The income tax provision is used while estimating the income tax for the current fiscal year. This estimation helps the businesses manage their short-term finances smoothly and beforehand. On the other hand, the process of income tax provision and its calculation make the tax liabilities estimation convenient before the actual date arrives.
If you are wondering, what income tax provision is and how to calculate it, then this reading might help you. In this blog, we will walk you through what the income tax provision is and what formula it uses to calculate the amount to be paid in tax in the current financial year. Moreover, We will briefly discuss the advantages and disadvantages of this process. So, let’s begin our discussion!
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What is the Income Tax Provision?
The income tax provision is the assessment of the liabilities of tax of a firm or organisation to analyse the expenses for a particular year. It helps the companies estimate the total tax expenditures before the deadline for paying income tax arrives.
Whatever the firm has earned as self-employed or in partnership, they are liable to pay income tax. So, it is important to consider the concept of this provision and how to calculate it.
Income Tax (Corporation Tax) In the UK
Companies in the United Kingdom have to pay corporation tax every year to the HMRC. The corporation tax rate is fixed at 19% at the base rate on the profits earned by the companies. On the other hand, if the profits of a company go beyond the threshold of £ 250 000, the corporation tax will be 25% as per the ruling of Budget 2021 and effective from 1st April 2023.
The small profit companies earning up to £ 50 000 will be liable to pay a corporation tax of 19%, effective also from 1st April 2023. Currently, the corporation tax rate is fixed at 19% of the profits except for the companies in the business of oil extraction and oil rights, also known as fence companies. Let’s move towards the next step of calculating the income tax provision using an example!
The formula for Income Tax Provision
Calculating income tax for the organisation is very simple and convenient. You need a bit of information about the income and expenses of a company and you can easily estimate the total tax liabilities of that company in a particular year.
Income Tax Provision = Income Earned (Profit) Before Tax * The Tax Rate
A company for estimating the total taxes payable in a year uses this formula for calculating the income tax provision. The tax rates applicable in the previous year are not applied to the next year. They are different as the earnings and the tax rates might differ year on year.
Example
For example, Company A has the following information about the income and the expenses. First, the profit of this company will be calculated and then the income tax provision. So, let’s begin our discussion!
| Particulars | Amount |
| Sales | £ 4 000 000 |
| Cost of Goods Sold (COGS) | £ 1 800 000 |
| Gross Profit | £ 2 200 000 |
| Other Income Sources | |
| Rental Income | £ 50 000 |
| Total | £ 2 250 000 |
| Expenses | |
| Administrative Expenses | £ 400 000 |
| Distributive Expenses | £ 200 000 |
| Total Expenses | £ 600 000 |
| Operating Profit | Total – Expenses = 2 250 000 – 600 000 = 1 650 000 |
| Financial Expenses | |
| Interest Expenses | 150 000 |
| Profit Before Taxes | 1 500 000 |
The profit before tax is £ 1 500 000 which will be taxed in a particular year. Let’s say this tax provision is being calculated for 31st December 2022.
As the corporation tax is fixed at 19% for all corporations, so we will calculate the corporation tax provision at this tax rate.
After this, the income tax will be calculated at a particular tax rate.
Income Tax Provision = Profit Before Tax * Tax Applicable
= £ 150 000 * 19%
= £ 28 500
So, the company is expected to pay £ 28 500 in tax at the end of the financial year 2022. If the profit before tax differs, the tax liability will also vary at the end of that financial year. However, it helps estimate the total tax expenses at the start of the year.
Benefits & Challenges of Income Tax Provision
Although there are some benefits of earlier calculation of corporate tax provisions, the challenges along with the process of calculation can not be ignored completely. Let’s first discuss the benefits of calculating this number!
Plan Short-term Finance
Planning the short-term finance is the best way to meet the current year’s tax obligations as well as the cash requirements of a company.
Smooth Tax Liability Process
Similarly, the tax liabilities process will become smooth as the tax laws change from year to year. So, it is necessary to keep an estimate of the tax liabilities in the future to plan ahead of time. So, other finances don’t go upside down at the end of the financial year.
Let’s now discuss the challenges in the process to make corporate tax provisions!
Getting the Right Data
Getting the right data from the tax department and financial department for a year is the most tiring process and it takes time in getting accurate data.
Accurate Estimation
Similarly, the corporate or income tax provision is based on the assessment of the profit before taxation and the tax rate. It is possible the profit before tax is more or less than the expected level or the tax laws change. In either case, the accurate estimation becomes challenging.
Wastage of Funds
Sometimes, the companies manipulate the corporate tax provision to get more funds. As a result, there is the probability of wasting the funds by the company managers. Otherwise, these resources could have been for other productive or efficient use.
Final Thoughts
To wrap up, we can say that the corporate tax for the UK companies is fixed at 19% for all the businesses. However, this rate will change from 19% to 25% for companies earning profits of more than £ 250 000. The formula for calculating income tax provisions consists of current and deferred tax provisions.
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Disclaimer: All the information provided in this article on Income Tax Provision including text and graphics is general in nature. It does not intend to disregard any of the professional advice.