Corporate Tax Basics
Many people throughout history have uttered the saying ‘Nothing is certain but death and taxes’, with the first recorded attribution often given to Daniel Defoe. This fatalistic idiom is quite good in highlighting the inevitability of taxes and how it is crucial individuals and businesses know as much as possible about specific tax codes to secure their finances.
For businesses, one of the most important taxes to understand is the corporate tax. This guide will help you understand the basics of corporate tax, as well as explain a bit about how the tax is imposed in different countries.
In this article, you will learn 1) what corporate tax is, 2) what is taxed under corporate tax, 3) whether there are tax deductions available for corporations, 4) filing tax returns, and 5) corporate tax in different countries.
WHAT IS CORPORATE TAX?
Corporate tax is a country specific tax, often known as either corporation tax or company tax. It is a levy placed on the income of the firm, with different rates often in place for different levels of income.
You’ll often see a corporate tax imposed on the income or the capital of the corporation. This could, for example, be the profit the company makes after operating costs.
As mentioned above, each country often sets its own corporate tax rates and the tax is generally imposed on corporations that do business in the country. The rates across the world can vary greatly.
The definition of a corporation
In order to understand corporate tax, you’ll also need to understand the definition of corporation. In general, corporation is a legal entity, which is separate from the owners. Corporations have rights and responsibilities, just like an individual does.
Some of these rights and responsibilities include the right to create contracts, to borrow as well as loan money, to hire employees, to own assets and the legal right to be sued and to sue. Among these responsibilities is the necessity to pay tax.
Corporations are set up by individuals and there are different types of corporations. While a corporation isn’t required to be a for-profit corporation, most corporations are set up with the aim of creating profit and returns for shareholders.
The history of corporate tax development
The history of taxation is almost as old as the human society. Ancient civilisations used the basic principles of taxation thousands of years ago. In fact, the earliest known tax records date to six thousand years B.C., to the region of the modern day Iraq.
Different societies used their own tax policies and different systems began developing. Taxation also ended up causing trouble between different factions and later nations.
When it comes to corporations, the income was typically taxed similar to income tax of individuals. People simply paid taxes on the money they made and businesses often had to pay tax on goods.
As businesses and the law and regulations around them became more sophisticated, the focus on fine-tuning the way corporate income is taxed became a bigger issue. While each country has different corporate tax basics, many have used the similar model honed in the US and the UK.
The US was known for its limited taxation, with the first federal income tax being enacted in 1861. After a long debate and changes in legislation, the Congress enacted an excise tax on corporations in 1909. The corporate tax, along with the rates, has been evolving ever since.
In the UK, corporations were subject to income tax on the profits, similarly to individuals. It wasn’t until 1965 that the government created the current Corporation Tax, which helped clarify how corporations pay tax and on what profits.
WHAT IS TAXED UNDER CORPORATE TAX?
Corporate tax is typically mainly imposed on income, but it is possible to tax other assets the corporation has in its use. In many instances, taxes are also imposed on property, as well as the existence of other similar assets and the equity structure of the corporation.
What falls under the tax depends on local legislation and some differences may arise depending on the type of corporation in question.
The following is a set of the most common parts of corporate tax.
As said previously, income is the main proponent of corporate tax. Income is taxed at varying rates across the world, with the rate always being different to individual income tax. You can find some of the corporate income tax rates further down in the guide.
In most countries, the corporate income is defined as all gross income. This means taking the sales of service and goods and deducting the cost of production as well as any income that might be tax exempt under the law. The remaining amount is then taxed according to the tax rate.
In a multinational world, corporations can have income coming in from different countries. How countries tackle this worldwide income is different for each country.
In most instances, resident corporations, i.e. corporations that have their main residency in a specific country, are taxed on the worldwide income. A corporation that is non-resident will only have to pay corporate tax on the income they make in the country of operation. Again, there are country differences to this rule.
Corporations typically end up paying part of their income and earnings back to shareholders. This distribution of earnings is known as paying dividends. Dividends are also taxable income, although they typically attract a lower rate for corporate income tax.
It is important to note that dividends are not only paid to individuals, but can also be provided to corporations. Therefore, the dividends a corporation receive will be subject to tax.
Other distribution of wealth
Corporations might also distribute some of their wealth through other means. These could include different provisions of assets or the transfer of equity or capital to new assets on behalf of the person. These are typically taxed under other unique tax rules.
Although transfer pricing is not directly related to corporate tax, it has an effect on what amount the corporations might end up paying. Transfer pricing refers to the prices the corporations apply for the goods, services or the use of property.
Therefore, it can relate to the total income the company makes both in domestic and international level. The tax authorities often set guidelines on transfer pricing to ensure the tax authorities are aware of changes companies might make.
Other alternative tax bases
Sometimes countries also impose alternative tax computations on corporations. These taxes are typically involved with the assets, capital payments and wages. These will have an alternative tax rate and function, depending on the country.
As mentioned briefly above, corporations can be taxed on both the income they make in a specific country or based on global income. In most instances, domestic corporations are taxed differently to foreign corporations.
While there isn’t any international law that would limit a country’s ability to tax residents, whether individuals or entities, there can be other limitations. In most cases, international and country specific treaties bring these about.
Treaties are typically designed to do two functions. First, they protect a country’s right to tax a company doing business within its borders. Second, they protect a corporation from having to pay tax on their income twice, both in their original country as well the country where they do business.
How corporations are taxed depends greatly on their setup. Branches and sister companies might be treated differently to foreign companies and so on.
ARE THERE TAX DEDUCTIONS AVAILABLE FOR CORPORATIONS?
