Companies pay corporation tax while owners of unincorporated businesses such as sole traders and partnerships pay income tax. Corporation tax is assessed on broadly the same basis as income tax though with different rates of tax, allowances and payment dates.
Under tax law, trading profit is based on the reported accounting profit per statutory accounts with adjustments specified in the tax law. The taxable profit is further subdivided according to its source and different rules are applied to each source. For companies there are three main sources of taxable income – trading profit, non-trading income and chargeable gains.
In March 2004 the Chancellor of the Exchequer confirmed in his budget that those companies prepared their financial statements in accordance with International Financial Reporting Standards (IFRS) would be able to use their statutory accounts as the starting point for their tax computations. They are not required to prepare separate UK GAAP accounts for tax purposes.
The most significant of adjustments to accounting profit to arrive at taxable profit are that depreciation of fixed assets are not allowed but substitutes instead with a system of capital allowances at prescribed rates over the economic useful life of the assets.
Trading stock must be valued lower of cost or at net realizable value. Any differences are to be reported in the profit and loss account. General provisions are not allowed unless it can be proof to be specific to a defined item of expected loss. Some business expenses such as legal fee on incorporation of business, entertaining and late filing penalty are not allowed for tax purposes.
Non- trading income includes investment income, rental income, interest and royalties. There are generally taxed on the basis of cash received basis rather than accruals basis.
Chargeable gains are the profits calculated on disposal of fixed assets. Indexation allowance, calculated to eliminate the inflationary element of the gain were available until 1998.
Remember that in planning your affairs, there is no substitute for professional advice.
Concise Accountancy – minimum tax comes from effective tax planning