Corporation Tax vs Income Tax

Corporation Tax vs Income Tax

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Discussion

98elise

Original Poster:

26,371 posts

160 months

Saturday 18th January 2020
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Does anyone have a simple guide to how corporation tax works with income tax?

In the past 3 or so years my drawings and pension payments have meant I had negligible CT to pay. I've not taken much out of my company this year so I have a large CT bill coming up if the cash is still in the business at year end.

How is this reconciled against my income tax liability if I draw the cash in a later year?

I'll talk to my accountant on Monday but it's suddenly on my mind as I'm getting my books up to date.

Greshamst

2,028 posts

119 months

Saturday 18th January 2020
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They are two separate things. Can you be a bit more specific about what you’re asking?

JulianPH

9,912 posts

113 months

Saturday 18th January 2020
quotequote all
Greshamst said:
They are two separate things. Can you be a bit more specific about what you’re asking?
^^^ This.

Happy to help but need more to go on! smile


98elise

Original Poster:

26,371 posts

160 months

Saturday 18th January 2020
quotequote all
If I take all profits as pay/dividends/pension before the end of the company year then there is no CT to pay, and I pay normal Income Tax and NI on the money

If I leave the cash in the company account beyond the end of the company year then I have a Corporation Tax liability. If a day later I take the cash as pay/dividends/pension then I would have Income Tax and NI to pay.

As I understood it the CT wasn't an additional Tax just for leaving cash in the company beyond the end of the year? That means there must be some reconciliation with Income Tax, or have I got that completely wrong?

As you can tell I'm no accountant!

Stay in Bed Instead

22,362 posts

156 months

Saturday 18th January 2020
quotequote all
Dividends are paid from profits after corporation tax. You could have PAYE & pension contributions to reduce the profit to almost zero.

If you don't utilise the profit as a justifiable expense you will pay corporation tax on it. If you then use it next financial year instead and create a loss for next year, you can reclaim part or all of the corporation tax you will have paid for this year.

JulianPH

9,912 posts

113 months

Saturday 18th January 2020
quotequote all
98elise said:
If I take all profits as pay/dividends/pension before the end of the company year then there is no CT to pay, and I pay normal Income Tax and NI on the money

If I leave the cash in the company account beyond the end of the company year then I have a Corporation Tax liability. If a day later I take the cash as pay/dividends/pension then I would have Income Tax and NI to pay.

As I understood it the CT wasn't an additional Tax just for leaving cash in the company beyond the end of the year? That means there must be some reconciliation with Income Tax, or have I got that completely wrong?

As you can tell I'm no accountant!
CT is paid on any profit remaining after all expenses have been paid (and any tax reclaims account for - such as R&D).

All the things you list are legitimate company expenses and therefore deplete (or mitigate) any profits, leaving reduced on zero CT to pay.

In an ideal world you would be maxing out the pension contribution your company makes for you, minimising your PAYE earnings within the annual allowance threshold (or even the NI threshold) and using dividends for all other drawings.

So, just using round numbers, if your company makes £100k in turnover, the costs of which are £50k, then the remaining £50k needs to make itself to you in the most tax efficient way possible to avoid any CT.

PAYE income at the two thresholds above, then company pension contributions and then dividends is usually (though not always) the best way of doing this.

Please ask further here or feel free to PM me if it is going to require you to divulge financial details that you don't want to publicly share. smile


JulianPH

9,912 posts

113 months

Saturday 18th January 2020
quotequote all
Stay in Bed Instead said:
Dividends are paid from profits after corporation tax. You could have PAYE & pension contributions to reduce the profit to almost zero.

If you don't utilise the profit as a justifiable expense you will pay corporation tax on it. If you then use it next financial year instead and create a loss for next year, you can reclaim part or all of the corporation tax you will have paid for this year.
I missed your post whilst I was typing and then on the phone (before finishing and pressing send)!


Greshamst

2,028 posts

119 months

Saturday 18th January 2020
quotequote all
I know I’m not being helpful here... but you’ve been running a company for three years and still don’t understand the basics around tax? You should educate yourself, it’s a very important part of owning a company...

Google about corporation tax and learn.

