See S. Réamonn, The Philosophy of the Corporate Tax (1970); H. Nurnburg, Cash Movements Analysis of the Accounting for Corporate Income Taxes (1971).
Originally introduced as a classical tax system, in which companies were subject to tax on their profits and companies' shareholders were also liable to income tax on the dividends that they received, the first major amendment to corporation tax saw it move to an imputation system in 1973, under which an individual receiving a dividend became entitled to an income tax credit representing the corporation tax already paid by the company paying the dividend. The classical system was reintroduced in 1999, with the abolition of advance corporation tax and of repayable dividend tax credits. Another change saw the single main rate of tax split into three. Tax competition between jurisdictions has reduced the main rate to 30%, and the main rate is planned to reduce to 28% from April 2008.
The UK government has faced problems with its corporate tax structure, including European Court of Justice judgements that aspects of it are incompatible with European Union treaties. Tax avoidance schemes marketed by the financial sector have also proven an irritant, and been countered by complicated anti-avoidance legislation.
The complexity of the corporation tax system is a recognised issue. The Labour government, supported by the Opposition parties, has expressed its commitment to wide-scale reform. The tax has slowly been integrating generally accepted accounting practice, with the corporation tax system in various specific areas based directly on the accounting treatment. Corporation tax is the next area scheduled to be tackled by the Tax Law Rewrite project, with a draft Bill due.
The tax system in the United Kingdom holds "capital" and "revenue" as distinct forms of income and expenditure. Neither term is formally defined; capital implies financial items that will have an enduring benefit, while revenue implies an ongoing or recurrent item, relating to something likely to be used for short period. For example, expenditure by a company on acquiring a new head office, and the proceeds realised on the disposal of the old head office, are capital; expenditure on stationery, and income from the sale of trading stock, are revenue. Some items that are capital for one company may be revenue for another: expenditure on acquiring a new head office could be a revenue item for a company whose business is building new office blocks.
Before 1965, companies were subject to income tax on their profits, at the same rate as was levied on individuals. An imputation system existed, whereby the income tax paid by a company was offset against the income tax liability of a shareholder who received dividends from the company. With the standard rate of income tax in 1949 at 50%, a company making £1,000 in profits would pay £500 in tax. If the company then chose to pay a £100 dividend, the recipient would be treated as if he had earned £200 and had paid £100 in income tax on it — the tax paid by the company fully covered the tax due from the individual on the dividend paid. If, however, the individual was subject to tax at a higher rate (known as "surtax"), he (not the company) would be liable to pay the additional tax.
In addition to income tax, companies were also subject to a profits tax, introduced by Labour Chancellor Sir Stafford Cripps, which was deducted from company profits when determining the income tax liability. It was a differential tax, with a higher tax rate on dividends (profits distributed to shareholders) than on profits retained within the company. By penalising the distribution of profits, it was hoped companies would retain profits for investment, which was considered a priority after the Second World War. The tax did not have the desired effect, so swingeing increases were introduced in the rates of the distributed profits tax by the post-war Labour government, in an attempt to coerce companies into retaining more of their profits. At the time of Hugh Gaitskell's 1951 budget, the profits tax was 50% for distributed profits and 10% for undistributed profits.
A series of reductions in the profits tax were brought in from 1951 onwards by the new Conservative government. The tax rates fell to 22.5% on distributed profits and 2.5% on undistributed profits by 1957, although the profits tax was no longer income tax-deductible. Derick Heathcoat-Amory's Budget of March 1958 replaced the differential profits tax with a single profits tax measure, applicable to both retained and distributed profits. This gradual decrease, and final abolition, of taxes on capital distributions reflected ideological differences between the Conservative and Labour parties: the Conservative approach was to distribute profits to capital holders for investment elsewhere, while Labour sought to force companies to retain profits for reinvestment in the company in the hope this would benefit the company's workforce.
The Finance Act 1965 also introduced capital gains tax, at a rate of 30%. This was a tax charged on the gains arising on the disposal of capital assets by individuals. While companies were exempted from capital gains tax, they were liable to corporation tax on their "chargeable gains", which were calculated in the same way as individuals' capital gains. The tax applied to company shares as well as other assets. Before 1965, capital gains were not taxed, and it was advantageous for taxpayers to argue that a receipt was non-taxable "capital" rather than taxable "revenue".
On introduction, ACT was set at 30% of the gross dividend (the actual amount paid plus the tax credit). If a company made a £70 dividend payment to an individual, the company would pay £30 of advance corporation tax. The shareholder would receive the £70 cash payment, plus a tax credit of £30; thus, the individual would be deemed to have earned £100, and to have already paid tax of £30 on it. The ACT paid by the company would be deductible against its final "mainstream" corporation tax bill. To the extent that the individual's tax on the dividend was less than the tax credit - for example, if his income was too low to pay tax (below £595 in 1973–1974) - he would be able to reclaim some or all of the £30 tax paid by the company. The set-off was only partial, since the company would pay 52% tax (small companies had lower rates, but still higher than the ACT rate), and thus the £70 received by the individual actually represented pre-tax profits of £145.83. Accordingly, only part of the double taxation was relieved.
