You told us that corporate tax was something you knew you needed to know but didn’t really understand so we reached out to Kreston Reeves, a leading accountancy and financial services firm based in London, and asked them to explain what corporate tax is, how it is calculated and when your start-up will have to start paying it.
Focusing on the key aspects, Michael O’Brien, partner and head of technology at Kreston Reeves, will provide you with everything you need to know – including why monitoring expenses is integral to a start-up’s financial strategy.
Corporation Tax is an important concept to understand when you set up your company; knowing what it is, how it’s calculated and when it becomes payable is crucial to ensuring the smooth running of your business and enable you to plan your cashflow appropriately.
Corporation Tax in the UK is a tax paid on the profits generated by a company. This is calculated as:
Total Turnover – Total Expenses = Profit
Turnover is the total revenue from a company’s business activities, such as the sale of software.
Expenses are costs incurred generating your turnover, such as the cost of manufacturing your products.
Your profit is what remains after your expenses are deducted from your turnover.
For example, your company may receive £100,000 from software sales.
- If your expenses total £75,000 the £25,000 profit would be taxable
- If your expenses total £100,000 the profit would be £0 so no tax would be charged
- If your expenses total £110,000 there would be a £10,000 loss with no tax payable
Company profits are taxed at the 20% corporate tax rate whereas sole-traders and partnerships are taxed at the potentially higher income tax rates. This Corporation Tax rate of 20% will be reduced in 2017 to 19% and then again in 2020 to 18% meaning the UK will have one of the lowest tax rates in the G20.
Any Corporation Tax payable is due to HM Revenue & Customs within 9 months of the company’s year end.
Monitoring expenses is integral to a start-up’s financial strategy. Typically, tech start-ups incur expenses in several major areas:
- Start-up costs – initial costs of starting a trade such as incorporating a company, establishing a premises, raising capital
- Cost of sales – product manufacturing, development, and/or purchasing costs
- Administrative costs – day-to-day running costs such as stationery costs, equipment hire
For tax purposes, HMRC only allows deductions for expenses incurred “wholly and exclusively” for the purpose of the company’s trade. For example:
- Hiring accountants to meet your company’s annual accounting requirements is an allowable expense incurred in relation to your trade
- The cost of travelling to a client is an allowable expense, whereas home to work travel is not
- IT costs (including phone charges) generally need to be apportioned if they are for both work and private use
- Incorporation costs are not considered to be “for the purpose of trade” so are not allowed
Usually the cost of assets – such as computers – with a lifespan over 2 years are not immediately deductible from that year’s turnover but spread across several years. Fortunately the Annual Investment Allowance allows full deductions of up to £200,000 for expenditure on assets incurred that year. This should cover most start-ups.
During the first years of trading most start-ups incur losses, especially in the technology industry where expenditure on IT infrastructure and R&D is high. Sole-traders and partnerships have the enviable option to offset losses from their first 4 years of trading against tax paid on personal income in the previous 3 years. Companies lack this opportunity but if they incur losses in their first years they can carry these losses forward to offset against company profits in future years, meaning tax will not be payable until the company is an a cumulative profit position. Also companies can apply for tax credits for costs incurred for R&D. This is a valuable tool for start-ups expecting substantial expenditure on development and can mean actually getting a tax refund from HM Revenue & Customs. Additionally, companies can offer tax efficient share options to employees to offset the lower salaries start-ups often offer.
Our Top Corporate Tax Tips for Tech Start-Ups
- Make a Business Plan – outline your business plan for the next 5 years
- Know your tax benefits – fully claim the available tax benefits
- Company vs Sole-trader – establish which business model offers the greatest advantage given your personal circumstances
The above highlights just the very basics of what can be a complicated tax. What’s important is that you work with your advisors to ensure that your business benefits from any tax efficient opportunities available and also plan ahead for any potential tax liabilities the company may have – avoiding any unpleasant surprises in the future!
Michael O’Brien
Partner, Head of Technology at Kreston Reeves
Michael specialises in working with clients in the technology, digital media and creative industries; including owner managed businesses and also large multinational corporations. Michael provides his clients with expert accounting, financial and tax advice and works with them to develop strategies for growth at home and internationally. He and his team provide mentoring support to a number of start-ups and he is a judge of the Cisco BIG Awards. For more information, you can visit their website or follow Kreston Reeves on Twitter.
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