Corporation Tax Explained for Small Companies

I meet new directors every month who tell me, with total confidence, that corporation tax is "19% if you're small, 25% if you're not." It's close enough to be dangerous, because the real system has three zones, not two, and the middle zone is where the genuinely interesting planning happens. This guide walks through exactly how corporation tax works for a small company in 2026/27, in plain terms, with the real numbers behind each answer.

Can You Explain What Corporation Tax Is and How It Works?

The basics

Corporation tax is the tax a UK limited company pays on its profits. Not revenue, not turnover, but profit: what's left after allowable costs have been deducted. It's charged on trading profits, investment income, and capital gains the company makes, and it's entirely separate from any tax you pay personally on salary or dividends.

Who pays it, and when

Every UK-resident company pays it, whether trading actively or sitting dormant with investment income. You need to register with HMRC within three months of starting to trade, and the company then files its own tax return, the CT600, reporting its profit and calculating the tax due.

Why it's separate from your own tax

This trips up a lot of first-time directors coming from employment, where tax is simply deducted from a payslip and that's the end of it. A limited company is its own legal person. It has its own tax bill, calculated on its own profit, and whatever you then draw out as salary or dividends is taxed again, separately, on you. Two tax bills from one business is normal, not a mistake.

I remember explaining this to a client who'd just left a long career as an employee to start her own consultancy. She'd budgeted carefully for her personal tax, based on her old salary, and was genuinely alarmed the first time she saw her company's corporation tax bill sitting alongside it. Once she understood that it was a second, separate bill, calculated on a separate pot of money, rather than some kind of double taxation on the same income, the shape of it made much more sense, and she could plan her cash flow properly around both dates instead of just one.

Corporation Tax Rates and Allowances for 2026/27

The three zones

For 2026/27, there isn't one rate. There are three zones. Profit up to £50,000 is taxed at 19%, the small profits rate. Profit above £250,000 is taxed at 25%, the main rate. Profit in between is taxed somewhere in the middle, using marginal relief, which tapers the rate smoothly from 19% up to 25% across that band.

How marginal relief is actually calculated

The formula for 2026/27 uses a fraction of 3/200. You work out tax at the full 25% rate first, then subtract (£250,000 minus your profit) multiplied by 3/200.

Take our £150,000 example from the start of this guide. Tax at 25% is £37,500. Marginal relief is £100,000 × 0.015, which is £1,500. Subtract that, and the bill is £36,000, an effective rate of 24%.

The detail that changes planning decisions

Here's what that formula means in practice: within the £50,000 to £250,000 band, every additional pound of profit is taxed at an effective marginal rate of 26.5%, not 25%. Higher than the main rate itself. If you're deciding whether to take on one more piece of work before your year end, and it sits inside that band, the true cost isn't what the headline rate suggests.

Associated companies change your thresholds

If you own, or are connected to, more than one company, the £50,000 and £250,000 limits are divided between them. Two associated companies means each gets a £25,000 and £125,000 threshold instead. I've seen directors plan around a £50,000 limit they genuinely didn't have, because a dormant second company set up years ago still counted. Our corporation tax guide walks through this with a full worked example.

Why the system is designed this way

It's worth understanding the thinking behind three zones rather than one flat rate, because it makes the whole thing easier to remember. The small profits rate exists to keep genuinely small businesses paying a lower rate, recognising that a company making £30,000 of profit is in a very different position from one making £3 million. The main rate applies once a company is clearly operating at scale. Marginal relief exists purely as a smoothing mechanism, so there's no sudden cliff-edge jump between the two, even though, as we've seen, it does create its own quirk in the form of that 26.5% marginal rate on the way through.

Do You Pay Corporation Tax on Turnover or Profit?

