Who pays corporation tax, and who doesn't

If you trade through a limited company, the company is a separate legal person in the eyes of the tax system. It pays corporation tax on its own taxable profits, whether you're a one-person consultancy, a small shop, or a growing firm with a handful of staff. Sole traders and ordinary partnerships don't pay it at all — they pay income tax and Class 4 National Insurance on their profits instead. If you've incorporated recently, that shift matters, because plenty of what you learned as a sole trader no longer works the same way.

Corporation tax is charged on the company's profits: trading profits, most investment income and chargeable gains. It is not charged on your personal income, and it is not charged on the money you take out of the company to live on. That last point causes more confusion than almost anything else, so it's worth unpicking properly.

Profits are not the same as drawings

A sole trader is taxed on the profit the business makes, and drawings are simply a withdrawal of that profit. A limited company works differently. The company is taxed on its profits, and whatever you take out is a separate event with its own tax consequences.

Take a company with £80,000 of profit before directors' pay. If the director takes a salary of £30,000, the company deducts that salary as a business cost, so it pays corporation tax on roughly £50,000. The salary itself attracts PAYE and National Insurance. If instead the director takes a £30,000 dividend, the company cannot deduct it — corporation tax is due on the full £80,000, and the dividend is taxed in the director's hands. Both routes can be sensible; the right mix depends on your other income and how much profit you want to retain.

Two practical traps are worth flagging:

• Overdrawn director's loan account. If you take money out that isn't salary, dividends or an expense reimbursement, it sits as a loan from the company to you. That can trigger a benefit-in-kind charge and, if it isn't repaid within nine months and one day of the year end, a 33.75% s455 tax charge.
• Dividends without profits. Dividends can only be paid out of accumulated distributable reserves. Paying them when there are none creates an unlawful distribution and a bookkeeping headache.

Allowable costs: what genuinely reduces the bill

Corporation tax is charged on profit, not turnover, so knowing what you can deduct is where real savings live. The core test is that a cost must be incurred wholly and exclusively for the purposes of the trade. In practice, allowable costs usually include:

• Employee and director salaries, employer's National Insurance and pension contributions
• Office rent, business rates, utilities, broadband and phone costs
• Accountancy and bookkeeping fees, professional indemnity insurance, bank charges
• Travel and subsistence for business journeys, plus mileage at HMRC's approved rates for your own vehicle
• Software subscriptions, marketing, website hosting and equipment repairs
• Stock, raw materials and subcontractor costs

Commonly disallowed items include client entertaining, fines and penalties for breaking the law, donations to non-charitable bodies, and your own personal spending run through the company. Accounting depreciation is also disallowed as a deduction — but that's not bad news, because capital allowances take its place.

Capital allowances instead of depreciation

When you buy equipment, vehicles, machinery or fit out premises, the cost generally can't be deducted as a normal expense. Instead you claim capital allowances. For most small companies the headline is the Annual Investment Allowance, which lets you deduct 100% of qualifying plant and machinery costs up to £1 million in the year of purchase. That covers most vans, tools, computers, office furniture and machinery.

Companies also benefit from full expensing for main-rate plant and machinery, giving 100% relief in year one with no £1 million cap, plus a 50% first-year allowance for special-rate items such as integral features. Cars are the exception: they follow the CO2 emissions bands, with only zero-emission cars qualifying for 100% relief. If you're planning a significant purchase, timing it near your year end can shift relief between periods, so it's worth a quick conversation before you commit.

Rates, reliefs and losses

From April 2023, the rate depends on your profit level. Profits up to £50,000 attract the small profits rate of 19%. Above £250,000, the main rate of 25% applies. In between, marginal relief tapers the effective rate. Associated companies share these thresholds, so if you own several trading companies the limits are divided between them.

Beyond the headline rate, useful reliefs include:

• Loss relief. Trading losses can normally be carried back 12 months, offset against other profits of the same period, or carried forward indefinitely against future trading profits.
• R&D relief. If you're solving technical problems in your field, you may qualify. The merged scheme and the enhanced support for R&D-intensive loss-making SMEs can be genuinely valuable.
• Patent Box and creative sector reliefs for qualifying activities.

Deadlines, payments and staying ahead

Corporation tax is normally due nine months and one day after the end of your accounting period. The CT600 return and statutory accounts are due 12 months after the period end. Larger companies with profits over £1.5 million pay in quarterly instalments instead. Late filing brings automatic penalties, and interest accrues on late payments, so set a reminder well before the deadline.

Keep your records for at least six years, run a monthly check on your profit position, and review your salary-versus-dividend mix each tax year rather than once. Small, regular decisions — a properly claimed expense here, a well-timed purchase there — usually matter far more than a last-minute scramble in January.