The scope of corporation tax

Welcome to Corporation Tax (TX)!

Welcome to the start of your journey into Corporation Tax (CT)! If you have already studied Income Tax, you are off to a great start. Think of Corporation Tax as the "Income Tax for companies." While individuals pay tax on their earnings, companies pay tax on their taxable profits.

In this chapter, we are going to look at the "Scope"—which basically means: Who has to pay? What do they pay on? And what time periods do we look at? Don't worry if this seems a bit technical at first; we will break it down piece by piece.

1. Who is Liable to Corporation Tax?

It’s not just big companies like Google or Amazon that pay Corporation Tax. In the eyes of the taxman (HMRC), the following must pay CT:

• Limited Companies: This is the most common group.
• Members' Clubs: Like your local amateur football club or a social club.
• Associations: Such as trade unions or housing associations.

Note: Partnerships and Sole Traders do NOT pay Corporation Tax. Instead, the individual partners or owners pay Income Tax on their share of the profits. This is a very common point of confusion, so keep it clear in your mind!

Quick Review: The "Company" Rule

If it has "Ltd" or "Plc" after its name, it’s definitely in the scope of Corporation Tax!

2. Residence: Where is "Home" for a Company?

Before we can tax a company, we need to know if it is a UK Resident. Why? Because UK resident companies are taxed on their worldwide profits. If a company is resident in the UK, it doesn't matter if it makes money in London, Paris, or Tokyo—the UK government wants a slice of it all!

A company is considered a UK resident if it meets either of these two tests:

1. The Incorporation Test: If the company was "born" (incorporated) in the UK, it is automatically a UK resident.
2. The Central Management and Control Test: If the company was incorporated abroad (e.g., in Bermuda), but the "brains" of the company—the directors who make the big decisions—meet and manage the company in the UK, then it is a UK resident.

Analogy: The Remote Worker

Imagine a person born in the UK (Incorporation) but living abroad. Or imagine someone born abroad but who does all their important thinking and decision-making while sitting in a London office (Central Management). In both cases, the UK claims them as "ours" for tax purposes!

What if a company is NOT a UK resident?

Non-UK resident companies only pay UK Corporation Tax if they are trading in the UK through a "Permanent Establishment" (like a physical branch or office). They only pay tax on the profits made through that UK branch, not their worldwide income.

Summary Key Takeaway:
UK Resident = Taxed on Worldwide profits.
Non-UK Resident = Taxed only on UK-sourced profits (if they have a branch here).

3. The Chargeable Accounting Period (CAP)

In Income Tax, we use "Tax Years" (6 April to 5 April). In Corporation Tax, we use Accounting Periods. A company’s tax year is usually the same as the period it prepares its accounts for.

The Golden Rule of Timing

A Corporation Tax accounting period can never be longer than 12 months.

If a company prepares accounts for a period longer than 12 months (for example, 15 months because they are changing their year-end), we must split it into two separate accounting periods:

1. The first 12 months.
2. The remaining 3 months.

When does an Accounting Period start?

An accounting period starts when:

• The company starts trading.
• Immediately after the previous accounting period ends.

When does an Accounting Period end?

An accounting period ends at the earliest of:

• 12 months after the start.
• The date the company's accounts are made up to.
• The company stops trading.

Example:
Bright Lights Ltd starts trading on 1 January 2023. It prepares its first set of accounts to 31 March 2024 (a 15-month period).
We must split this into two periods for tax:
1. 1 January 2023 to 31 December 2023 (12 months).
2. 1 January 2024 to 31 March 2024 (3 months).

4. Financial Years (FY)

The UK government sets the Corporation Tax rates and rules for "Financial Years." A Financial Year (FY) runs from 1 April to 31 March.

• FY 2023: Starts 1 April 2023, ends 31 March 2024.
• FY 2024: Starts 1 April 2024, ends 31 March 2025.

Did you know? The Financial Year is named after the calendar year in which it begins. So, the year starting April 2023 is FY2023.

Common Mistake: Confusing CAP and FY

Students often mix up the company's own accounting period (CAP) with the government's Financial Year (FY). If a company's accounting period straddles two Financial Years (e.g., year ended 31 December 2023), you may need to split the profits between the two years to apply the correct tax rates. We do this using months.

Calculation Example:
If a company has \( \$120,000 \) of profit for the year ended 31 December 2023:
\nThe period falls into two Financial Years:
\n• FY 2022 (portion from 1 Jan 2023 to 31 March 2023) = 3 months.
\n• FY 2023 (portion from 1 April 2023 to 31 Dec 2023) = 9 months.
\nProfit for FY 2022: \( \$120,000 \times \frac{3}{12} = \$30,000 \)
\nProfit for FY 2023: \( \$120,000 \times \frac{9}{12} = \$90,000 \)

5. Summary and Key Terms Review

Before you move on to calculating the actual tax, make sure you are comfortable with these basics:

• Taxable Total Profits (TTP): This is the final figure we multiply by the tax rate. It includes trading income, investment income, and capital gains.
• Worldwide Basis: UK resident companies pay tax on everything they earn globally.
• The 12-Month Limit: Never let a tax accounting period exceed 12 months in your exam answers!
• Incorporation vs. Management: The two ways a company becomes a UK resident.

Don't worry if the math for splitting periods feels a bit dry. Once you practice a few "straddling" examples, it will become second nature. You're doing great—keep going!