What is Corporation Tax?
Corporation Tax is a tax on the profits made by companies, public corporations and unincorporated associations such as industrial and provident societies, clubs and trade associations. It is not a tax on revenue.
Profit is the amount left after the cost of doing business is deducted from the revenues a business earns. As such, Corporation Tax does not act as any barrier to companies trading. Taxable profit can differ from profits reported by companies in their annual accounts (accounting profit).
How is taxable profit calculated?
In order to calculate taxable profits, trading profits are added to other taxable income and net capital gains.
A company can then deduct capital allowances, which are allowances based on the cost of buying capital goods such as plant and machinery. Trading losses from previous years can also be set against current profits.
Companies can make further deductions allowed under tax law, for example, tax credits generated by research and development expenditure, and deduct losses made by other companies in the same group (group relief). The various deductions permitted mean that across all companies the total chargeable profit is 2/3rds of trading profits.
Source: HMRC, Corporation Tax Statistics 2020, page 6.
How does the UK’s Corporation Tax rate compare to other countries?
The rate of Corporation Tax is currently 19%, which is the lowest it has ever been in the UK and one of the lowest in the G20. Rates have fallen steadily since the 1990s. Since 2010 they have fallen from 28% to 19%.
The European average rate is 20%, but this includes a number of very small economies with very low rates. The average European rate when weighted by GDP is 24.6%. The G7 average rate is 27.2% (27% weighted by GDP). The OECD average rate is 23.5% (26.3% weighted by GDP)
Source: The Tax Foundation, Corporate Tax Rates Around the World 2020, page 7
How much would increasing Corporation Tax raise?
HMRC estimates that a 1% increase in Corporation Tax (to 20%) from 1 April 2021 would yield £2bn in 2021–22, £3bn in 2022–23, and £3.4bn in 2023–24.1.
This compares to an estimated £5.4bn by 2023 for raising the basic rate of income tax by 1%.1
It is important to note that the UK Government uses what is called a “Computable General Equilibrium” model to calculate the impacts of tax policy changes on revenue. This model takes into account any theoretical impact that a policy change may have on investment or wages and the consequences that may have on revenue.2
How much does Corporation Tax contribute to the Treasury?
Source: HMRC, Annual Report and Accounts 2019-2020, page 21.
After income tax, National Insurance Contributions (NIC) and Value Added Tax (VAT), Corporation Tax is the next largest source of tax revenue from taxation. During financial year 2019 to 2020, HMRC collected total tax revenues of £636.7 billion. Corporation tax yielded £53.0bn, compared to income tax (£194.2bn), NIC (£141.9bn) and VAT (£137.4bn).
Who pays Corporation Tax?
Companies that are liable to Corporation Tax account for 1/3rd of total businesses in the UK.
Of the three main legal forms of businesses in the private sector (sole proprietorships (also known as sole traders), ordinary partnerships, and companies) only companies are liable to Corporation Tax.
At the start of 2020 there were 3.5 million sole proprietorships (59%), 414,000 ordinary partnerships (7%) and 2.0 million actively trading companies (34%) in the UK.3 Almost half of the actively trading companies had no employees.
Source: Department for Business, Energy & Industrial Strategy, Business population estimates 2020, page 6
Of the approximately 2.0 million actively trading companies4, only 1,533,570 paid Corporation Tax in 2018-19. Of these 1,024,000 had a liability of less than £10,000 and 732,000 had a liability of less than £5,000.
Fifty five percent (or £30.2 billion) of the total Corporation Tax liability was paid by the 4,500 companies that contributed over £1 million each. In contrast companies that had a liability of less than £10,000 each contributed just 6% (or £3.4 billion) of the total Corporation Tax liability.
Source: Department for Business, Energy & Industrial Strategy, Business population estimates 2020, page 6.
The Corporation Tax and Covid-19
There is a lively debate around whether or not it is desirable to raise Corporation Tax rates during a pandemic, with fears being raised that increasing tax rates would hinder economic recovery after the pandemic.
These views are founded on economic theories about how the government regulates the economy. The overarching theory is that governments should not seek to remove money, or deflate the economy at the time when demand is depressed. Instead, governments should be seeking to stimulate demand, which they can do through government spending or tax cuts.
However, demand is not the only economic issue facing the country and Corporation Tax does not exist in a vacuum. It is perfectly possible to increase Corporate Tax rates whilst also stimulating economic demand through spending and tax cuts elsewhere.
As a tax on profit, companies that have suffered losses during the pandemic are shielded from the increase in rates, and companies that have done well from the pandemic contribute more. In fact, companies that have made losses in this year will be able to offset those losses against future tax charges.
Capital allowances also mean that a company can invest in plant and machinery without being hit by Corporation Tax and mitigate against theoretical pressures on wages caused by increases in Corporation Tax rates.
As a result, the economists at the International Monetary Fund have argued that in order to promote inclusive growth following the pandemic countries should set Corporate Tax rates at “reasonable” levels. With the UK having one of the lowest rates in the world, this would suggest there is room to increase rates.5
Page updated 02 March 2021
1HMRC, Direct effects of illustrative tax changes, 22 January 2021.
2HMRC and HMT, Analysis of the dynamic effects of Corporation Tax reductions, 5 December 2013
3 Department for Business, Energy & Industrial Strategy, Business population estimates 2020.
4In this categorisation, companies include both corporate entities that are liable to corporation tax, such as Public Limited Companies, Private Limited Companies and public corporations and nationalised bodies in which the working directors are classed as employees and Limited Liability Partnerships whose partners are liable to income tax on their profits. The number of companies liable to corporation in 2018-19 is, therefore, fewer than the 2.0 million actively trading companies.
5R. de Mooij et al, Tax Policy for Inclusive Growth after the Pandemic, IMF Fiscal Affairs, December 2020