ACT was not payable on dividends from one UK company to another (unless the payor company elected to pay it). Also, the recipient company was not taxed on that dividend receipt, except for dealers in shares and life assurance companies in respect of some of their profits. As the payor company would have suffered tax on the payments it made, the company that received the dividend also received a credit that it could use to reduce the amount of ACT it itself paid, or, in certain cases, apply to have the tax credit repaid to them.
The level of ACT was linked to the basic rate of income tax between 1973 and 1993. The March 1993 Budget of Norman Lamont cut the ACT rate and tax credit to 22.5% from April 1993, and 20% from April 1994. These changes were accompanied with a cut of income tax on dividends to 20%, while the basic rate of income tax remained at 25%. Persons liable for tax were lightly affected by the change, because income tax liability was still balanced by the tax credit received, although higher rate tax payers paid an additional 25% tax on the amount of the dividend actually received (net), as against 20% before the change.
The change had bigger effects on pensions and non-taxpayers. A pension fund receiving a £1.2 m dividend income prior to the change would have been able to reclaim £400,000 in tax, giving a total income of £1.6 m. After the change, only £300,000 was reclaimable, reducing income to £1.5 m, a fall of 6.25%.
Gordon Brown's summer Budget of 1997 ended the ability of pension funds and other tax-exempt companies to reclaim tax credits with immediate effect, and for individuals from April 1999. This stealth tax rise has been blamed for the poor state of British pension provision, with critics such as Member of Parliament Frank Field describing it as a "hammer blow" and the Sunday Times describing it as a swindle, with the hypothetical £1.5 m income described above falling to £1.2 m, a fall in income of 20%, because no tax would be reclaimable.
ACT that had been incurred prior to 1999 could still be set off against a company's tax liability, provided it would have been able to set it off under the old imputation system. In order to keep the stream of payments associated with advance corporation tax payment, 'large' companies (comprising the majority of corporation tax receipts) were subjected to a quarterly instalments scheme for tax payment.
The 1979 Conservative Budget of Geoffrey Howe cut the small companies' rate to 40%, followed by a further cut in the 1982 Budget to 38%. The Budgets of 1983–1988 saw sharp cuts in both main and small companies' rates, falling to 35% and 25% respectively. Budgets between 1988 and 2001 brought further falls to a 30% main rate and 19% small companies' rates. From April 1983 to March 1997 the small companies' rate was pegged to the basic rate of income tax. During the 1980s there was briefly a higher rate of tax imposed for capital profits.
Chancellor Gordon Brown's 1999 Budget introduced a 10% starting rate for profits from £0 to £10,000, effective from April 2000. Marginal relief applied meaning companies with profits of between £10,000 and £50,000 paid a rate between the starting rate and the small companies' rate (19% in 2000).
The 2002 Budget cut the starting rate to zero, with marginal relief applying in the same way. This caused a vast surge in incorporations, as businesses that had operated as self employed, paying income tax on profits from just over £5000, were attracted to the corporation tax rate of 0% on income up to £10,000. Previously self-employed individuals could now distribute profits as dividend payments rather than salaries. For companies with profits under £50,000 the corporation tax rate varied between 0% and 19%. Because dividend payments come with a basic rate tax credit, provided the recipient did not earn more than the basic rate allowance, no further tax would be paid. The number of new companies being formed in 2002–2003 reached 325,900, an increase of 45% on 2001–2002.
The fact that individuals operating in this manner could potentially pay no tax at all was felt by the government to be unfair tax avoidance, and the 2004 Budget introduced a Non-Corporate Distribution Rate. This ensured that where a company paid below the small companies' rate (19% in 2004), dividend payments made to non-corporates (for example, individuals, trusts and personal representatives of deceased persons) would be subject to additional corporation tax, bringing the corporation tax paid up to 19%. For example, a company making £10,000 profit, and making a £6,000 dividend distribution to an individual and £4,000 to another company would pay 19% corporation tax on the £6,000. Although this measure substantially reduced the number of small businesses incorporating, the Chancellor in the 2006 Budget said tax avoidance by small businesses through incorporation was still a major issue, and scrapped the starting rate entirely.
