Many people don’t realise that there is a difference between accounting profit and taxable profit – and that they are very rarely exactly the same figure.
Lots of business owners arrive at their accounting profit – thinking it’s also their taxable profit – multiply it by the relevant tax rate, and think that they have arrived at their tax figure. Sadly it’s not that simple, and that is because things that are allowable for accounting purposes are not always allowable for tax purposes, and vice versa.
Let’s look at simple company example, where you have purchased some machinery for £30k in the year and will be depreciating it evenly over three years:
Sales £50k
Legal costs £2k
Depreciation £10k
Entertaining £3k
Profit before tax £35k
Now if you multiply the £35k profit by the corporation tax rate of 19% you get a tax figure of £6,650, but that is not correct.
Included within legal costs is a £1k parking fine, and this is not allowable for tax, nor is £2k of the entertaining as it related to clients, which is not tax allowable either. Depreciation costs are not allowable so that needs to be added back, but you can claim £30k Annual Investment Allowance (AIA) for the cost of buying the machinery.
Once all of those are adjusted for, you actually have a lower taxable profit of £18k and a tax bill of only £3,420 – very different from the accounting profit and its corresponding tax charge.
Let’s say the same figures applied, but you made the plant purchase in the prior year, so then you wouldn’t have the £30k AIA to claim, so your taxable profit would actually be £48k and your corporation tax bill would be £9,120.
From the simple example above it is very easy to see how confusion can arise and how errors can be made – which is why it’s vital that you seek professional guidance when making your tax calculations rather than ‘having a go’ yourself.