A UK resident company is taxed on its worldwide total profits.
Total profits are the aggregate of (i) the company's net income from each source and (ii) the company's net chargeable gains arising from the sale of capital assets.
The main sources of income are (i) profits of a trade, (ii) profits of a property business, (iii) non-trading profits (or losses) from loan relationships, mainly interest receivable or payable, (iv) non-trading gains (or losses) on most intangible fixed assets, and (v) non-exempt dividends or other company distributions. The amount of income for sources (i) to (iv) is measured based on the company’s accounts, with specific adjustments. Taxable income from non-exempt dividends and calculating chargeable gains or income from other sources is based on actual amounts.
The rules for measuring the gross income are different for each category, and there are subtle differences in the rules about tax deductions and how gains are calculated. Because of this continuing reliance on taxing companies on a 'source-by-source' basis, it is difficult to explain the rules about income determination and deductions as two wholly separate topics.
Basic rules for accounts-based sources
The main source of profits is often from trading. A company's trading profits are based on its worldwide profit before tax in its accounts. Adjustments are made for non-trading receipts (such as dividends from other companies and income from property) and non-deductible expenditure (such as capital expenditure). Depreciation for tax purposes (known as capital allowances) is calculated and substituted for the depreciation charged in the accounts. A number of other statutory adjustments are made; three important ones are that pension contributions, deferred pay, and benefits in kind are broadly deductible only when paid, that a deduction is available for the notional cost of certain share awards to employees, and that, where certain acquired intangibles are not depreciated in the accounts, a flat-rate deduction can usually be claimed. There are many other adjustments.
Similar principles apply in relation to the calculation of profits of a property business.
Financial profits from a company's trading and non-trading loan relationships and related matters are usually based on the accounts, and the distinction between 'capital' and 'revenue' receipts and deductions is not relevant. Instead, all credits and debits in the accounts are aggregated in order to find the net profit or deficit. Certain statutory adjustments have to be made, which include an interest capping limitation.
For traders, any profit or loss on loan relationships, and/or on intangibles, is generally included within the trading profits. If the company doesn’t have a trade, then loan relationships and intangibles are treated as a separate source of income or loss.
Where a loss arises in respect of a particular source of income, there are detailed rules regarding the possible offset of the loss. Carryback and sideways reliefs are often allowed within limits; carryforward is generally allowed and carried forward losses do not time expire, although since 1 April 2017, the maximum carried forward loss offset is broadly limited to GBP 5 million plus 50% of the current year profits in excess of that amount. Losses can also be utilised by other group companies (see the Group taxation section).
More specifically, dealing with the main sorts of income losses:
- Trading losses may be set off against any other source of profit or gains in the same year, may be carried back one year (three years on the cessation of the trade) against any other source of profit or gain, or may be carried forward without time limit against profits of the same trade only (for trading losses accruing up to 1 April 2017) or against total profits (for trading losses accruing on or after 1 April 2017). As noted above, trade losses arising in accounting periods ending in the two-year period from 1 April 2020 to 31 March 2022 could be carried back three years (as opposed to the normal one-year carryback). The one-year carryback of trade losses was unlimited. There was a GBP 2 million limit (a groupwide cap) on the amount of losses that can be carried back more than one year.
- Property business losses may also be set off against any other source of profit or gains in the same year, or may be carried forward without time limit against profits of any sort; they cannot, however, be carried back. Relief is also available for certain income tax losses arising to non-resident companies that were formerly subject to income tax on the profits from their UK property business.
- Non-trading deficits (NTDs) (i.e. interest and financing losses) can again be set off against any other source of profit or gains in the same year may be carried back one year against non-trading credits (i.e. interest and financing profits), or may be carried forward without time limit against non-trading profits (for NTDs accruing up to 1 April 2017) or against total profits (for NTDs accruing on or after 1 April 2017).
- Non-trading companies may deduct non-capital management expenses incurred in managing their investments from their total profits. Any excess management expenses can be carried forward without limit to set against profits in future years.
While income losses can generally be offset against capital gains of the same accounting period, capital losses are never available for offset against any type of income.
There are complex anti-avoidance rules that restrict the utilisation of all types of losses where there is a change in ownership of the company. Specific rules can also deny or limit loss relief or deductions arising from brought forward losses or potential losses where certain conditions are met.