The Finance Act 1993 introduced rules to make tax on exchange gains and losses mimic their treatment in a company's financial statements in most instances. The Finance Act 1994 saw similar rules for financial instruments, and in the Finance Act 1996 the treatment of most loan relationships was also brought into line with the accounting treatment. The Finance Act 1997 saw something similar with rental premiums. A year later, the Finance Act 1998 went even further, making it clear that taxable trading profits (apart from those accruing to a Lloyd's corporate name or to a life assurance company) and profits from a rental business are equal to profits calculated under generally accepted accounting practice ("GAAP") unless there is a specific statutory or case law rule to the contrary. This was followed up by the Finance Act 2004, which ruled that where a company with investment business could make deductions for management expenses, they were calculated by reference to figures in the financial statements.
There has never been a general anti-avoidance rule ("GAAR") for corporation tax. However, it inherited an anti-avoidance rule from income tax relating to transactions in securities, and since then has had various "mini-GAARs" added to it. The best known "mini-GAAR" prevents a deduction for interest paid when the loan to which it relates is made for an "unallowable purpose".
The Finance Act 2004 introduced disclosure rules requiring promoters of certain tax avoidance schemes that are financing- or employment-related to disclose the scheme. Taxpayers who use these schemes must also disclose their use when they submit their tax returns. This is the first provision of its kind in the UK, and the Finance Act 2005 has shown a number of tax avoidance schemes being blocked earlier than would have been expected prior to the disclosure rules.
Up until 1999 no corporation tax was due unless HM Revenue & Customs (HMRC) raised an assessment on a company. Companies were, however, obliged to report certain details to HMRC so that the right amount could be assessed. This changed for accounting periods ending on or after 1 July 1999, when self-assessment was introduced. Self-assessment means that companies are required to assess themselves and take full responsibility for that assessment. If the self-assessment is wrong through negligence or recklessness, the company can be liable to penalties. The self-assessment tax return needs to be delivered to HMRC 12 months after the end of the period of account in which the accounting period falls (although the tax must be paid before this date). If a company fails to submit a return by then, it is liable to penalties. HMRC may then issue a determination of the tax payable, which cannot be appealed — however, in practice they wait until a further six months have elapsed. Also, the most common claims and elections that may be made by a company have to be part of its tax return, with a time limit of two years after the end of the accounting period. This means that a company submitting its return more than one year late suffers not only from the late filing penalties, but also from the inability to make these claims and elections.
From 2004 there has been a requirement for new companies to notify HM Revenue & Customs of their formation, although HMRC receives notifications of new company registrations from Companies House. Companies will then receive an annual notice CT603, approximately 1–2 months after the end of the company's financial period, notifying it to complete an annual return. This must also include the company's annual accounts, and possibly other documents, such as auditors' reports, that are required for certain companies.
In the United Kingdom the source rule applies. This means that something is taxed only if there is a specific provision bringing it within the charge to tax. Accordingly, profits are only charged to corporation tax if they fall within one of the following, and are not otherwise exempted by an explicit provision of the Taxes Acts:
|Schedule A||Income from UK land|
|Schedule D||Taxable income not falling within another Schedule|
|Schedule F||Income from UK dividends|
|Chargeable gains||Gains as defined by legislation that are not taxed as income|
|CFC charge||Profits made by controlled foreign companies where no exemption applies|
Schedule D is itself divided into a number of cases:
|Case I||Profits from a UK trade|
|Case III||Interest-type income and gains/losses on loans, derivatives, financial instruments and intangibles|
|Case V||Overseas income|
|Case VI||Annual income not falling within Cases I, III and V, and other income/gains specifically taxed under Case VI|
The rate of corporation tax is determined by the financial year, which runs from 1 April to the following 31 March. Financial year FY05 started on 1 April 2005 and will end on 31 March 2006. Where a company's accounting period straddles a financial year in which the corporation tax rate has changed, the company's profits for that period are split. For example, a company paying small companies' rate with its accounting period running from 1 January to 31 December, and making £100,000 of profit in 2007, would be deemed to have made 90/365*£100,000 = £24,657.53 in FY06 (there are 90 days between January 1 and March 31), and 275/365*£100,000=£75,34.47 in FY07, and would pay 19% on the FY06 portion, and 20% on the FY07 portion.
|Tax rates for 2007–2008|
|Small companies' rate 20%||0 – 300,000|
|Marginal relief (blended between 20% and 30%)||300,001 – 1,500,000|
|Main rate 30%||1,500,001 or more|
Most companies are required to pay tax nine months and a day after the end of an accounting period. Larger companies are required to pay quarterly instalments, in the seventh, tenth, thirteenth and sixteenth months after a full accounting period starts. These times are modified where an accounting period lasts for less than twelve months. From 2005 onwards, for tax payable on oil and gas extraction profits, the third and fourth quarterly instalments are merged, including the supplementary 10% charge.