Profit, not turnover, and the distinction matters enormously

This question comes up constantly, and the answer is always profit. A company can have £500,000 of turnover and a relatively modest tax bill, if its costs are high. A company with £100,000 of turnover and very low costs can pay a proportionally larger amount. Turnover tells you how much money came in. Profit tells you what's actually taxable, and the two can look very different.

Why directors conflate the two

I think the confusion comes from how personal tax works, where PAYE is deducted from gross pay before you see it, making "income" and "taxable amount" feel like the same thing. For a company, they genuinely aren't. Legitimate costs, salaries, rent, equipment, materials, reduce the profit figure before any tax rate is applied at all.

What counts as taxable profit

Taxable profit starts from your accounting profit and gets adjusted: certain costs added back because they're not tax-deductible (client entertaining is the classic example), and reliefs deducted, such as capital allowances replacing accounting depreciation. The final figure, not your turnover and not even your accounting profit, is what the 19%, 25% or marginal rate applies to.

How Much Can a Ltd Company Earn Before Paying Corporation Tax?

The honest answer: none, technically

If your company makes any profit at all, it's liable to corporation tax at the small profits rate, from the very first pound. There's no tax-free profit allowance in the way individuals have a personal allowance.

Why this question usually means something else

When directors ask this, they're often really asking when they need to register, or when their first bill is due. The registration deadline is within three months of starting to trade, regardless of profit level. Corporation tax payment itself is due nine months and one day after your company's year end, and the tax return twelve months after. So there's no earnings threshold before registration applies, but there's a meaningful gap between making a profit and actually having to pay the tax on it.

A new company's first year

A genuinely new company often makes very little profit, or even a loss, in its first year, simply because start-up costs are high relative to early revenue. In that scenario, the tax bill in year one can be small or nil, not because of any special allowance, but because there's genuinely little or no profit yet.

How Does Tax Work on a Small Business?

It depends enormously on structure

A sole trader and a limited company are taxed in completely different ways, and "small business" covers both. A sole trader pays income tax and National Insurance directly on their business profit, through Self Assessment, with no separation between the business and the individual. A limited company pays corporation tax on its own profit first, and then the director pays separate personal tax on whatever they draw out.

Why the limited company route often wins at higher profit levels

The appeal of a limited company usually shows up once profits grow. Corporation tax at 19% or 25% is often lower than the income tax and National Insurance a sole trader would pay on the same profit at higher levels, and a limited company lets you control the timing of when profit becomes personal income, by choosing how much to draw as salary and dividends versus leaving in the company.

The trade-off

None of this makes a limited company automatically better. It comes with more administration, two sets of filings instead of one, and rules around dividends and director's loans that a sole trader simply doesn't have to think about. The right structure depends on your profit level, your plans, and how much complexity you're comfortable managing, or paying someone else to manage for you.

I generally tell clients that the crossover point, where incorporating starts to make a meaningful tax difference, tends to arrive once profits comfortably exceed what you personally need to live on. Below that, the extra administration of running a company often isn't worth it for the saving involved. Above it, the gap between the two structures tends to widen every year, which is exactly why this is worth revisiting as a business grows rather than deciding it once at the very start and never looking again.

Does Paying Dividends Reduce Corporation Tax?

No, and this is one of the most common misunderstandings I come across

Dividends are paid from profit that has already had corporation tax deducted. They're a distribution of what's left, not a business expense, so they have no effect on your corporation tax bill whatsoever. Salary works differently: it's a deductible cost, so it reduces the profit corporation tax is calculated on. Dividends don't.

Why the confusion exists

I think directors conflate this with the idea that dividends are "tax efficient," which is true, but for a different reason entirely. Dividends are efficient because they avoid National Insurance on the personal side. They do nothing at all on the company side. The order is always: work out profit, pay corporation tax on it, and only then decide how much of what's left to pay out as a dividend.

What does genuinely reduce corporation tax

Salary (including employer National Insurance), employer pension contributions, capital allowances, and R&D relief all reduce the profit figure before corporation tax is calculated. Our guide to paying yourself explains how salary and dividends interact with both layers of tax.

