How to calculate Corporation Tax

To work out your company's taxable profits, start with your pre-tax profit figure (sometimes known as 'profit before tax') in your financial accounts for a financial year.

Once you've done that, you must:

• Add back any depreciation charges included in the accounts.
• Deduct any capital allowances - they take the place of depreciation charges. Capital Allowances for a company are the same as those for a sole trader (see 'Capital allowances' under Income Tax for sole traders). You can get further information on capital allowances on the HMRC website.
• Add any other relevant income or chargeable gains.
• Deduct any other relevant deductions, reliefs, allowances or losses.

Then:

• Apply the relevant tax rate to calculate the gross Corporation Tax payable.
• Deduct any relevant tax credits and any Income Tax already deducted from interest income the company received (for example, the tax deducted by a bank before it paid the company interest).

Finally:

• Deduct any Corporation Tax already paid, e.g. tax paid early, or the amount of Corporation Tax that you can claim back as an overpayment.

Chargeable gains

If your company has made a profit from selling a chargeable asset, e.g. a building used for its trade, this profit (called a 'chargeable gain') is added to the trading profits. You should include it in the Company Tax Return. Corporation Tax is paid on this profit instead of Capital Gains Tax. Your company will also have to pay Corporation Tax if it gives away or otherwise disposes of the asset. To work out the chargeable gain:

• Start with sale proceeds and deduct any costs of sale, such as solicitor's or surveyor's fees.
• To get the unindexed gain, which is the gain before inflation is taken into account, deduct:
• the original cost of the asset;
• incidental costs of purchase, such as solicitor's fees and Stamp Duty Land Tax; and
• any money spent on permanent improvements (e.g. an extension)
• Calculate the indexation allowance.

The Indexation Allowance is an allowance for inflation. It's based on the movement in the Retail Prices Index (RPI) between:

• the date of acquisition of the asset and the date of sale; and/or
• the date the money was spent improving the premises and the date of sale.

Deducting the Indexation Allowance strips away the gain due to inflation, leaving the real gain in the value of the asset. However, since 1 January 2018 the Indexation Allowance has been frozen, meaning the Allowance that is applied will be calculated up to December 2017.

You can find tables of the indexation factors on the HMRC website.

To calculate the indexation allowance for the original expenditure, the original cost of the asset and incidental costs of purchase are multiplied by the indexation factor for the date of purchase.

If you spent money on improving the asset, the indexation allowance for the improvements is calculated by multiplying the cost of the improvements by the indexation factor for the date of this expenditure. The indexation allowances for the original expenditure and for the improvements are added to give the total indexation allowance.

Deduct the total indexation allowance from the unindexed gain. You'll then be left with the indexed gain, which represents the real gain when the effect of inflation is stripped away.

Example calculation of indexed gain

The company bought premises to be used for the trade in September 2005 for £250,000. Incidental costs of purchase were £4,000. It sold the premises in September 2021 for £420,000. Costs of sale were £3,000. In May 2007, it had spent £25,000 on a small extension. The relevant indexation factors for an asset sold in September 2013 are:

• September 2005 - 0.305
• May 2007 – 0.222

To calculate the chargeable gain:

Deduct indexation allowance:

• On cost of purchase £250,000 x 0.305 = 76,250
• On incidental costs of purchase £4,000 x 0.305 = 1,220
• On cost of improvements £25,000 x 0.222 = 5,550

Capital losses

If the company has sold more than one asset in its accounting period, and it has made a capital loss on one of them and chargeable gains on the others, it can deduct this loss from the chargeable gains made on the sale of the other assets. The net chargeable gain is included in the calculation of corporation tax.

If, in an accounting period, you deduct all the chargeable gains of your company from the capital loss and still have some loss left (an 'unabsorbed loss'), your company can carry this unabsorbed loss forward. The unabsorbed loss can be set against chargeable gains made in future accounting periods. It can't, however, be set against income profits.

