Changes to Corporation Tax

As mentioned in a previous blog, and trailed in the media for the last couple of years, the rate of corporation tax has changed from 1^st April 2023.

For the last few years, corporation tax for small companies has been relatively simple, there has been a single rate of corporation tax, which was 19%.

From 1^st April 2023, there are effectively three rates of corporation tax:

1. For profits up to £50,000 – 19%
2. For profits between £50,000 and £250,000 – 26.5% (*)
3. For profits over £250,000 – 25%

(*) the tax rate for this band is actually 25%, but is reduced using a marginal relief calculation, which gives the effective tax rate of 26.5%.

This means that if your taxable company profits are less than £50,000, the company should still pay 19% corporation tax.

This has a particular relevance for small owner managed businesses.  For the last few years, there has been little difference between income tax paid by individuals (20%) and corporation tax paid by limited companies (19%).  The change now creates a clear difference, but the relationship between company and personal tax is contingent upon:

• The likelihood that company profits will be above £50,000,
• Whether the directors have any other personal income.

It also may influence company pension payments for the director(s), as tax relief could be higher than normal (25% and/or 26.5%, rather than 19%).

Associated Companies

A further complication arises where two or more companies are owned by the same people.  Associated Companies for Corporation Tax rules have been reintroduced, applying from 1^st April 2023.

The upper and lower limits for taxable profits (£50,000 & £250,000) are reduced depending on the number of associated companies, the taxable profit limits being divided equally among all the associated companies.

This means that if there are 2 associated companies they will pay 25% on profits of £125,000 and above (being half of the rate of £250,000), and will move out of the 19% rate once the profits reach £25,000 each rather than £50,000.

This highlights the importance of examining the relationship between companies in which you own shares, and the likely profit levels in each.

What is an associated Company?

Broadly a company is associated with another company if at any time within the preceding 12 months:

• One company has control of the other, or
• The same person, or persons, have control of both of them.

Please note that dormant companies are exempt from this test.

Meaning of ‘control’

A person is treated as having ‘control’ if they can exercise control over the company. This normally comes with owning more than 50% of the share capital.

In certain circumstances the rights and ownership of other people can be attributed to you and combined with your shareholding. This is most common with spouses or partners but can also include children or siblings.

For example, if you own 35% of the shares in a company and your spouse owns 20% these shareholdings are added together; as you jointly own 55%, you are judged as having control.

In addition, where there is “substantial commercial interdependence” between two companies, we also need to take into account the rights and powers of each shareholder’s “associates” when looking at whether the companies are under common control. Associates for these purposes include relatives (spouses/civil partners, parents, grandparents, children, grandchildren, siblings and so on), partners, and some trustees and settlors. 

The rights of an individual’s associates only need to be considered if there is substantial commercial interdependence between the companies. For example, if a husband and wife each have 100% control of their own companies, those companies will not be associated unless there is substantial commercial interdependence between them.

Substantial commercial interdependence

There are three types of commercial interdependence:

• Financial – one company financially supports the other, or each has a financial interest in the affairs of the same business. 
• Economic – the companies have the same economic objective, common customers or the activities of one benefit the other. 
• Organisational – the companies have common management, employees, premises or equipment.

Just one of the above is enough for substantial commercial interdependence to exist. For example, if a company lends to another that may be enough to constitute substantial commercial interdependence even if there is no other link between them.

Further technical information from HMRC can be found here.