Tax Advice and Tax Planning: Corporate Tax in the United Kingdom
. Corporation tax is a tax levied in the United Kingdom on the profits made by UK-resident companies and associations. It is also levied on non-UK resident companies and associations which trade in the UK through a permanent establishment. The tax was introduced by the Finance Act 1965, and has been levied from 1 April 1965. The Finance Act 1965 simultaneously removed companies and associations that became liable to corporation tax from the charge to income tax. The tax borrowed its basic structure and many of its rules from income tax. It is currently governed by the Income and Corporation Taxes Act 1988 as amended from time to time. As the UK's tax law rewrite project has proceeded with the passing of the Income Tax (Earnings and Pensions) Act 2003 and the Income Tax (Trading and Other Income) Act 2005 the rules governing corporation tax have diverged more and more from those governing income tax. Corporation tax is the next area scheduled to be tackled by the tax law rewrite project and it is thought that two Acts of Parliament will be required to bring it into line with the aims of the project.
Corporation tax is an annual tax, which means it must be passed annually by parliament, otherwise there is no authority to collect it. Up until the Finance Act 1997, the charge was passed in that year's Finance Act: so the charge for the financial year beginning 1 April 1997 was imposed by the Finance Act 1997. In 1998 this changed - so the Finance Act 1998 imposed the charge for the 1998 and 1999 financial years, and the Finance Act 1999 imposed the charge for the 2000 financial year, and so on. The tax is charged in respect of accounting periods, which usually coincide with the 12 month period for which most companies prepare accounts known as financial statements. Unlike value added tax, which is levied on the sale of goods, corporation tax is levied on the net profits of the company. Therefore, except for tax paid by certain life assurance companies, it is borne by the proprietor. This makes it a direct tax, as opposed to an indirect tax, such as value added tax (a sales tax collected by retailers from the consumers on whom it is nominally levied).
HM Revenue and Customs has one year from the normal filing date, which is one year after the end of the period of account, to open an enquiry into the return. This period is extended if the return is filed late. The enquiry continues until all issues that the Revenue wish to ask about a return are dealt with. However, a company can appeal to the Commissioners of Income Tax to close an enquiry if the Revenue delays. If the Revenue and the taxpayer dispute the amount of tax that is payable, either may appeal to either the General or Special Commissioners of Income Tax. The Commissioners' decisions of fact are binding and can only be appealed if no reasonable Commissioner could have made that decision. However, appeals on points of law may be made to the High Court (Court of Session in Scotland), then the Court of Appeal, and finally, with leave, to the House of Lords.
Further information
If a multinational corporation (meaning, a company with subsidiaries or affiliates in more than just one or two countries) needs to be based in a high-tax country, for instance because it must have a listing on a major stock exchange, then the UK is often a good choice. As a member state of the EU, the UK is within the EU parent-subsidiary directive, and in addition the UK has 110 double tax treaties, more than any other EU country, so that the UK is well placed to receive dividend income with the lowest possible amount of foreign tax deduction. However, this advantage has been somewhat compromised by measures in successive Finance Acts to limit international tax planning by multinationals. Firstly, the UK's Controlled Foreign Company rules have been tightened to the point at which only marginal benefits can be obtained by locating a subsidiary in a low-tax jurisdiction - most types of income and capital gain in 40% offshore subsidiaries are now caught for UK corporation tax whether remitted to the UK or not.
An offshore company owned by several unrelated UK entities would still escape the rules, but that does not accommodate many business situations. In addition, enabling legislation in the 2002 Finance Act allows the British government to alter the tax treatment of controlled foreign companies in jurisdictions which are considered to allow harmful tax practices.
Further changes were brought forward in the 2005 budget. The 2005 Controlled Foreign Companies (Excluded Countries) (Amendment) Regulations aim to prevent CFCs from manipulating their profit location in order to evade taxes, to stop them from secreting income in non-corporate entities, and to exclude them from receiving the benefits of the CFC regime if they are not liable for tax in another country.
The measures came into full force on March 31st. Secondly, the use of tax 'mixing' intermediate companies in such jurisdictions as Holland and Denmark was severely pruned back by the Finance Act 2000. Whereas it used to be possible to use, say, a Dutch holding company to mix dividends from foreign subsidiaries taxed at say 10% and 50% to achieve a blended rate of 30%, thus ensuring that only a very small amount of UK corporation tax would be payable, the rules have now changed. Mixing has been brought onshore by limiting the availability of tax credits to directly held subsidiaries only, and the maximum 'mixable' rate of tax is limited to 45%. Evidently this has a substantial impact on the usefulness for UK companies of Danish and Dutch intermediary holding companies.
Twelve of the EU's 15 member countries impose company emigration exit charges. They include the UK, France, Germany, Italy. The huge tax penalties act as a deterrent on companies wanting to relocate to other member states where running costs are less. Tax charges vary from country to country, but most countries, including the UK, levy a penalty of about 30% of the value of a company's capital assets. Individuals must often pay up to 40%. The ECJ has ruled against national governments in a number of cases involving freedom of establishment, and in August 2003 the English High Court followed ECJ precedents in test case brought by Deutsche Morgan Grenfell, concerning EU 'freedom of establishment' and anti-discrimination laws.
