What is Corporation Tax and how does it work for small companies?

At Towerstone Accountants we provide specialist small business accountancy services for owners, directors, and growing businesses across the UK. We created this webpage for small business owners who want clear guidance on managing finances, meeting tax obligations, and making informed decisions without jargon. Our aim is to help you stay compliant, improve cash flow, and build a more resilient business.

Corporation Tax is one of those topics that small company owners often feel they should understand better, but rarely feel confident about. Many directors know it exists, know it needs paying at some point, and know it can cause problems if ignored, yet the detail often feels confusing or intimidating. That uncertainty can lead to poor planning, cash flow stress, and unpleasant surprises long after the money has been spent.

In my experience as a chartered accountant running my own firm, Corporation Tax issues are rarely caused by people deliberately doing things wrong. They usually come from a lack of clarity about how the system works, when tax is due, what profits really mean, and how business decisions affect the final bill. Once those pieces are understood, Corporation Tax becomes far more manageable and far less stressful.

In this article, I want to explain clearly what Corporation Tax is, how it works for small companies in the UK, how it is calculated, when it must be paid, and how it fits into wider business planning. This is written from real world experience working with owner managed companies, startups, and growing businesses, and it is designed to be practical rather than theoretical.

What Corporation Tax Actually Is

Corporation Tax is a tax charged on the profits made by limited companies and certain other organisations. If you run a small company in the UK, your company is almost certainly within the scope of Corporation Tax.

It is important to understand that Corporation Tax is not a personal tax. It is a tax on the company itself. This distinction underpins almost everything else that follows.

Corporation Tax is charged on:

• Trading profits

• Investment income

• Chargeable gains

For most small companies, trading profit is the main focus.

Why Corporation Tax Only Applies to Companies

Corporation Tax applies to companies because companies are separate legal entities. A limited company exists in its own right, separate from the people who own or run it.

This is very different from sole traders, where the business and the individual are legally the same.

Because of this separation:

• The company pays Corporation Tax on its profits

• The director or shareholder pays personal tax on what they take out

Understanding this separation is essential to avoiding mistakes.

What Counts as Profit for Corporation Tax

Profit for Corporation Tax purposes is not simply the money left in the bank. It is calculated using accounting rules and tax adjustments.

In basic terms, profit is:

• Income earned by the company

• Minus allowable business expenses

However, not all accounting expenses are treated the same way for tax. Some costs are allowable for Corporation Tax. Others are disallowed or treated differently.

This is why accounting profit and taxable profit are not always the same.

Allowable Expenses for Corporation Tax

Most ordinary business expenses are allowable for Corporation Tax, provided they are incurred wholly and exclusively for business purposes.

Common allowable expenses include:

• Staff costs and salaries

• Rent and utilities

• Office costs and software

• Marketing and advertising

• Professional fees

Disallowed expenses may include:

• Client entertaining

• Fines and penalties

• Personal expenses

Capital items such as equipment are treated differently, usually through capital allowances rather than being deducted in one go.

How Corporation Tax Rates Work for Small Companies

Corporation Tax rates can change, and they have become more complex in recent years. The rate your company pays depends on its level of profits.

Small companies often assume there is a single flat rate, but that is no longer the case.

In broad terms:

• Companies with lower profits pay a lower effective rate

• Companies with higher profits pay a higher effective rate

• There may be marginal relief between thresholds

This means that two companies earning different levels of profit can face very different tax outcomes.

Because rates and thresholds can change, it is important to review this regularly rather than relying on old assumptions.

When Corporation Tax Becomes Payable

One of the most common causes of cash flow problems is misunderstanding when Corporation Tax is due.

Corporation Tax is usually payable:

• Nine months and one day after the end of the accounting period

This timing catches many directors out, especially in the first year.

For example, a company might earn profits during its first year, spend the cash on growth or drawings, and then face a large tax bill months later when trading feels quieter.

The key point is that Corporation Tax is based on past profits, not current cash availability.

Accounting Periods and Corporation Tax

Your accounting period is the period your accounts cover, usually twelve months.

Corporation Tax is calculated for each accounting period, and a Corporation Tax return must be submitted for each period.

Even if your company is small or made very little profit, a return is still required if the company was active.

Corporation Tax Returns and Deadlines

Every company within Corporation Tax must submit a Corporation Tax return to HMRC.

This includes:

• A CT600 tax return

• Full statutory accounts

• Supporting computations

The filing deadline is usually:

• Twelve months after the end of the accounting period

This means that the filing deadline is later than the payment deadline. Paying late attracts interest. Filing late attracts penalties.

These two timelines often get confused, which leads to unnecessary penalties.

Why First Year Companies Often Struggle

First year companies face several challenges with Corporation Tax.

These include:

• No prior experience of the process

• A long gap between earning money and paying tax

• Cash flow pressure from startup costs

• Lack of clarity about what to set aside

Many directors underestimate how quickly Corporation Tax can become a problem if it is not planned for from the beginning.

Setting Money Aside for Corporation Tax

One of the healthiest habits a company can develop is setting aside Corporation Tax as profits are earned.