In the financial year 2004–2005, approximately 39,000 companies paid corporation tax at the main rate. These 4.7% of active companies are responsible for 75% of all corporation tax receipts. Around 224,000 companies paid the small companies rate, with 34,000 benefiting from marginal relief. 264,000 were in the starting rate, with 269,000 benefiting from the lower band of marginal relief. The total revenue was £41.9bn from 831,885 companies. Only 23480 companies had a liability in excess of £100,000.
If either side disputes the amount of tax that is payable, they may appeal to either the General or Special Commissioners of Income Tax. 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. However, decisions of fact are binding and can only be appealed if no reasonable Commissioner could have made that decision.
Once an enquiry is closed, or the time for opening an enquiry has passed, HMRC can only re-open a prior year if they become aware of an issue which they could not reasonably have known about at the time, or in instances of fraud or negligence. In fraud or negligence cases, they can re-open cases from up to 20 years ago.
After an HMRC enquiry closes, or after final determination of an issue by the courts, the taxpayer has 30 days to amend their return, and make additional claims and elections, if appropriate, before the assessment becomes final and conclusive. If there is no enquiry, the assessment becomes final and conclusive once the period in which the Revenue may open an enquiry passes.
Double taxation is avoided for UK dividends by exempting them from tax for most companies: only dealers in shares suffer tax on them. Where double taxation arises because of overseas tax suffered, relief is available either in the form of expense or credit relief. Expense relief allows the overseas tax to be treated as a deductible expense in the tax computation. Credit relief is given as a deduction from the UK tax liability, but is restricted to the amount of UK tax suffered on the foreign income. There is a system of onshore pooling, so that overseas tax suffered in high tax territories may be set off against taxable income arising from low tax territories.
Where a company has losses arising in an accounting period (other than capital losses, or losses arising under Case V or VI of Schedule D) in excess of its other taxable profits for the period, it may surrender these losses to a group member with sufficient taxable profits in the same accounting period. The company receiving the losses may offset them against their own taxable profits. Exceptions include that a company in the oil and gas extraction industry may not accept group relief against the profits arising on its oil and gas extraction business, and a life assurance company may only accept group relief against its profits chargeable to tax at the standard shareholder rate applicable to that company. Separate rules apply for dual resident companies.
Full group relief is permitted between companies subject to UK corporation tax that are in the same 75% group, where companies have a common ultimate parent, and at least 75% of the shares in each company (other than the ultimate parent) are owned by other companies in the group. The companies making up a 75% group do not all need to be UK-resident or subject to UK corporation tax relief. An open-ended investment company cannot form part of a group.
Consortium relief is permitted where a company subject to UK corporation tax is owned by a consortium of companies that each own at least 5% of the shares and together own at least 75% of the shares. A consortium company can only surrender or accept losses in proportion to how much of that company is owned by each consortium group.
|Example Company Ltd|
|Schedule A (UK land)||100,000|
|— Case I (UK trade)||200,000|
|— Case I losses brought forward 1||(100,000)||100,000|
|— Case III (loan relationships, derivatives, financial instruments)||100,000|
|— Case V (overseas)||300,000|
|— Case VI (other annual profits)||10,000|
|Chargeable gains (capital gains)||150,000|
|Allowable (capital) losses brought forward||(50,000)||100,000|
|Less: Non-trading debits brought forward ²||(50,000)|
|Less: Management expense deduction ³||(20,000)|
|Less: Charges (donations to UK charities)||(10,000)|
|Less: Group relief accepted||(50,000)|
|Profits chargeable to corporation tax||580,000|
|Tax @ 30%||174,000|
|Less: Marginal relief 4||(46,750)|
|Less: Double tax relief 5||(30,000)|
|Tax liability for the period||97,250|
A number of cases where UK tax laws are believed to be discriminatory have been bought to the European Court of Justice, usually with respect to freedom of establishment and freedom of movement of capital. Key cases which have been decided include:
Also, the case of ICI v Colmer led to the UK amending its definition of a group, for group relief purposes. Previously, the definition required that all companies and intermediate parent companies in a group to be UK resident.
There are also a number of other cases making their way, slowly, up to the European Court. In particular:
In August 2002, Reform of corporation tax — A consultation document was published, outlining initial proposals for the abolition of the Schedular system. This was followed up in August 2003 by Corporation tax reform — A consultation document, which further discussed the possible abolition of the Schedular system, and also whether the capital allowances (tax depreciation) system should be abolished. It also made proposals that were ultimately enacted in the Finance Act 2004. (The first two of these listed below were in response to threats to the UK tax base arising from recent European Court of Justice judgments.) The changes were to:
In December 2004, Corporation tax reform — a technical note was published. It outlined the Government decision to abolish the Schedular system, replacing the numerous schedules and cases with two pools: a trading and letting pool; and an "everything else" pool. The Government had decided that capital allowances would remain, though there would be some reforms, mostly affecting the leasing industry.
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