Corporate tax

Definition

Corporate tax refers to a tax charged by governments on the profits earned by businesses, corporations, and other legal entities. It is a significant source of revenue for governments and is distinct from individual income tax.

What is corporate tax?

Corporate tax is applied to the net income or profits of a business entity. Net income is calculated by subtracting allowable business expenses, deductions, and credits from the total revenue generated by the company during a specific period.

Corporations can often deduct certain expenses, such as costs associated with producing goods or services, employee wages, interest on loans, and depreciation of assets. These deductions serve to reduce the taxable income, thereby lowering the overall tax liability.

One characteristic of corporate taxation is the potential for double taxation. This occurs when a corporation is taxed on its profits, and then the shareholders are also taxed on any dividends received. 

Governments may offer tax incentives and credits to encourage specific activities or industries. These could include research and development tax credits, incentives for investment in certain regions, or tax breaks for environmentally-friendly practices.

Corporate tax policies can influence investment decisions, job creation, and the overall competitiveness of a country in attracting businesses. High corporate taxes may discourage investment, while low rates can stimulate economic growth.

Example of corporate tax

ABC Corporation is a manufacturing company that operates in a country with a corporate tax rate of 20%. At the end of the fiscal year, ABC Corporation calculates its taxable income.

Let’s say ABC Corporation had a total revenue of $1 million and incurred $600,000 in allowable business expenses, such as manufacturing costs, employee salaries, and other operational expenses. The taxable income would be $1 million – $600,000 = $400,000.

Applying the corporate tax rate of 20%, ABC Corporation would owe $400,000 x 0.20 = $80,000 in corporate taxes. This $ƒ80,000 represents the amount the company is required to pay to the government as its corporate income tax.