Corporate tax
A corporate tax, also called corporation tax or company tax, is a type of direct tax levied on the income or capital of corporations and other similar legal entities. The tax is usually imposed at the national level, but it may also be imposed at state or local levels in some countries. Corporate taxes may be referred to as income tax or capital tax, depending on the nature of the tax.
The purpose of corporate tax is to generate revenue for the government by taxing the profits earned by corporations. The tax rate varies from country to country and is usually calculated as a percentage of the corporation's net income or capital. Corporate tax rates may also differ for domestic and foreign corporations.
Many countries have tax laws that require corporations to pay taxes on their worldwide income, regardless of where the income is earned. However, some countries have territorial tax systems, which only require corporations to pay taxes on income earned within the country's borders.
A country's corporate tax may apply to:
Company income subject to tax is often determined much like taxable income for individual taxpayers. Generally, the tax is imposed on net profits. In some jurisdictions, rules for taxing companies may differ significantly from rules for taxing individuals. Certain corporate acts or types of entities may be exempt from tax.
The incidence of corporate taxation is a subject of significant debate among economists and policymakers. Evidence suggests that some portion of the corporate tax falls on owners of capital, workers, and shareholders, but the ultimate incidence of the tax is an unresolved question.[1]
Interest deduction limitations[edit]
Most jurisdictions allow a tax deduction for interest expense incurred by a corporation in carrying out its trading activities. Where such interest is paid to related parties, such deduction may be limited. Without such limitation, owners could structure financing of the corporation in a manner that would provide for a tax deduction for much of the profits, potentially without changing the tax on shareholders. For example, assume a corporation earns profits of 100 before interest expense and would normally distribute 50 to shareholders. If the corporation is structured so that deductible interest of 50 is payable to the shareholders, it will cut its tax to half the amount due if it merely paid a dividend.
A common form of limitation is to limit the deduction for interest paid to related parties to interest charged at arm's length rates on debt not exceeding a certain portion of the equity of the paying corporation. For example, interest paid on related party debt in excess of three times equity may not be deductible in computing taxable income.
The United States, United Kingdom, and French tax systems apply a more complex set of tests to limit deductions. Under the U.S. system, related party interest expense in excess of 50% of cash flow is generally not currently deductible, with the excess potentially deductible in future years.[51]
The classification of instruments as debt on which interest is deductible or as equity with respect to which distributions are not deductible can be complex in some systems.[52]
Foreign corporation branches[edit]
Most jurisdictions tax foreign corporations differently from domestic corporations.[53] No international laws limit the ability of a country to tax its nationals and residents (individuals and entities). However, treaties and practicality impose limits on taxation of those outside its borders, even on income from sources within the country.
Most jurisdictions tax foreign corporations on business income within the jurisdiction when earned through a branch or permanent establishment in the jurisdiction. This tax may be imposed at the same rate as the tax on business income of a resident corporation or at a different rate.[54]
Upon payment of dividends, corporations are generally subject to withholding tax only by their country of incorporation. Many countries impose a branch profits tax on foreign corporations to prevent the advantage the absence of dividend withholding tax would otherwise provide to foreign corporations. This tax may be imposed at the time profits are earned by the branch or at the time they are remitted or deemed remitted outside the country.[55]
Branches of foreign corporations may not be entitled to all of the same deductions as domestic corporations. Some jurisdictions do not recognize inter-branch payments as actual payments, and income or deductions arising from such inter-branch payments are disregarded.[56] Some jurisdictions impose express limits on tax deductions of branches. Commonly limited deductions include management fees and interest.
Nathan M. Jenson argues that low corporate tax rates are a minor determinate of a multinational company when setting up their headquarters in a country. Nathan M. Jenson: Sinha, S.S. 2008, "Can India Adopt Strategic Flexibility Like China Did?", Global Journal of Flexible Systems Management, vol. 9, no. 2/3, pp. 1.
Losses[edit]
Most jurisdictions allow interperiod allocation or deduction of losses in some manner for corporations, even where such deduction is not allowed for individuals. A few jurisdictions allow losses (usually defined as negative taxable income) to be deducted by revising or amending prior year taxable income.[57] Most jurisdictions allow such deductions only in subsequent periods. Some jurisdictions impose time limitations as to when loss deductions may be utilized.
Groups of companies[edit]
Several jurisdictions provide a mechanism whereby losses or tax credits of one corporation may be used by another corporation where both corporations are commonly controlled (together, a group). In the United States and Netherlands, among others, this is accomplished by filing a single tax return including the income and loss of each group member. This is referred to as a consolidated return in the United States and as a fiscal unity in the Netherlands. In the United Kingdom, this is accomplished directly on a pairwise basis called group relief. Losses of one group member company may be "surrendered" to another group member company, and the latter company may deduct the loss against profits.