Wombat3

11,962 posts

205 months

Saturday 18th January 2020
quotequote all
Stay in Bed Instead said:
Dividends are paid from profits after corporation tax. You could have PAYE & pension contributions to reduce the profit to almost zero.

If you don't utilise the profit as a justifiable expense you will pay corporation tax on it. If you then use it next financial year instead and create a loss for next year, you can reclaim part or all of the corporation tax you will have paid for this year.
A simple & neat explanation.

CT is a tax on profits, only justifiable expenses (including Pensions & PAYE but NOT dividends) will reduce your taxable profit.

As someone who owns their own business you basically have 2 choices as to how you take money out your company

You either take it as salary in which case you pay standard Tax & NI & the company pays employers NI on it, but in doing so you reduce your profits & hence CT liability

or

You take it as dividends payable from profits AFTER you have paid CT on them. You can't take a dividend if there is nothing in your P&L account though. Divi tax rates are lower to balance the fact that you have paid CT already on the same money.

The latter route tends to be preferable with the benefit being around NI payments rather than tax (Income vs CT + Divi tax).







98elise

Original Poster:

26,371 posts

160 months

Saturday 18th January 2020
quotequote all
Stay in Bed Instead said:
Dividends are paid from profits after corporation tax. You could have PAYE & pension contributions to reduce the profit to almost zero.

If you don't utilise the profit as a justifiable expense you will pay corporation tax on it. If you then use it next financial year instead and create a loss for next year, you can reclaim part or all of the corporation tax you will have paid for this year.
Bingo. It was Dividend tax I wasn't factoring in. The rates reflect that it's after Corp Tax.

I'll stop panicking now!

I was using a simple Income tax calculator to estimate my personal taxes for the year, which didn't help.


Edited by 98elise on Saturday 18th January 15:05

98elise

Original Poster:

26,371 posts

160 months

Saturday 18th January 2020
quotequote all
Greshamst said:
I know I’m not being helpful here... but you’ve been running a company for three years and still don’t understand the basics around tax? You should educate yourself, it’s a very important part of owning a company...

Google about corporation tax and learn.
I pay an accountant to do that for me. CT isn't something I've needed to address for 3 years so it can easily slip the mind.

Why is asking Google better than asking people?

Eric Mc

121,775 posts

264 months

Saturday 18th January 2020
quotequote all
Agreed, People should never be told off for asking questions.

A company pays Corporation tax on its taxable business profits. The taxable business profit is arrived at after allowable business costs have been deducted.

Apart from normal trading costs, such as purchase of supplies and sundry overheads, salaries and their related Employer's National Insurance contributions are also looked on as allowable business costs - so they help to reduce the remaining profit.

An example

Sales - £100,000

Less:
Purchases - £30,000
Overheads - £10,000
Directors Salary (including Employer's NI) - £20,000

Profit for Corporation tax purposes - £40,000
Less:
Corporation Tax at 19% - £7,600

Remaining profit from which dividends can be paid - £32,400
Less:
Dividends - £20,000

Profit carried to reserves - £12,400

JulianPH

9,912 posts

113 months

Saturday 18th January 2020
quotequote all
Eric Mc said:
Agreed, People should never be told off for asking questions.

A company pays Corporation tax on its taxable business profits. The taxable business profit is arrived at after allowable business costs have been deducted.

Apart from normal trading costs, such as purchase of supplies and sundry overheads, salaries and their related Employer's National Insurance contributions are also looked on as allowable business costs - so they help to reduce the remaining profit.

An example

Sales - £100,000

Less:
Purchases - £30,000
Overheads - £10,000
Directors Salary (including Employer's NI) - £20,000

Profit for Corporation tax purposes - £40,000
Less:
Corporation Tax at 19% - £7,600

Remaining profit from which dividends can be paid - £32,400
Less:
Dividends - £20,000

Profit carried to reserves - £12,400
Or + £40k pension contribution = £0 CT and profit carried forward! smile


Stay in Bed Instead

22,362 posts

156 months

Saturday 18th January 2020
quotequote all
98elise said:
Bingo. It was Dividend tax I wasn't factoring in. The rates reflect that it's after Corp Tax.

I'll stop panicking now!

I was using a simple Income tax calculator to estimate my personal taxes for the year, which didn't help.


