Recently a client asked: every time someone pays me, how much should I put aside for corporation tax?
The answer isn’t as straightforward as money in/money out, so it’s worth explaining the difference in how we manage this tax.
Unlike other taxes (like VAT) where it's as simple as get paid and put a percentage aside, corporation tax is based on the profit you make. Determining the amount of money to set aside for corporation tax involves understanding the concept of taxable profit, which is not the same as the profit reflected in your bank account. This is the same process we go through when we do year-end accounts.
This is how we go about calculating taxable profit:
- We start with your accounting profit, which is the profit shown in your financial statements based on accrual accounting*.
*In straightforward terms, Accrual accounting is an accounting method where a business acknowledges income and expenses at the time they occur, even if the actual payment happens later
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We make adjustments to align your accounting profit with your taxable profit: This involves considering income and expenses that are deductible or not deductible for tax purposes. Common adjustments include depreciation, capital allowances, and provisions.
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We deduct allowable expenses: we identify and deduct allowable business expenses from your taxable profit. This can include costs like rent, utilities, materials, and employee salaries.
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We consider capital allowances: We factor in any available capital allowances for eligible capital expenditures, such as investments in equipment, technology, studio space etc. These allowances allow you to reduce your taxable profit by a certain percentage of the capital expenditure.
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We also check for any available tax credits or incentives that might reduce your corporation tax liability. This could be research and development tax credits, for example.
You can learn more about corporation tax in this guide.
As you can see, it’s a more complicated process to figure out the percentage you’d need to put aside. Which is why our advice to clients when they ask this question is to get set up with management accounts…
If you want to be confident you’re putting the right amount aside for corporation tax then you need management accounts.
The easiest way to think of management accounts is as a scaled down, almost real-time version of your year-end financial accounts.
Unlike financial accounts, they’re issued within the accounting period, not after year-end – usually monthly, depending on how big and complex your business is.
To know how much to put aside for corporation tax, we’ll calculate the profit on the same basis we would for the year end accounts, post it and show you. That way you’ve got a balance sheet that shows how much corporation tax is accruing, rather than having to wait until the year end.
If you’re unsure how to manage your taxes through the year, and you want to be forward thinking rather than missing opportunities - read more about management accounts here or drop us a note to chat about it with one of the team.