How can we reduce our corporation tax bill?
17th September, 2023
The question of reducing corporation tax bills through allowable expenses is a perennial query posed by company directors in boardrooms around the world at the same time every year. That point is normally around 10-11 months into the financial year as the scale of that year’s profits, and therefore tax payable on them starts to become clear.
The simple answer offered to this question by accountants all around the world is that 10-11 months into the year is about 10-11 months too late to be planning. Ideally, the business will have longer-term tax planning and investment strategies in place that mitigate and offset tax. However, in the real world, it is accepted that not every business has the long-term visibility or in-house skillset to plan much beyond a 12 to 36-month window.
The positive news is that there are several, simple strategies and routes that can be followed that allow a degree of extra flexibility for in-year tax mitigation.
What reduces corporation tax?
With corporation tax being based on profits the obvious answer is to reduce your profits. On the face of it, that sounds like an oxymoron, surely the aim is to remain profitable? And so, the challenge is to make the profits, but find a way of keeping the money in the business or getting it to the shareholders/owners in a tax-efficient manner. This process is harder for the professional services industry as companies in this sector don’t tend to have the trappings of kit and machinery etc that others do.
As of 2023, there are probably around nine ways of reducing corporation tax whilst retaining the benefit of the money earned and these vary between benefiting the business, the owners and the wider community.
- Research and Development (R&D): With Research and Development, if it is believed that you’re trying to innovate a product, service, or process within your company’s industry, you have the capability to claim tax relief in this field.
- Investments: Like individuals, it is possible for businesses to make investments into schemes like the enterprise investment scheme (EIS), meaning you can defer your taxes for up to three years and receive income tax relief of up to 30% as well. Doing this has a two-fold effect in cutting a company’s Corporation Tax: firstly, the starting amount gets lowered by up to 30% when investing, and secondly, any profits from selling those investments won’t be taxed.
- Obtaining Abroad Credits and Losses: If you own a business that runs in another country, you will be able to reduce corporation tax by claiming foreign tax credit on the profits you’ve made (while paying tax), and the same applies to losses. If you’re not in control of the reasons you’re losing money, you can claim these losses as deductions against taxable cash flow in the UK.
- Fixed assets: Investing in new kit, machinery or freehold premises is a good way of reducing taxable profits and in many cases, there is an annual allowance that few fully utilise.
- Capital Gains: Using capital gains tax reliefs as a UK business will allow you to reduce your payment of corporation tax, as long as you can use these allowances and immunities—typically available for businesses that sell assets within a set timeframe.
- Invoice each individual expense: By using this plan to reduce corporation tax charges, you can send a bill for your regular costs separately from the money you make from the sales you make. This helps keep those costs from being counted when figuring out how much they have to pay in taxes.
- UK Business Capital Allowances: As soon as you buy an asset as a company, you will benefit from tax relief. The price of the asset can be subtracted from your company’s taxable income over several years.
- Transfer Pricing Strategy: As a British company, you can use ‘Transfer Pricing’ to lower your Corporation Tax numbers, meaning you can set prices for a deal being made between parts of the company in different countries (if you have worldwide locations). This can help you move profits from places with high taxes to places with lower taxes.
- Using Your Previous Losses: As a business owner in the UK, if you provide evidence of previous losses within your company, you can use them against each profit you make in order to decrease the amount of corporate tax you have to pay.
What is not an allowable expense for corporation tax purposes?
Whilst the list of allowable expenses above is not exhaustive there is one common theme across anything which can help to reduce your corporation tax liabilities and that is the good old allowance. Nearly all allowable expenses will have an allowance – a threshold up to which corporation tax is reduced. But exceed this threshold and you will once again begin to pay corporation tax on the remaining profits. In some cases, these allowances are so big that it is near impossible to exceed them, but before assuming there is no ceiling it is worth checking.
Apart from exceeding limits on allowable expenses, there are a few items that are added back to the profits ahead of the calculation of corporation tax. The most obvious example of this is corporate hospitality or client entertainment. Any money spent on entertaining clients and customers simply goes to reduce cash, not taxable profits.
How is corporation tax calculated?
Is there a rule of thumb calculation?
Corporation tax has become much simplified over the last 20 years. In a post-Brexit trading environment, we can probably expect the rates to remain a key lever used by successive governments to encourage businesses to relocate to and invest in the UK.
As a result of the simplification process and the relatively long-term rate trend sticking around the 20% mark, there is a basic rule of thumb calculation for corporation tax which is to take the sum of gross sales minus allowable expenses and divide the answer by five. This will get you to a neat ballpark figure for planning purposes.
Obviously, this is a very rough calculus and should not be relied upon. The actual figure needs to consider the comments earlier in this post about what is and what is not an allowable expense and further year-end adjustments such as amortisation and depreciation.