Understanding Corporation Tax
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:
Use of home office
Profit before tax (sales - expenses)
Corporation tax @ 19%
Profit after tax (before tax - tax)
- Add up all your sales for the year
- Add up all your expenses for the year
- Total sales less total expenses = profit before tax
- To work out your tax, multiply profit before tax by 19%
- Profit before tax less the Corporation Tax is your profit after tax
- 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.
Use of home office
Post & stationery
- 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.
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!