Corporation tax - Basis of charge

Learning Outcomes

This article explains the fundamental principles determining which entities are liable for UK corporation tax and on what basis that liability is calculated. After reading this article, you should understand the concepts of company residence, permanent establishment, and how income profits and chargeable gains form the basis of a company's taxable profits for corporation tax purposes. This knowledge is essential for advising business clients on their UK tax obligations and potential liabilities.

SQE1 Syllabus

For SQE1, you are required to understand the practical application of corporation tax rules, particularly the basis upon which a company is charged to tax. You should focus your revision on:

• Identifying chargeable persons and entities for corporation tax purposes.
• Understanding the territorial scope of corporation tax, including the rules on UK residence and permanent establishments for non-resident companies.
• Knowing the components of taxable profits, specifically how trading income and chargeable gains are determined for corporation tax.
• Appreciating the significance of accounting periods in the calculation of corporation tax liability.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following entities is generally liable to UK corporation tax?
   1. A sole trader operating in the UK.
   2. A partnership where all partners are individuals resident in the UK.
   3. A company incorporated and managed in the UK.
   4. A charity registered in the UK.
2. On what basis are UK resident companies typically charged to corporation tax?
   1. Only profits arising from UK activities.
   2. Worldwide profits, including income and chargeable gains.
   3. Only chargeable gains arising in the UK.
   4. Only trading profits arising worldwide.
3. A company incorporated in France has a sales office in London which negotiates and concludes contracts on its behalf. Is the French company likely to be liable for UK corporation tax?
   1. No, because it is not incorporated in the UK.
   2. Yes, on its worldwide profits because it trades in the UK.
   3. No, because its central management and control is outside the UK.
   4. Yes, on profits attributable to its UK permanent establishment.

Introduction

Corporation tax (CT) is the tax levied on the profits of companies and certain other bodies, such as unincorporated associations. It is distinct from income tax and capital gains tax, which apply primarily to individuals. For the purposes of SQE1, a foundational understanding of how a company becomes liable to CT and what profits are subject to the tax is essential. This involves identifying the entities within the scope of CT and the types of profits that form the basis of the charge.

The primary legislation governing CT includes the Corporation Tax Acts of 2009 and 2010. CT is charged on the profits of a company arising in its accounting period. These profits include both income profits (such as trading profits) and chargeable gains (profits from the disposal of capital assets).

Chargeable Persons and Territorial Scope

The liability to UK corporation tax depends primarily on a company's residence status or its level of activity within the UK.

UK Resident Companies

A company is considered resident in the UK for tax purposes if it meets either of the following conditions:

• It is incorporated in the UK.
• Its central management and control are exercised in the UK.

Key Term: UK Resident Company
A company liable to UK corporation tax on its worldwide profits, determined either by its place of incorporation or the location of its central management and control.

UK resident companies are liable to corporation tax on their total profits from all sources, wherever those profits arise globally. This includes both income profits and chargeable gains.

Non-UK Resident Companies

A company that is not resident in the UK may still be liable to UK corporation tax if it trades in the UK through a permanent establishment.

Key Term: Permanent Establishment
A fixed place of business in the UK through which a non-resident company carries on its trade, or a UK-based agent acting on behalf of the company with authority to conclude contracts.

If a non-resident company has a permanent establishment in the UK, it is liable to UK corporation tax, but only on the profits attributable to that UK establishment. This includes trading income arising directly or indirectly through the establishment, income from property or rights used by the establishment, and chargeable gains on the disposal of assets situated in the UK and used for the establishment's trade.

Worked Example 1.1

Global Solutions Ltd is incorporated in England and has offices in London and New York. TechCorp Inc. is incorporated in the USA but has a branch office in Manchester that independently negotiates and concludes sales contracts for the UK market. Which company is liable for UK CT and on what basis?

Answer: Global Solutions Ltd is a UK resident company because it is incorporated in the UK. It is liable for UK CT on its worldwide profits (from both London and New York). TechCorp Inc. is not UK resident, but its Manchester branch office constitutes a permanent establishment in the UK. Therefore, TechCorp Inc. is liable for UK CT on the profits attributable to its UK branch activities.

Taxable Profits: The Basis of Charge

Corporation tax is charged on the company's 'profits'. For CT purposes, profits mean the company's income profits plus its chargeable gains arising in an accounting period.

Key Term: Profits (for Corporation Tax)
The sum of a company's income (e.g., trading profits, property income, investment income) and its chargeable gains arising in an accounting period, after deducting allowable expenses and reliefs.

Income Profits

Income profits are calculated according to principles similar to those used for calculating income tax for individuals, particularly trading profits. This involves:

1. Identifying chargeable receipts (revenue from trade, property income, investment income etc.).
2. Deducting allowable expenses incurred wholly and exclusively for the purposes of the trade (e.g., salaries, rent, cost of materials).
3. Deducting capital allowances for expenditure on qualifying plant and machinery.

Chargeable Gains

Chargeable gains for companies are calculated similarly to capital gains for individuals but with some key differences. The basic calculation is:

1. Determine the disposal proceeds from selling a capital asset.
2. Deduct the acquisition cost and any allowable expenditure (e.g., costs of enhancement or disposal).
3. Apply the indexation allowance (where applicable, for periods up to December 2017) to adjust the cost for inflation.

Unlike individuals, companies do not benefit from an annual exemption for chargeable gains. Various reliefs, such as rollover relief on replacement of business assets, may be available to defer the gain.

Worked Example 1.2

Innovate Ltd, a UK resident company, has the following results for its accounting period:

• Trading income after allowable expenses but before capital allowances: £500,000
• Capital allowances claimed: £50,000
• Sale of an office building (purchased 10 years ago) resulting in a chargeable gain after indexation allowance: £75,000

What are the company's total profits chargeable to corporation tax for the period?

Answer: Income Profits = Trading income less capital allowances = £500,000 - £50,000 = £450,000

Chargeable Gains = £75,000

Total Profits = Income Profits + Chargeable Gains = £450,000 + £75,000 = £525,000

Innovate Ltd's total profits chargeable to CT are £525,000.

Accounting Periods

Corporation tax is charged on profits arising in a company's accounting period.

Key Term: Accounting Period (for Corporation Tax)
The period for which a company prepares its accounts and for which corporation tax is calculated. It normally aligns with the company's financial year and cannot exceed 12 months.

If a company's accounting period does not align with the corporation tax financial year (1 April to 31 March) and the tax rate changes, profits must be apportioned between the two financial years.

Revision Tip

Remember the key distinctions: UK resident companies are taxed on worldwide profits, while non-UK resident companies with a UK permanent establishment are taxed only on UK-attributable profits. Profits include both income and chargeable gains.

Key Point Checklist

This article has covered the following key knowledge points:

• Corporation tax is levied on the profits of UK resident companies and non-UK resident companies trading through a UK permanent establishment.
• UK resident companies are taxed on their worldwide profits. Non-UK resident companies are taxed on profits attributable to their UK permanent establishment.
• A company is UK resident if incorporated in the UK or if its central management and control is exercised there.
• A permanent establishment can be a fixed place of business or a dependent agent with authority to contract.
• Profits for corporation tax include both income profits (calculated similarly to income tax) and chargeable gains (calculated similarly to capital gains tax, but without an annual exemption).
• Corporation tax is charged for a company's accounting period, which normally aligns with its financial year and cannot exceed 12 months.

Key Terms and Concepts

• UK Resident Company
• Permanent Establishment
• Profits (for Corporation Tax)
• Accounting Period (for Corporation Tax)