The corporate income tax generally only applies to C corporations (also known as regular corporations). These corporations—named for Subchapter C of the Internal Revenue Code (IRC), which details their tax treatment—are generally treated as taxable entities separate from their shareholders. That is, corporate income is taxed once at the corporate level according to the corporate income tax system. When corporate dividend payments are made or capital gains are realized income is taxed again at the individual-shareholder level according to the individual tax system. This treatment leads to the so-called “double taxation” of corporate profits. In contrast, non-corporate businesses, including S corporations and partnerships, pass their income through to owners who pay taxes. Collectively, these non-corporate business entities are referred to as pass-throughs. For these types of entities, business income is taxed only once, at individual income tax rates. The corporate income tax is designed as a tax on corporate profits (also known as net income). Broadly defined, corporate profit is total income minus the cost associated with generating that income. Business expenses that may be deducted from income include employee compensation; the decline in value of machines, equipment, and structures (i.e., deprecation); general supplies and materials; advertising; and interest payments. The corporate income tax also allows for a number of other special deductions, credits, and tax preferences. Oftentimes, these provisions are intended to promote particular policy goals, as deductions reduce taxes paid by corporations.
Most corporate income is subject to a 35% statutory tax rate. To generate this flat rate, which applies to the largest businesses, income is taxed at rates that vary from 15% on the first $50,000 of income to 35% on income over $18,333,333.6 This rate structure benefits smaller corporations, encouraging some small firms to incorporate to take advantage of scenarios where paying corporate taxes is less costly than paying according to the individual tax system.
It is also important to understand that effective tax rates can vary substantially among U.S. corporations and across corporations in the same industry. For example, some corporations rely more on debt financing, which is treated more favorably than equity financing in the tax code. Those corporations that rely on tax-preferred financing reduce their effective tax rate relative to those who do not. Some corporations and industries rely more on certain physical assets that can be depreciated (“written-off”) more quickly than investments made by companies in others industries, which again leads to differing effective tax rates. Other corporations and industries have more extensive overseas operations, which may affect their effective U.S. tax rate.
This chapter cover two topics – corporate tax reform and issues arising from the introduction of the 0% starting rate of corporation tax in April 2002. Since 1997, the government has made some substantial reforms to the UK corporation tax system. In recent years, it has been consulting on furtherreform. Section 6.1 provides some background to the debate and discusses the main proposals for reform. Section 6.2 looks at a specific tax change – the introduction of the 0% corporation tax rate for companies with taxable profits of less than £10,000. It discusses the incentives created by this tax change for individuals to set up incorporated businesses, and in particular the incentives faced by self-employed individuals to incorporate.
The current government has made a number of important changes to the UK’s
corporate tax system4 and has now undertaken three rounds of consultations. It thus seems reasonable to ask when the reform process will be completed, or, at least, in what direction it is heading. After all, these reforms are taking place under a chancellor who stressed in his first Budget Speech that ‘in a global economy, long-term investment will come to those countries that demonstrate stability in their monetary and fiscal policies’.5 For the benefits of stability, it might appear preferable to stop constant tinkering with the system. This is, however, not always an option, as the UK’s corporate tax system is facing pressures over which the government has little control.
First, in a global economy, the UK’s corporate tax system is in competition
with those of other economies, both in the EU and beyond. If the UK’s system became uncompetitive, both real activity and reported profits could move elsewhere and reduce the UK’s corporate tax revenues. Second, the UK’s tax legislation is increasingly under threat of challenges at the European Court of Justice, as multinational companies have become more willing to take national governments to court if their tax systems appear to be in breach of the European Community Treaty.