UK: UK Trading Companies

Last Updated: 11 July 2013

UK companies can be used for a variety of trading and investment activities. In recent years companies have become a popular vehicle through which to conduct business, particular for the tax advantages that they offer. Companies are generally taxed at significantly lower rates than individuals and partnerships. In addition, the shareholders of a UK limited company benefit from limited liability status.

Basis of Taxation

The profits of a trade must be calculated in accordance with generally accepted accounting practice, subject to any adjustments required or authorised by tax law in calculating profits for corporation tax purposes. The basis of taxation of UK trading companies is set out below:

  • Corporation tax

UK trading companies are subject to corporation tax at the following rates on both income profits and capital gains:

20% Small profits rate for profits up to £300,000

23% Main rate of tax for profits over £1,500,000

23.75% Marginal rate of tax for profits between £300,001 and £1,500,000

From 1 April 2014 the main rate of corporation tax will be reduced to 21% and from 1 April 2015 will further reduce to a single rate of 20%.

  • Trading losses

Trading losses may be:

  • Carried forward indefinitely and set off against subsequent profits of the same trade; and/or
  • Set off against other income of the company of the same or preceding accounting year and against capital gains of those years.

Profit Extraction

Planning should be undertaken on an annual basis to ensure that the optimum overall tax position is achieved for both company and shareholder. The most common methods of extracting profits from a company are:

  • Remuneration (e.g. salaries and bonuses)

Although these payments are an allowable deduction against the company's taxable profits, they are taxed by HMRC as employment income in the hands of the employee or Director. Therefore, a taxpayer in receipt of these payments is liable to income tax at their marginal rate (see below).

Tax on employment income:

In addition to suffering income tax, national insurance contributions (NICs) will also be payable. Individuals suffer class 1 NICs at a rate of 12% on employment income between £7,748 and £41,444; and 2% on earnings above £41,444. The company will also have to pay 13.8% on any gross salaries above £7,696.

As an employer, the company has a responsibility to register with HMRC and to deduct PAYE (Pay As You Earn) and NICs from payments made to employees and account for these deductions to HMRC.

  • Dividends

Although dividends do not qualify as an allowable deduction against the company's taxable profits, they are treated as investment income in an individual shareholder's hands and therefore do not attract an NIC liability.

Dividends received by a basic rate taxpayer do not attract any additional income tax in their hands, making the payments of dividends within this tax band a very tax efficient method of profit extraction.

Dividends received by higher rate taxpayers suffer income tax at the following effective rates on the net dividend:

Tax on dividends:

It may be possible to diversify ownership of the shares amongst other family members such as spouse or adult children in order to utilise their basic rate bands and so receive dividends from the company at lower rates of tax, subject to anti-avoidance provisions.

  • Pension contributions

Pension contributions are generally an allowable deduction against the company's taxable profits. There is also no further tax charge on the employee provided that the pension contributions are made to a pension scheme that is approved by HMRC.

  • Interest

If the company is financed by way of loan then the company may pay interest, at a commercial rate, on that loan as a way of extracting profit. Interest paid is an allowable deduction against corporation tax, but has the added advantage that there is no NIC liability. However, it is necessary for the company to deduct income tax at the basic rate from any interest payments it makes to UK residents and generally the interest rate should be at arm's length.

  • Rent

An individual who runs his or her business through a company, but also owns the premises from which the company trades, is entitled to charge a market value rent to the company for the use of the property. This is another example of profit extraction which is an allowable deduction against corporation tax without a NIC liability.

Corporation Tax Compliance

UK companies are required to file a Corporation Tax Return with HMRC for each accounting period. This tax return must generally be filed within 12 months of the end of the accounting period.

The deadline for payment of corporation tax is generally 9 months and 1 day after the end of the accounting period. Larger companies may need to make quarterly payments of tax. Please ask us for our separate briefing sheet on this.

VAT Registration

A company is required to register for VAT if:

  • It supplies taxable goods or services and its turnover for the previous 12 months has exceeded the current registration threshold of £79,000, or
  • It expects to exceed this figure in the next 30 days.

A company which makes or intends to make taxable supplies may decide to apply for VAT registration voluntarily.

The standard VAT rate is 20%.

Summary

The low UK corporation tax rates compared to higher income tax rates means that many UK businesses choose to trade through a company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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