This usually involves:

• Estimating taxable profit regularly

• Transferring a percentage into a separate savings account

• Treating that money as unavailable

Many companies use a simple rule of thumb to start with, then refine it as the year progresses.

The exact percentage depends on expected profits and current tax rates, but the principle is the same. Corporation Tax money should not be spent.

How Dividends and Corporation Tax Interact

Dividends are paid out of profits after Corporation Tax.

This means Corporation Tax is calculated first. Dividends come later.

A common mistake is assuming that dividends reduce Corporation Tax. They do not.

If a company earns £50,000 in profit, Corporation Tax is calculated on that profit regardless of how much is later paid out as dividends.

This is why directors must be careful not to drain the company of cash before tax liabilities are met.

Salary, Corporation Tax, and Planning

Salaries paid to directors and staff are allowable expenses for Corporation Tax purposes.

This means:

• Salaries reduce company profit

• Lower profit usually means lower Corporation Tax

This interaction is often used as part of tax planning, but it must be done properly through payroll and PAYE.

Poorly structured salaries can cause problems with National Insurance or compliance.

Capital Allowances and Corporation Tax

When a company buys equipment or certain assets, it usually cannot deduct the full cost as an expense straight away.

Instead, capital allowances are used to claim tax relief.

These allowances reduce taxable profit and therefore reduce Corporation Tax.

Understanding how capital allowances work can make a significant difference to the timing of Corporation Tax bills.

Losses and Corporation Tax

Not all companies make profits straight away.

If your company makes a loss, that loss can usually be carried forward to offset against future profits.

In some cases, losses can also be carried back.

Losses do not remove the requirement to file accounts or tax returns, but they can reduce future Corporation Tax bills significantly.

Failing to file properly can mean losing the benefit of these losses.

What Happens if You Do Not Pay Corporation Tax on Time

HMRC takes Corporation Tax deadlines seriously.

Late payment leads to:

• Interest charged daily

• Potential enforcement action

• Damage to the company’s compliance record

Late filing leads to penalties, even if no tax is due.

Ignoring Corporation Tax rarely ends well, and problems tend to grow rather than disappear.

Corporation Tax and Director Responsibility

Directors have a legal duty to ensure the company meets its tax obligations.

This does not mean you must personally prepare the returns, but you are responsible for making sure they are done correctly and on time.

Claiming ignorance does not usually help if things go wrong.

How Corporation Tax Affects Cash Flow

Corporation Tax is one of the largest single outflows for many small companies.

Because it is paid long after profits are earned, it can feel disconnected from day to day trading.

This is why Corporation Tax planning is really cash flow planning.

Companies that struggle with Corporation Tax usually struggle with cash flow visibility rather than profitability.

Common Myths About Corporation Tax

There are several misconceptions that regularly cause confusion.

These include:

• Corporation Tax is only for big companies

• If I take dividends, there is no Corporation Tax

• HMRC will remind me when to pay

• If I made little profit, it does not matter

None of these assumptions are reliable.

How an Accountant Helps With Corporation Tax

Accountants play a key role in managing Corporation Tax.

This includes:

• Calculating taxable profit accurately

• Claiming allowances and reliefs correctly

• Advising on timing and cash flow

• Ensuring deadlines are met

More importantly, accountants help you understand what the numbers mean, not just file forms.

Planning Rather Than Reacting

The biggest difference between companies that struggle with Corporation Tax and those that manage it well is planning.

Planning allows you to:

• Anticipate liabilities

• Set money aside gradually

• Make informed decisions about spending and drawings

Reacting leads to panic and rushed decisions.

How Corporation Tax Fits Into the Bigger Picture

Corporation Tax is not an isolated issue. It interacts with:

• Dividends

• Salaries

• Investment decisions

• Business growth plans

Understanding this bigger picture helps directors make better choices.

Reviewing Your Corporation Tax Position Regularly

Corporation Tax should not be looked at once a year and forgotten.

Regular reviews allow:

• Early identification of problems

• Adjustment of savings

• Better decision making

Even quarterly reviews can make a significant difference.

What Happens if You Close the Company

If a company closes, Corporation Tax does not disappear.

Final accounts and a final Corporation Tax return are usually required, and any outstanding tax must be settled before closure.

This is another area where misunderstandings often cause delays and stress.

Final Thoughts

Corporation Tax is a core part of running a limited company, but it does not need to be frightening or confusing.

At its heart, it is a tax on profits, calculated using clear rules, and paid on a predictable timeline. Problems arise when those rules are misunderstood or ignored, not because the system itself is unreasonable.

For small companies, understanding Corporation Tax early, setting money aside consistently, and reviewing the position regularly can remove one of the biggest sources of financial stress.

If you are unsure how Corporation Tax applies to your company, or feel uncertain about your current position, that uncertainty is worth addressing sooner rather than later. Clarity brings control, and control makes running a company far more manageable.

You may also find our guidance on How can an accountant help my business save tax and When do small businesses have to start paying tax useful when exploring related small business questions. For a broader range of practical advice, you can visit our small business guidance hub.