Understanding Corporation Tax

31 July 2017

At first glance, Corporation Tax may seem a tricky subject to understand. It's actually quite straightforward when you break it down into a few steps.

Here are the key points:

  • Your profit before tax is calculated on your sales less your expenses
  • Tax is calculated at 19% on your profit before tax
  • You are then left with your profit after tax
  • You can only take dividends out of your profit after tax

Calculating your profit before and after tax:

Sales

£60,000

Telephone

£600

Salary

£11,000

Use of home office

£208

Accountancy fees

£1,200

Mileage

£1,000

(£14,008)

Profit before tax (sales - expenses)

£45,992

Corporation tax @ 19%

(£8738.48)

Profit after tax (before tax - tax)

£37,253.52

  1. Add up all your sales for the year
  2. Add up all your expenses for the year
  3. Total sales less total expenses = profit before tax
  4. To work out your tax, multiply profit before tax by 19%
  5. Profit before tax less the Corporation Tax is your profit after tax
  6. You can only take dividends out of profit after tax

How do you know how much money to keep in the company for taxes?

Let’s take a hypothetical scenario of a contractor who has a day rate of £500 (VAT ignored for ease of calculation) per day. Note that this is a simple example and many other factors do come into play when calculating your tax. The below is intended to give you a rough idea of your potential tax liability.

Step 1 – Estimate sales

Work out your total sales for the year:

  • There are 5 days a working week
  • 52 weeks in the year
  • Deduct 4 weeks (or however many weeks holiday you plan to take)
  • 48 paid weeks remaining in year

The calculation would be:

  • £500 * 5 days = £2,500 per week
  • £2,500 * 48 weeks = £120,000 per year

Step 2 – Estimate expenses

Work out your total expenses for the year. Your annual salary counts as an expense, so you can start with that and then estimate the figures.

Salary

£11,000

Accountancy fee

£1,200

Mobile Phone

£540

Mileage

£1,350

Use of home office

£208

Professional fees

£300

Bank charges

£180

Post & stationery

£122

Sundry

£100

£15,000

  • Salary - we will always advise you in advance of the most tax efficient salary for the year
  • Accountancy – simply multiply our fee by 12 months
  • Mobile - You should put your mobile phone contract through the company as this is tax efficient. £45 per month for 12 months used as an example.
  • Mileage – Take a sensible estimate of the number of business miles you drive throughout the year. Figure used here is 3000 miles @ 45p
  • Use of home office – standard allowance of £208 per year
  • Professional fees – estimate for any professional fees/membership subscriptions
  • Post & stationery – estimate for paper/pens/books etc.
  • Sundry – estimate for random bits and pieces through the year

Step 3 - Profit before tax:

Total sales: £120,000

Total expenses: £15,000

Profit before tax: £120,000 - £15,000 = £105,000

Step 4 – Work out your tax

Corporation tax is 19%, so simply:

£105,000 * 19% = £19,950

This means you would need to keep at least £19,950 in the business bank account to cover your tax bill.

Step 5 – Profit after tax

Profit before tax: £105,000

Less: Corporation tax: £19,950

Profit after tax: £85,050

This is the amount of dividends you could take out of the company. Remember you want to be tax efficient, have a read of our 17/18 tax guide for more info.

FreeAgent

If you use our FreeAgent software then you can simply go to to the Corporation Tax section and you will give a live estimate of your expected tax bill!