In general, the book and tax methods of inventory valuation will conform. In practice, inventories are normally valued for tax purposes at the lower of cost or net realisable value. A first in first out (FIFO) basis of determining cost where items cannot be identified is acceptable, but not the base-stock or the last in first out (LIFO) method.
Gains on capital assets are taxed at the normal corporation tax rates. The chargeable gain (or allowable loss) arising on the disposal of a capital asset is calculated by deducting from gross proceeds the costs of acquisition and subsequent improvements, plus the incidental costs of sale and indexation allowance up to December 2017. Indexation allowance compensates for the increase in costs based on the percentage rise (if any) in the UK retail prices index to the earlier of date of disposal or December 2017. Indexation allowance is, however, limited; it cannot create or increase a capital loss, it can only reduce or eliminate a chargeable gain. Generally, these calculations must be done in sterling, so any foreign exchange gains and losses will be taxed (or relieved) on disposal.
Special rules apply to assets held at 31 March 1982, and for the disposal of UK immovable property by non-UK residents (see below).
Most acquisitions and disposals between UK group companies (and non-UK companies within the charge to UK tax on immovable property gains) are treated as made on a no gain no loss basis (i.e. at base cost plus indexation). Otherwise, acquisitions from, or disposals to, affiliates are treated as made at fair market value, as are other acquisitions or disposals not at arm's length.
Capital losses can only be deducted from capital gains. An excess of capital losses over capital gains in a company's accounting period may be carried forward without time limitation but may not be carried back. Relief for carried forward capital losses was brought into line with relief for carried forward income losses from 1 April 2020. Capital losses carried forward can only be offset in a later accounting period against 50% of any capital gains arising in excess of GBP 5 million ‘deductions allowance’, with a single GBP 5 million ‘deductions allowance’ being available per group against which carried forward losses (both income and/or capital) can be set.
Gains or losses arising on a particular asset can be allocated to another group member. So, the capital losses of one company can sometimes be set against the gains of a fellow group member in the same or subsequent period.
There is a good deal of anti-avoidance legislation concerning the computation of chargeable gains, notably to stop losses being created or gains avoided where assets are depreciated by intra-group transactions, or where losses are 'bought in' from third parties.
Gains realised on certain types of assets can be deferred where all or most of the proceeds are reinvested in other assets of those types within a specified period (generally three years). The 'rolled-over' gain then crystallises as and when the latter assets are sold. At present, the main asset categories qualifying for roll-over are land and buildings used for a trade.
Most disposals of shareholdings of 10% or more are exempt from tax. The main exceptions will be those of non-trading subsidiaries or subgroups, or of companies acquired within the previous year. Note that gains on goodwill and other intangibles acquired after March 2002 are taxed as income, not as capital gains.
Capital gains on disposal of UK immovable property by non-UK residents
Prior to April 2019, only capital gains on direct disposals of UK residential property were subject to UK tax for non-UK residents. However, from April 2019, UK tax is charged on capital gains made by non-residents on direct and certain indirect disposals of all types of UK immovable property.
The indirect disposal rules apply where a person makes a disposal of an entity in which it has at least a 25% interest (or any interest in certain collective investment vehicles) where that entity derives 75% or more of its gross asset value from UK land.
The 25% ownership test looks for situations where the person holds at the date of disposal, or has held within two years prior to disposal, a 25% or more interest in the property-rich company. This holding may be direct, through a series of other entities, or via connected persons.
The 75% 'property richness' test will look at the gross assets of the entity being disposed of. Where a number of entities are disposed of in one arrangement, their assets will be aggregated to establish whether the 75% test is met.
There is a trading exemption, so that disposals of interests in property-rich entities where the property is used in a trade are excluded from the charge. This is likely to apply where, for example, a non-UK resident disposes of shares in a retailer that owns and operates from UK property.
All non-UK resident companies and certain collective investment vehicles that are deemed to be companies are charged to corporation tax rather than capital gains tax on their gains. The provisions relating to annual tax on enveloped dwellings (ATED)-related capital gains tax on UK residential property have been abolished.
Existing reliefs and exemptions available for capital gains continue to be available to non-UK residents, with modifications where necessary. Those who are exempt from capital gains for reasons other than being non-UK resident continue to be exempt (e.g. overseas pension schemes and certain EU charities). The provisions of any relevant DTT would also need to be considered.