Edited by 98elise on Saturday 18th January 15:05
https://www.itcontracting.com/calculators/limited-company-dividend-tax-calculator-2019-20/

98elise

Original Poster:

26,371 posts

160 months

Saturday 18th January 2020
quotequote all
JulianPH said:
Eric Mc said:
Agreed, People should never be told off for asking questions.

A company pays Corporation tax on its taxable business profits. The taxable business profit is arrived at after allowable business costs have been deducted.

Apart from normal trading costs, such as purchase of supplies and sundry overheads, salaries and their related Employer's National Insurance contributions are also looked on as allowable business costs - so they help to reduce the remaining profit.

An example

Sales - £100,000

Less:
Purchases - £30,000
Overheads - £10,000
Directors Salary (including Employer's NI) - £20,000

Profit for Corporation tax purposes - £40,000
Less:
Corporation Tax at 19% - £7,600

Remaining profit from which dividends can be paid - £32,400
Less:
Dividends - £20,000

Profit carried to reserves - £12,400
Or + £40k pension contribution = £0 CT and profit carried forward! smile
That's pretty much been my strategy for the previous 3 years. I was using carry forward to move all profit into my pension, hence no CT to worry about.



JulianPH

9,912 posts

113 months

Saturday 18th January 2020
quotequote all
98elise said:
JulianPH said:
Eric Mc said:
Agreed, People should never be told off for asking questions.

A company pays Corporation tax on its taxable business profits. The taxable business profit is arrived at after allowable business costs have been deducted.

Apart from normal trading costs, such as purchase of supplies and sundry overheads, salaries and their related Employer's National Insurance contributions are also looked on as allowable business costs - so they help to reduce the remaining profit.

An example

Sales - £100,000

Less:
Purchases - £30,000
Overheads - £10,000
Directors Salary (including Employer's NI) - £20,000

Profit for Corporation tax purposes - £40,000
Less:
Corporation Tax at 19% - £7,600

Remaining profit from which dividends can be paid - £32,400
Less:
Dividends - £20,000

Profit carried to reserves - £12,400
Or + £40k pension contribution = £0 CT and profit carried forward! smile
That's pretty much been my strategy for the previous 3 years. I was using carry forward to move all profit into my pension, hence no CT to worry about.
Then keep calm and carry on! biggrin

Just PM me or ask here with anything else. Eric seriously know his stuff though.

Cheers



Edited for one of my usual typos!


Edited by JulianPH on Saturday 18th January 16:49

Eric Mc

121,775 posts

264 months

Saturday 18th January 2020
quotequote all
If only.

JulianPH

9,912 posts

113 months

Saturday 18th January 2020
quotequote all
Eric Mc said:
If only.
You do mate, you seriously do! smile


dmahon

2,717 posts

63 months

Sunday 19th January 2020
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Generally dividends are taxed less than PAYE so most contractors will pay themselves minimum wage as PAYE, pay corproration tax on the balance and take around 35k as dividends up to the higher rate threshold. This used to mean a net tax rate of around 25% but the dividend tax closed the gap. It’s still the most tax advantageous position though.

Corporation tax + dividend tax < paye tax is the main thing you need to know.

Eric Mc

121,775 posts

264 months

Sunday 19th January 2020
quotequote all
The main reason why dividends still remain attractive from a "tax" point of view is not really the tax position at all. It's much more to do with the difference in National Insurance treatment between salaries and dividends.

In British tax law, there is a clear distinction between "earned income" and "investment income". Earned Income generates both tax and NI liabilities. Investment Income only generates tax liabilities.

Dividends have always been treated as "Investment Income" and therefore are not charged to National Insurance.

The reason why dividends are always treated as investment income rather than earned income is because a dividend is paid out based on the "investment" the shareholder makes in buying shares in a company. A salary is paid to an individual (director or employee) because of the work they do for the employer.

What this differentiation never really envisaged was the proliferation of small "owner managed" one-man-band type companies which exploit the fact that these individuals claim that the dividend (i.e. the return on their monetary investment - often as low as £1) is the reason why they take large annual dividends, and that the hours they put into the business (often massively exceeding legal working limits) only justify a tiny salary (often well below the National Minimum Wage).

HMRC is well aware of this and have spent decades trying to prevent this exploitation (IR35 is one method used).