This is mostly the 'mixing' question. The Finance Act 2000, after changes made in response to pressure from business, allowed some types of 'onshore mixing', that is, companies could mix highly-taxed and low-taxed income streams in the UK, but there are so many limitations ('anti-avoidance' provisions) that what started as a good idea, to allow companies to do at home what they had previously had to do in offshore or tax-privileged overseas countries such as the Netherlands, became an expensive straight-jacket. For example, the mixing privilege only extended to the first layer of subsidiaries, unless the intermediate company was in the UK, which would have forced on many groups a complete global restructuring, with other uncalculable tax consequences.
The Holy Grail for international businesses would be a 'participation exemption', such as exists in both Holland and Denmark, for both income streams and capital gains (see below). A widely drawn participation exemption would allow foreign income to remain untaxed in the hands of an onshore parent, regardless of its origin. The Budget 2001 included some quite open discussion of the possibility of an income participation exemption for the UK, and promised a consultation paper. But these good intentions have been overtaken by events, and a participation exemption for income is now on the farthest edge of what is likely. In February 2005, in advance of the budget, new measures to 'prevent tax avoidance by companies', including a rule that relief for foreign tax on income received as part of a company's trade will be restricted to the UK tax on the net profit derived from that income.
The change was initially due to enter into force on Budget day. However, the Treasury saw fit to bring the rule forward so that it will apply to income received from February 10.
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WHAT IS CORPORATION TAX - CORPORATION TAX RATES 2005/6
Corporation tax is the tax on the profits of a limited company. The tax is determined at the end of each company's financial year and is due for payment to the Inland Revenue within 9 months of the year end.
For Corporation Tax, companies have to work out their own tax liability, pay their tax without prior assessment by the Inland Revenue and are liable to penalties if they do not deliver a return by the statutory filing date, normally 12 months after the end of the accounting period.
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ACCOUNTING PERIOD
An accounting period cannot be more than 12 months. If a company prepares accounts for more than 12 months, the profits are apportioned between the first 12 months and the remainder. Non-resident companies may be subject to CT where they trade in the UK through a permanent establishment. Accounting period: A company incorporated in the UK is treated as UK resident. A non-UK incorporated company is treated as resident in the UK if its central management and control is exercised in the United Kingdom. The amounts of income and capital gains are basically determined by the tax rules that apply to individuals. For example, trading profits may be reduced by allowable expenditure incurred wholly and exclusively for the trade. However, companies are subject to many special rules.
CAPITAL GAINS
A company's capital gains are subject to CT at the normal rates. Companies continue to receive indexation relief on gains and do not receive taper relief. Capital gains may be offset by capital losses of the same accounting period or capital losses brought forward from previous periods. Roll-over relief is available, but not reinvestment relief. Companies are subject to different identification rules from individuals for disposals of shares and securities.
RATES OF TAX
The main rate of CT is 30%. This is charged on the whole of profits where they exceed £1,500,000, and in all cases for close investment-holding companies. The small companies rate of 19% is charged on the first £300,000 of profits where profits are between £50,000 and £1,500,000.
Profits between the lower and upper profit thresholds (£300,000-£1,500,000), are in effect charged at a marginal rate of tax of 32.75%. Until 31 March 2006, a company with taxable profits up to £50,000 was charged at 0% on the first ?10,000 and an effective marginal rate of 23.75% on the next £40,000. Profits equal to dividends paid in the period to non-corporate shareholders were charged at 19%. The remaining profits are charged at the underlying rate. This is the average rate that would apply if all the profits were taxed at 0% on the first £10,000 and 23.75% on the next £40,000.
Where a company has associated companies, all the rate thresholds are divided by the number of associated companies plus one. For example, a company with three associated companies is taxed at 19% on profits between £12,500 (£50,000 divided by four) and £75,000 (£300,000 divided by four). Associated companies are broadly companies under common control.
COMPANY LOSSES
A company's trading losses can normally be set against: Income and gains of the same accounting period. Income and gains of the previous year. Trading profits from the same trade in future years.
DIVIDENDS, DISTRIBUTIONS AND ADVANCE CORPORATION TAX (ACT)
Companies do not have to pay tax at the time they pay a dividend. Corporation tax is paid at the normal time on the company's taxable profits without any deduction for dividends paid. A shareholder receives the dividend with an accompanying tax credit equal to 10% of the dividend plus tax credit. The tax credit is equivalent to the basic rate of income tax on dividends. Companies pay no tax on dividends received. Companies that paid dividends before 6 April 1999 had to pay advance corporation tax (ACT) of one-quarter of the dividend. The ACT could usually be set against a company's CT liability. The maximum ACT that could be offset was an amount equal to 20% of the company's chargeable profits, and surplus ACT could be carried back against profits of up to the previous six years. Any surplus ACT at 5 April 1999 that was not relieved in this way may be carried forward to periods after 5 April 1999 and set against CT after deducting "shadow ACT". Shadow ACT is equal to one-quarter of any dividends paid in the period, ie the ACT that would have been paid if the dividend had been paid before 6April 1999.
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