The United States has extensive regulations dealing with consolidated returns.[58] One such rule requires matching of income and deductions on intercompany transactions within the group by use of "deferred intercompany transaction" rules.
In addition, a few systems provide a tax exemption for dividend income received by corporations. The Netherlands system provides a "participation exception" to taxation for corporations owning more than 25% of the dividend paying corporation.
[edit]
Most income tax systems levy tax on the corporation and, upon distribution of earnings (dividends), on the shareholder. This results in a dual level of tax. Most systems require that income tax be withheld on distribution of dividends to foreign shareholders, and some also require withholding of tax on distributions to domestic shareholders. The rate of such withholding tax may be reduced for a shareholder under a tax treaty.
Some systems tax some or all dividend income at lower rates than other income. The United States has historically provided a dividends received deduction to corporations with respect to dividends from other corporations in which the recipient owns more than 10% of the shares. For tax years 2004–2010, the United States also has imposed a reduced rate of taxation on dividends received by individuals.[59]
Some systems currently attempt or in the past have attempted to integrate taxation of the corporation with taxation of shareholders to mitigate the dual level of taxation. As a current example, Australia provides for a "franking credit" as a benefit to shareholders. When an Australian company pays a dividend to a domestic shareholder, it reports the dividend as well as a notional tax credit amount. The shareholder utilizes this notional credit to offset shareholder level income tax.
A previous system was utilised in the United Kingdom, called the advance corporation tax (ACT). When a company paid a dividend, it was required to pay an amount of ACT, which it then used to offset its own taxes. The ACT was included in income by the shareholder resident in the United Kingdom or certain treaty countries, and treated as a payment of tax by the shareholder. To the extent that deemed tax payment exceeded taxes otherwise due, it was refundable to the shareholder.
Alternative tax bases[edit]
Many jurisdictions incorporate some sort of alternative tax computation. These computations may be based on assets, capital, wages, or some alternative measure of taxable income. Often the alternative tax functions as a minimum tax.
United States federal income tax incorporates an alternative minimum tax. This tax is computed at a lower tax rate (20% for corporations), and imposed based on a modified version of taxable income. Modifications include longer depreciation lives assets under MACRS, adjustments related to costs of developing natural resources, and an addback of certain tax exempt interest. The U.S. state of Michigan previously taxed businesses on an alternative base that did not allow compensation of employees as a tax deduction and allowed full deduction of the cost of production assets upon acquisition.
Some jurisdictions, such as Swiss cantons and certain states within the United States, impose taxes based on capital. These may be based on total equity per audited financial statements,[60] a computed amount of assets less liabilities[61] or quantity of shares outstanding.[62] In some jurisdictions, capital based taxes are imposed in addition to the income tax.[61] In other jurisdictions, the capital taxes function as alternative taxes.
Mexico imposes an alternative tax on corporations, the IETU. The tax rate is lower than the regular rate, and there are adjustments for salaries and wages, interest and royalties, and depreciable assets.
Tax returns[edit]
Most systems require that corporations file an annual income tax return.[63] Some systems (such as the Canadian, United Kingdom and United States systems) require that taxpayers self assess tax on the tax return.[64] Other systems provide that the government must make an assessment for tax to be due. Some systems require certification of tax returns in some manner by accountants licensed to practice in the jurisdiction, often the company's auditors.[65]
Tax returns can be fairly simple or quite complex. The systems requiring simple returns often base taxable income on financial statement profits with few adjustments, and may require that audited financial statements be attached to the return.[66] Returns for such systems generally require that the relevant financial statements be attached to a simple adjustment schedule. By contrast, United States corporate tax returns require both computation of taxable income from components thereof and reconciliation of taxable income to financial statement income.
Many systems require forms or schedules supporting particular items on the main form. Some of these schedules may be incorporated into the main form. For example, the Canadian corporate return, Form T-2, an eight-page form, incorporates some detail schedules but has nearly 50 additional schedules that may be required.
Some systems have different returns for different types of corporations or corporations engaged in specialized businesses. The United States has 13 variations on the basic Form 1120[67] for S corporations, insurance companies, Domestic international sales corporations, foreign corporations, and other entities. The structure of the forms and imbedded schedules vary by type of form.
Preparation of non-simple corporate tax returns can be time consuming. For example, the U.S. Internal Revenue Service states in the instructions for Form 1120 that the average time needed to complete form is over 56 hours, not including record keeping time and required attachments.
Tax return due dates vary by jurisdiction, fiscal or tax year, and type of entity.[68] In self-assessment systems, payment of taxes is generally due no later than the normal due date, though advance tax payments may be required.[69] Canadian corporations must pay estimated taxes monthly.[70] In each case, final payment is due with the corporation tax return.