Losses arising to non-UK residents under the new rules are available. However, from April 2019, the offset by companies of carried forward capital losses will be subject to a loss restriction. The loss restriction limits to 50% the amount of capital gains against which brought forward capital losses in excess of GBP 5 million can be offset.
There are options to calculate the gain or loss on a disposal using the original acquisition cost of the asset or using the value of the asset at commencement of the rules in April 2019. However, where the original acquisition cost is used in the case of an indirect disposal, and this results in a loss, this will not be an allowable loss.
Special rules apply to collective investment vehicles.
Trading in and developing UK land
Trading profits earned by a non-resident owner were historically only subject to UK tax if the owner carried on a trade through a PE in the United Kingdom, subject to corporation tax, or exercised a trade in the United Kingdom, subject to income tax. Certain activities in relation to UK land carried out by a non-UK resident could, however, still be subject to UK income tax.
However, since 2016:
- UK corporation tax applies to non-UK resident companies that carry on a trade of dealing in UK land or developing UK land (whether or not the trade is carried on through a PE in the United Kingdom). The intention is to tax all non-UK traders in UK land on the whole of their profit wherever it arises.
- The 'transactions in land' provisions are designed to ensure that profits from activities that are fundamentally trading in nature are taxed as income rather than capital gains and apply to both direct disposals of land and also indirect disposals (i.e. disposals of shares or other assets that derive at least 50% of their value from land). The ‘direct disposals’ provisions provide a statutory definition of trading in land (very broadly, where one of the main purposes of acquiring or developing land is to realise a profit or gain). The ‘indirect disposals’ provisions will apply when the person making the disposal is party to an arrangement concerning the development of the land.
- The 'anti-fragmentation' rule may increase the profits charged to UK tax by the value of any 'contribution' to the development made by an associated person that is not subject to UK tax.
- Anti-avoidance provisions apply to counteract arrangements that are intended to avoid any of the rules mentioned above.
Non-resident companies within corporation tax on UK property rental business income from 6 April 2020
Prior to 6 April 2020, non-UK tax resident companies were subject to UK income tax on UK property rental income (either through withholding or by direct assessment) unless the income was in relation to a UK PE through which they were also carrying on a trade.
From 6 April 2020, all non-UK tax resident companies that carry on a UK property business have been brought within the scope of corporation tax in respect of the profits of that business from that date.
Notwithstanding that corporate non-resident landlords (NRLs) are now within the scope of corporation tax in respect of the profits of their property rental business, the NRL scheme (that requires the NRL's letting agent or tenants to withhold income tax at 20% at source unless they have been notified that the NRL has applied for and been given permission to receive gross rents) still applies.
Since profits of a UK property business (for corporation tax purposes) do not take into account debits or credits from loan relationships or derivative contacts, a non-UK tax resident company that carries on a UK property business is also chargeable to corporation tax in respect of its debits or credits that arise from loan relationships or derivative contracts that the company is a party to for the purpose of that business.
In addition to the difference in the tax rates that apply (the income tax rate is 20% and the corporation tax rate is 25%), there are other changes as a result of the move to corporation tax. The corporation tax filing and payment requirements and deadlines are different.
There are, amongst other things, additional restrictions on the deductibility of interest (interest capping), deductions related to hybrid mismatches, restrictions on the amount of losses brought forward from earlier periods that can be offset, and other provisions relating to the taxation of loan relationships and derivative contracts. In addition, there are late payment restrictions that can apply where interest is not paid within 12 months of the year-end to certain connected recipients.
It is possible to surrender or claim eligible corporation tax losses to/from other companies in the same group that are subject to corporation tax.
Most foreign and UK dividends received by UK companies are exempt from corporation tax; however, one of several criteria has to be met, but these are widely drawn (one test, for example, is that the recipient controls the payer). For non-exempt, foreign-source dividends, double tax relief (DTR) will usually be available on a dividend-by-dividend basis. It is unusual for companies to be taxed on UK dividends because of the breadth of the exemption; however, where they are taxed, there is no concept of DTR for UK dividends. Property income distributions received from a UK REIT are subject to tax as if they were profits from a UK property business.
Royalty income received by corporates will normally be taxed in the same way as other forms of income. To the extent it arises from a trade, it is taxed as trading profits. Royalties from IP not comprising a trade will be taxed as income from intangible fixed assets.
