income taxes, UK employees (other than the very low paid) and their UK employer are subject to NIC. In the current tax year (to 5 April 2019), a UK employer must pay NIC at 13.8 per cent of their employees' gross earnings. The self-employed also pay NIC, but at lower rates.
Employees must also pay NIC on their earnings and the employer is responsible for collecting it from their earnings. It is charged at a fixed rate (currently 12 per cent) between a threshold and an upper earnings limit (currently £892 per week), and thereafter at 2 per cent.