How to calculate corporation tax and apply marginal relief

Understanding what marginal relief is and how it works is crucial for any company that has corporation tax liability. Our guide will explain how this new change will impact limited company business owners as well as provide examples of how to calculate corporation tax and apply marginal relief.

What is corporation tax?

Corporation tax is tax due from UK limited companies which make a profit. Profits can be accumulated either through trading activities, investments (except franked investments), or by selling assets. UK companies with overseas branches are responsible for paying corporation tax on profits from all branches regardless of where they are located. In addition, each international branch may be liable for their own local taxes. UK companies with overseas subsidiaries only need to pay corporation tax on UK activities. Finally, overseas companies with a UK branch or subsidiary will be liable for UK corporation tax on those businesses located in the UK only.

Who has to pay corporation tax?

Sole traders and partnerships do not have to pay corporation tax, and instead should declare income and income tax via a self-assessment tax return. Partnerships will also have to submit a partnership tax return. Only businesses that operate as a limited company have to pay corporation tax when they have taxable earnings. This means that the company only pays corporation tax if they make a profit for that financial year and may have no corporation tax to pay if they break even or have losses to carry forward or back if they are in negative revenue.

What is the corporation tax rate?

Since April 2023, the main corporation tax rate has increased from 19% to 25%. This main corporation tax rate applies to all companies with profits of £250,000 and more. However, during the 2023 Spring Budget, the Chancellor also introduced a Small Profits Rate  for those companies with profits of £50,000 or less. The small profits rate remains at 19%. For companies with profits over £50,000 but under £250,000 the main rate will taper and this is known as marginal relief.

How to calculate corporation tax

To calculate your company’s corporation tax due, you should follow this formula:

Taxable Profit (Income – Expenses + Disallowable Expenses and Depreciation – Capital Allowances – Brought Forward Losses) x Corporation Tax Rate

The first step is calculating your income for your accounting period (the period which is reported for your corporation tax return). Your income is made up from your trading earnings as well as investments (except franked investments) and selling business assets.

Next you need to total up all expenses which are also often referred to as overheads. Common allowable expenses include salaries, rent and business rates, utilities, professional services (such as legal fees or accountancy fees), travel expenses, and marketing spend.

Some business costs are not allowable. This means that, although you may have incurred legitimate costs through the course of running your business, the value of that expenditure will not reduce your corporation tax and should therefore be added back on as part of your taxable profit. A common example of this is client/supplier entertainment costs (staff entertainment costs are however allowable so long as you remain within the allowance).

Then consider whether you have spent money on any equipment for your business that is intended to be used long-term. Often this kind of equipment (or plant and machinery as HRMC will classify it) is eligible for tax reliefs known as capital allowances. Note that some intangible assets will also qualify for capital allowances such as research and development, intellectual property, and patent rights.

Due to the nature of long-term business assets, it is necessary to account for them losing value over time due to wear and tear. This is known as depreciation. Depreciation is not an allowable expense and therefore needs to be added back into your taxable profit.

If you have suffered any trading losses, then you’ll be able to offset these against your profit to reduce your corporation tax. Where the losses are from a previous year, you can bring these forwards to offset against your current year taxable profit. If you are suffering losses in your current year, you can carry these back to reclaim corporation tax paid in the immediate 12-month period before. If you have suffered capital losses, then you can only offset these against capital gains so you may need to carry it forwards.

Once you have totalled each group of expenses or allowances, you can follow the above formula. The taxable profit is multiplied by the corporation tax rate which then leaves you the amount of corporation tax to be paid to HMRC.

When is corporation tax due?

A very important point to be aware of is that your corporation tax is due 9 months and 1 day after your accounting period. This is a different deadline to when your corporation tax return is due which is 12 months after the end of your accounting period. If it is your first time paying for your corporation tax or completing a corporation tax return, then this difference may catch you out!

What is marginal relief when calculating corporation tax?

Marginal relief is a gradual reduction of the main corporation tax rate. If your company does not fall into either the main corporation tax rate or small reliefs rate, then marginal relief will apply, but can make calculating corporation tax a bit more complicated. The marginal relief fraction is set at 3/200 and you will need to use this to calculate how much marginal relief can be claimed.

Who can claim marginal relief?

If you’re a company with annual profits of over £50,000 but under £250,000 then you’ll automatically be able to claim marginal relief. Where your accounting period is less than 12 months, the thresholds will be proportionately reduced as well. Furthermore, if your company has associated companies (companies which are significantly controlled by another company or individual) then the limits are divided by the total number of companies. For example, if you are a company which has one associate company the limits are divided by 2. The upper limit becomes £125,000 and the lower limit becomes £25,000 which will apply to both the companies. If your company is a non-UK resident company, you will be ineligible to claim marginal relief.

An example of how to calculate corporation tax and apply marginal relief

At it’s most basic, to calculate marginal relief you multiply the marginal relief fraction by the difference of the upper limit and your company’s profits. For example, if your taxable profits for a 12-month accounting period are £150,000 you would use the calculation 3/200 x (£250,000 – £150,000). This equates to £1,500 which is the amount of relief you will receive from corporation tax.

To determine the amount of corporation tax you will need to pay on £150,000 you then need to multiply £150,000 by the main corporation tax rate of 25%. This equates to £37,500. You can deduct the marginal relief of £1,500 from this and would need to pay corporation tax of £36,000.

However, currently the calculation for corporation tax and applying marginal relief is more complicated. This is because marginal relief only came into use from 1 April 2023 and means that, for the first year it is in place, companies will need to calculate how many days of their accounting period fall before 1 April 2023 and how many days fall after. For all days prior 1 April 2023, the previous main tax rate of 19% will remain. All profits after 1 April 2023 will be subject to the main corporation tax rate of 25% where the company’s profits are above £50,000 for the total accounting period. We therefore highly recommend using HMRC’s marginal relief calculator to determine how much corporation tax relief you are entitled to.

How to pay corporation tax

In order to pay corporation tax, you must register to be able to do so with HMRC first. When setting up a limited company, you register with Companies House, but need to remember to also register with HMRC to be able to file your company’s taxes which is a separate step. Once you have registered, you will receive a Unique Taxpayer Reference (UTR) for your company. You need this to be able to pay your corporation tax no matter which method you choose to use to pay.

There are several options to pay your corporation tax depending on how quickly you want payment to arrive with HMRC. Bear in mind that, although there are no penalties if you fail to make your corporation tax payment by its deadline, HMRC will add interest. On the other hand, if you pay your corporation tax early, HMRC will pay you interest so it’s well worth considering doing so if you can.

For payments to go through on the same day you can approve a payment through your online bank account, use Faster Payments or CHAPS, or pay online using a debit or corporate credit card. Payments by direct debit (where you’ve already set one up), by Bacs either online or by telephone, or paying at your bank or building society will take 3 working days. If you are setting up a direct debit with HMRC for the first time, then payment will take 5 working days to complete.

Get help with completing your corporation tax return

Accounting for expenses, capital allowances, and depreciation can be complicated and challenging to do so accurately. If you’re looking for expert corporation tax accountants, then why not get in touch using our online form for a personalised quote? We don’t simply help you submit your corporation tax return; we’ll proactively look for solutions to reduce your corporation tax liability as well.