Realised and unrealised exchange gains/losses
Unrealised exchange gains and losses tend to arise on debts and derivatives; they are then taxed or allowed, together with realised amounts, on an accounts basis in the same way as other debits and credits arising out of loan relationships. Where gains or losses arise on other payables or receivables, to a trader or property investor, they will again generally be taxed or allowed on an accounts basis. For a trader, the taxable or allowable amount will become simply part of the trading profit or loss; for other companies, it will become a separate source of taxable profit (a 'non-trading credit') or loss (a 'non-trading deficit').
Where unrealised differences arise on other capital assets, they will not generally be taxable or allowable at that stage; instead, the exchange difference becomes part of the computation and is effectively taxed or allowed when the asset is disposed of and any difference is realised.
In broad terms, if companies participate in UK partnerships (whether general partnerships, limited partnerships, or limited liability partnerships [LLPs]), they will be taxed on a flow through basis. This will, in very broad terms, mean that UK corporate partners will be taxed on trading, property, or financing income as it arises in the partnership accounts, and on non-exempt dividends on a receipts basis. The UK’s transfer pricing rules need to be considered when determining the taxable income of the partnership. There are specific anti-avoidance provisions in respect of Partnerships with both corporate and individual partners that can, in certain circumstances, reallocate (for UK tax purposes) profits from a corporate partner to an individual where the individual could confer some benefit from the corporate partner's profit share. Other anti-avoidance provisions may also be triggered, such as transfer of income streams where profits are diverted away from an individual partner to a corporation. Both sets of anti-avoidance provisions are a highly complex area of UK legislation, and we would suggest specialist advice.
When considering overseas entities, the UK authorities will not be bound by how the entity is classified in its country of origin. Case law has determined a number of matters that should be considered when establishing whether a non-UK entity should be taxed in the United Kingdom as if it were a company or a partnership. HMRC also maintains a public list of non-UK entities and the decisions it has previously made regarding their classification. However, if the parties have flexibility regarding the constitution of such entities, then their classification may be viewed differently, either by HMRC or the courts. This area is complex; consequently, specialist advice should be sought.
In principle, the United Kingdom taxes on a worldwide basis. However, where a company makes the necessary election, an exemption is applicable to profits attributable to the non-UK PEs through which it carries on a business.
Where an election has been made, it applies to all accounting periods starting after the date it was submitted and to all the company's PEs (so it cannot be made on a PE-by-PE basis). The election is irrevocable and has the effect of exempting all profits (including gains) of the PE, subject to certain adjustments and exclusions. Equally, relief for PE losses will be denied.
Certain profits are excluded from this exemption. Profits and losses from a company’s business that consists of the making of investments are not covered by the exemption unless they arise from assets that are ‘effectively connected’ with any part of the PE through which a trade or overseas property business of the company is carried out in the territory concerned. HMRC interprets ‘effectively connected’ narrowly for this purpose, considering it to only cover incidental amounts of investment income that arise in connection with a trade or overseas property business.
Profits and losses from a company’s trade of dealing in or developing UK land, UK property business, and other UK property income are also excluded from the exemption, along with any profits or losses arising from loan relationships or derivatives that relate to such activity.
Profits will be measured by reference to DTTs or, where none is applicable, OECD principles. The adjustments required include:
- Gains attributable to a foreign branch of a close company are not exempt unless they accrue on the disposal of assets that have been used (and only used) for the purposes of a trade carried on by the company in the relevant territory through the company’s PE there.
- Profits attributable to a foreign branch of a small company are not exempt if the PE is in a territory other than a 'full treaty territory' (broadly, a territory that has a DTT with the United Kingdom that has an exchange of information article).
- If the branch concerned has previously been in a loss-making position, loss transitional rules may prevent the exemption being available immediately.
- To the extent the branch profits are considered to have been artificially diverted from the United Kingdom, the anti-diversion rule will stop them qualifying for the exemption (akin to the controlled foreign company [CFC] rules that apply to profits of subsidiaries).
Where no election is made, profits from non-UK PEs are computed and taxed in the normal way for UK tax resident companies. However, UK tax will generally be reduced by credit for local direct taxes paid, either under a treaty or via the UK's unilateral relief rules (see Foreign tax credit in the Tax credits and incentives section for more information).