How to Reduce Corporation Tax in a Limited Company?

The legitimate toolkit

None of what follows is a loophole. These are reliefs Parliament has deliberately built into the system, and the companies that use them properly simply pay what they genuinely owe, not less than that through aggressive planning, and not more than they need to through not knowing the rules exist.

Corporation tax expenses and reliefs

Start with the basics: claim every allowable expense, properly recorded. Beyond day-to-day costs, the two biggest levers are capital allowances and pension contributions. The Annual Investment Allowance lets you deduct up to £1 million of qualifying equipment in full, in the year you buy it. An employer pension contribution is fully deductible, avoids National Insurance, and isn't taxed as a dividend on the way to you. Our capital allowances guide and pension contributions guide cover both in depth.

How do I avoid the 25% rate specifically?

You can't avoid it if your profit genuinely sits above £250,000, but you can reduce how much profit sits there. Timing capital spending to fall before your year end, making a pension contribution that brings profit down, and checking whether associated companies have shrunk your thresholds unexpectedly are the three most common levers. Inside the marginal relief band, where the effective rate hits 26.5%, these same moves are worth even more, because you're saving tax at a rate higher than the headline main rate itself.

The most overlooked tax break in the UK

If I had to pick one relief that genuinely gets missed more than any other in the corporation tax world specifically, it's R&D tax relief. Claims fell by more than a quarter in a single recent year, not because companies stopped innovating, but because the rules tightened and a lot of genuinely eligible businesses never claimed in the first place. I still meet directors running manufacturing firms, software businesses, and specialist trades companies who assume "R&D" means a lab coat and a microscope. It doesn't. If your company has spent real time resolving a genuine technical uncertainty this year, something a competent professional in your field couldn't have simply looked up, it's worth a proper conversation before assuming you don't qualify. Our R&D relief guide explains what counts and what the relief is actually worth.

Why Do Big Companies Pay So Little Tax?

The honest answer: scale and structure, not a secret rate

Large multinational companies aren't paying a lower corporation tax rate than you are. They're operating across multiple countries, with far more complex structures, far more capital spending to offset against profit, and considerably more sophisticated tax planning behind every decision.

Where the gap actually comes from

A multinational group can allocate costs, profits and debt across different jurisdictions in ways a single UK company simply can't. It can carry forward enormous historical losses from previous years of investment. It can claim reliefs, including R&D relief, at a scale that dwarfs anything a small company would ever consider. None of it is secret, and increasingly, international rules have tightened considerably around the most aggressive versions of this kind of structuring.

Why this isn't really relevant to your own planning

It's a fair question to ask, and a genuinely interesting one, but it's not a blueprint for a small UK company. The reliefs available to you, capital allowances, pension contributions, R&D relief, and sensible timing around your year end, are the same tools in miniature, proportionate to your own scale. Used properly, they bring your effective rate down meaningfully, just not to the headline-grabbing levels that occasionally make the news for a household-name company with a very different set of circumstances behind it.

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Corporation tax rewards understanding far more than it rewards guesswork. The difference between assuming "it's 19% or 25%" and actually knowing where your company sits, what reliefs apply, and how the marginal relief band affects your next decision, can run into thousands of pounds a year. If you'd like us to review your own position, get in touch with the team at Cannon Accountants.

For the wider picture of how corporation tax fits alongside salary, dividends, expenses and everything else covered in this series, head back to our complete Limited Company Tax Guide 2026/27: Corporation Tax, Dividends & Director Tax →.

Disclaimer:

The content of this blog is for general informational purposes only and should not be considered professional tax advice. The information is correct at the time of publishing but may change following future UK budget announcements or updates to HMRC guidance. Individual circumstances vary, and tax obligations can differ based on your personal situation. We strongly recommend consulting with us or a qualified tax professional to receive advice tailored to your specific needs.