Reliefs for chargeable gains

Business Asset Rollover relief

Your company may be able to claim Business Asset Rollover relief if it buys a new qualifying asset to be used in the business within a specified timeframe of selling an old qualifying business asset.

This relief will allow your company to postpone payment of corporation tax on its chargeable gain made on the old asset until it sells the new asset. Apart from the fact that goodwill isn't a qualifying business asset for corporation tax, this relief works in the same way for companies as it does for unincorporated businesses such as sole traders and partnerships (see 'Capital Gains Tax' under Relief from Tax for sole traders for more information).

Reliefs for trading losses

Carry-across and carry-back relief

Your company can claim to set off a trading loss:

• against total profits of the accounting period in which the loss was incurred (carry-across relief); and
• if there is still an unabsorbed loss, against its total profits of the preceding 12 months (carry-back relief). A company must set its loss against profits of the current period first, before setting them off against profits of the previous 12 months*.

If your company is claiming carry-across/back relief, it must set the loss against total profits, i.e. income profits plus chargeable gains. It can't choose to set off its loss only against particular items of income or gains.

Losses may be only carried back against profits of the preceding 12 months if the company was carrying on the same trade in part of that period. However, it isn't necessary for the trade to have been carried on for the whole of the preceding 12 month period.

Example

A company makes a trading loss of £40,000 in its 12-month accounting period ending 31 December 2021. It made a chargeable gain in that year of £10,000. It had made a total profit of £50,000 in the previous 12-month accounting period which ending 31 December 2020.

It can set its loss against the chargeable gain in the year of the loss (year ending 31 December 2021) so that it pays no Corporation Tax in respect of that gain. £10,000 of the loss would be set against the chargeable gain leaving a loss of £30,000, which the company could then carry back and set against the profit of £50,000 in the previous year. That would reduce the total profit in the previous year on which Corporation Tax is calculated to £20,000.

This is a simple example, but you may need professional advice if your situation is more complex.

*The government announced in the Spring Budget 2021 that losses realised in accounting periods ending in the period 1 April 2020 to 31 March 2022 can now be carried back for an additional 2 years. There is no limit on the amount which can be carried back for one year, but the amounts which may be carried back to earlier years will be limited to £2 million for each of the 2 accounting periods (the one ending in the period 1 April 2020 to 31 March 2021, and the one ending in the period 1 April 2021 to 31 March 2022). Groups of companies will have to split the £2 million cap between group members.

Carry-forward relief

Relief for trading losses is available by carrying forward trading losses and setting them against future trading income from the same trade.

The loss available for carry-forward is the loss sustained, less any part of that loss already used on Carry-across or carry-back relief (see 'Carry-across and carry-back relief' above).

You can't pick and choose the subsequent years in which you use the relief. You must set the loss against the profits of each subsequent year in chronological order until the loss is used up.

Example

A company makes a trading loss of £40,000 in its 12-month accounting period ending 31 December 2021. It projects it will make trading profits of £30,000 in the next accounting period ending 31 December 2022, and £60,000 in the accounting period ending 31 December 2023. It could elect to use carry-forward relief to set the loss against future profits of the same trade.

The disadvantage of carry forward relief is that the company has to wait until future profits are made in order to benefit from the relief. Also, the trading loss can only be set against future trading profits and not any other income or chargeable gains.

Corporation Tax rate

The Corporation Tax rate is 19% for companies with profits under £50,000 ('small profits rate') and 25% for companies with profits over £250,000 ('main rate'). Companies with profits between £50,000 and £250,000 will pay tax at the main rate, reduced by a marginal relief. This provides a gradual increase in the effective Corporation Tax rate. These rates will also apply in Northern Ireland. While the Corporation Tax (Northern Ireland) Act 2015 provides for the Northern Ireland Assembly to have the power to set the rate of corporation tax, the final devolution is subject to agreement between the UK Government and the Northern Ireland Executive, which has not yet been reached.