Just like individuals are able to deduct certain payments from their income tax expenses, corporations also have tax deductions available for them. These vary from country to country, but most countries do offer some types of tax deductions.
The tax deductions available for corporations often fall under three separate categories: tax exemptions, interest deductions and losses.
Tax exemptions are always non-taxable and won’t need to be claimed back, as they are removed from the income tax calculation at the point of filing.
When it comes to corporate tax exemption, income and costs generated by certain transactions are often non-taxable. For instance, the formation of a corporation will in many countries be tax-exempt event. Furthermore, acquisitions and re-organisation of a business is typically a tax-exempt event.
Corporations might also be able to deduct certain interest payments from the tax. For example, corporations are generally able to deduct interest expenses generated by trading activities. Certain bank loans might also provide the option for interest payment deductions.
There are often country-specific limits on interest deductions. Certain interest payments might be, for example, deductible if made to shareholders, while be subject to tax if paid to the corporation itself.
When a corporation makes a loss, many jurisdictions allow them to deduct part or all of these losses. This is unique to corporations, as individuals aren’t able to deduct losses from taxation.
Losses available for deduction are also involved with machinery, equipment and other such corporate assets. In most instances, corporations aren’t able to deduct losses against a previous year’s income. Many countries also have strict time limitations as to when losses can be deducted.
FILING TAX RETURNS
Most countries use a similar system for collecting taxes. The system requires individuals and corporations to file their tax returns and make the payments according to the rules set by the tax authorities.
Typical filing systems
Most often, the system requires corporations to file an annual corporate tax return. There are two different ways the return might be filed:
- Through a self-assessment method, where the corporation sends its own tax assessment to the tax authorities.
- By returning the tax administration pre-filed form, where the authority has calculated the tax based on some pre-filed information and the corporation has to make sure the information is correct.
In many systems, the tax returns must be somehow certified. This often means using an authorised accountant and in the case of big corporations, the company’s own auditors.
The difficulty of the filing system depends quite a bit on the country’s legislation. Some tax return systems are straightforward, while others can be extremely complex. The complexity can also depend on the nature of the business.
Furthermore, the technological revolution has changed the way corporations, as well as individuals, need to file their taxes. Most countries are slowly moving to technology-based filing, where the majority of the return forms can be filed online.
For many countries, the system still operates both electronic and paper return systems. Corporations are often able to choose between the two, although electronic forms are becoming increasingly common.
Different taxation periods
Corporate tax is generally paid on an annual basis. Some of the other taxes imposed on corporations can sometimes be paid quarterly or even monthly. The taxation periods depend on the country’s legislation and in some instances on the size of the corporation.
Furthermore, it is good to note that tax year is not the same as a calendar year. This said, some countries might apply calendar year as the tax year, but exemptions are more often the case. For example, in the UK the tax year runs from April to April.
The taxes are often paid in retrospect and not in advance.
Who needs to file?
As mentioned above, corporate tax return often requires some sort of official certification. In many instances, this can mean that an account will go through the corporate tax return before sending it to the authorities.
The right procedure, as well as the right tax payments, depends on the structure of the corporation as well as the type of corporation in question.
CORPORATE TAX IN DIFFERENT COUNTRIES
The guide should have made it clear that the final, detailed structure of corporate tax depends on the specific country in question. As an example of corporate tax and the differences between countries, here is a short introduction to some of the systems in use in the bigger countries.
Corporations in the US is taxed at the same rate depending on the type of income the corporation makes. But different rates might be applied based on the income level of the corporation and the size of the corporation. There are also some federal differences in some states.
The US system is quite a complex one and the filing requires several forms, both for the basic tax return as well as any possible exemptions.
When it comes to foreign and domestic companies, the US taxes resident corporations based on worldwide income. Non-resident corporations must only pay income tax to the US, based on the income generated in the country.
The UK corporate tax shares many similarities with the US, although there is only one rate used in the UK. Like the US, the UK applies corporate tax on worldwide income for corporations that are based in the UK. If the corporation has a branch in the country, they are only subject to pay tax on the income they generate in the UK.
Corporate tax in the UK is calculated on what the company makes from:
- Doing business
- Selling assets for profit
China’s tax system can seem quite different and it’s hard to navigate through as a foreign business. Nonetheless, in its most basic, the corporate tax system treats domestic and foreign companies in a similar manner to the UK and the US.
Interestingly in China, the payments are made quarterly and based on estimation payments. Furthermore, the corporation will then file their annual tax return. If they have made excess payments during the year, they can use them to offset the annual instalments.
Corporate tax havens
It is all worth to mention that some countries in the world do not impose any corporate tax on any type of income. These so-called ‘tax havens’ often have many multinational companies place their residence in the country in order to avoid or pay lower taxes.
Some of the countries with no corporate tax include:
- Cayman Islands
- Isle of Man
Corporate tax rate examples from around the world
Finally, here are some of the current corporate tax rates in different countries around the world. The rates are provided by KPMG, the international services company specialised in taxation.
|Hong Kong SAR||16.5|
Although there are some countries that impose no corporate tax, the global average rate falls to around 23.68%. The highest regional average is in North America, with 33.25%, and the lowest in Europe, with 20.24%.
Corporate tax has evolved over time and in a way has become more complex. The basic principles are generally the same around the world, but the finer details and the ways corporations must file and pay taxes can change a lot from one country to another.
International tax treaties have removed some issues over corporate taxation, but different country rates have resulted in companies planning carefully where they set up. Tax planning is important for companies who want to make sure they aren’t financially worse off and understanding corporate tax basics is an essential tool in making sure a business succeeds.
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