In October 2022, the government announced changes to the Corporation Tax rate from 1 April 2023, increasing the main rate of Corporation Tax to 25%. In addition, the standard small profits rate is reintroduced to ensure that companies with small profits pay corporation tax at a lower rate.
In determining the rate of corporation tax for a company, its augmented profits, and the number of associated companies need to be considered. The associated company rules replace the current ‘related 51% group company’ rules.
NEW CORPORATION TAX RATES
From 1 April 2023 the corporation tax rates for companies with no associates will be as follows:
- For companies with augmented profits of less than £50,000, the corporation tax rate will continue to be 19%.
- For companies with greater than £250,000 in augmented profits, the corporation tax rate will be 25%.
- For companies with augmented profits between £50,000 and £250,000 the tax due is calculated at 25% but tapered down using a marginal relief calculation.
Augmented profits are defined as the company’s taxable total profits of the period plus any exempt dividends from non group companies. Group companies for these purposes are where the company receives a dividend from its 51% subsidiary or the company receiving the dividend is a 51% subsidiary itself. Group companies can also include a trading or holding company owned by a consortium of which the company receiving the dividend is a member.
The above profit limits are pro-rated on a daily basis for shorter accounting periods.
EXCLUSIONS TO THE SMALL COMPANIES REGIME
Close investment holding companies are generally not eligible for the standard small profits rate or marginal relief, and are taxed at 25%. A close company is usually a company controlled by five or fewer ‘participators’ and their associates or controlled by any number of directors who are participators. All close companies are considered to be close investment holdings companies unless they exist wholly or mainly for the purpose of trading commercially or investing in land for letting to unconnected parties; or acting as a holding or service company within a group that exists wholly or mainly to trade or to invest in land for letting to unconnected parties.
Companies are associated if one company has control of the other, or if both companies are controlled by the same person or persons. The definition of control is the same as the close company definition, which looks at who exercises or is able to exercise direct or indirect control over a company’s affairs.
Companies are considered associated for the full accounting period, even if they are only associated for part of that period. Associated companies can include both UK and Non-UK tax resident companies. Companies which are not carrying on any trade or business are excluded, for example dormant companies, from the associated company calculation as are certain non-trading holding companies. Although the trading status of a company is usually clear there is Case Law around more ambiguous scenarios. There are also separate and specific rules which can treat associations via fixed rate preference shares, loan creditors and trustees as persons able to exercise control, and may affect the number of associated companies.
Where a company has one or more associated companies, the lower and upper limits are divided by the total number of associated companies (i.e. one plus the number of associated companies).
When considering whether a person has control over more than one company, and thus the companies are associated, a persons ‘associates’ must also be considered using the same rules as associates of participators for close companies. Associated persons include close relatives (e.g. spouse/civil partner and immediate family). However, companies controlled by an associate are only included in the associated companies figure if there is a ‘substantial commercial interdependence’.
Substantial commercial interdependence between two companies can include financial, economic or organisational interdependence. The application of these rules depends on the facts of each particular case and need only include one of the three links.
Where the augmented profits fall between the lower limit of £50,000 and upper limit of £250,000 the taxable profits are charged at the 25% rate of Corporation Tax. This is then reduced by the calculated marginal relief. The marginal relief is calculated using the following formula:
Marginal relief = (F x ( U-A)) x (N/A)
Where F = the standard marginal relief fraction, currently set by parliament at 3/200.
U = the upper limit
A = Augmented Profits
N = Taxable Total Profits
As an example company A Ltd has the accounting period for the year ended 31 March 2024. A Ltd is controlled by Mr B. Mr B is married to Mrs B who controls C Ltd, and the companies are deemed to have a commercial interdependence. A Ltd has taxable total profits of £60,000, an exempt distribution received of £2,000 and so the corporation tax liability is calculated as:
25% x £60,000 = £15,000.
The Upper Limit of £250,000 is halved as A Ltd and C Ltd are associated companies.
Marginal relief is ((3/200) x (125,000 – 62,000)) x (60,000/£62,000) = £915.
Corporation tax liability due = £15,000 - £915 = £14,085.
As a practical point - for accounting periods which straddle 1 April 2023, the pre and post 1 April 2023 periods are treated as two separate notional periods. The taxable profits for the accounting period are apportioned on a time basis. The 19% rate will be applied to the pre April 2023 notional period, the associated companies tests and augmented profits are considered for the post April 2023 period. It should be noted that there may be future changes to the upper and lower limits, and marginal relief fraction and so the notional split in accounting periods across a financial year end will apply then too.
EFFECTIVE MARGINAL RATES
There is another way to calculate and conceptualise the corporation tax rates. This is to apply a rate of 19% to profits below the lower limit, 26.5% between the lower and upper limits, and 25% above the upper limit. This is important for prioritising group relief when losses could be surrendered against profits suffering tax at the different marginal rates.
QUARTERLY INSTALMENT PAYMENTS FOR LARGE AND VERY LARGE COMPANIES
As well as impacting the rate of corporation tax a company is subject to, one of the other consequences of the associated companies rules from 1 April 2023 is that it will also affect the Quarterly Instalments Payment regime.
Companies need to consider whether they are considered large or very large for corporation tax purposes on an annual basis. The current limits are augmented profits of £1.5m to be considered large, and £20m to be considered very large. The current rules are that these limits are reduced by the number of related 51% group companies plus the company itself. For periods beginning on or after 1 April 2023 however, this 51% group companies test is replaced by the associated company rules.
With the associated companies definition above being broader than the 51% company definition, it is easy to see that more companies could find themselves requiring to make quarterly tax instalments. The first instalment for quarterly payments is due:
- Six months and 13 days after the first day of the accounting period for large companies,
- Only two months and 13 days after the first day of the accounting period for very large companies.
Therefore, careful consideration should be given sooner rather than later to the number of associated companies for cash flow purposes for a business and also to avoid any interest or penalties arising on late payments.
Now that there is no longer a single rate of corporation tax companies need to consider the number of their associated companies under the reintroduced small profits regime in order to determine what rate of corporation tax they will be charged. This will require not only considering the number of companies in a corporate group, but with the replacement of the concept of a 51% subsidiary by a wider concept of associated companies, common ownership and ownership by associated persons will have an impact on the number of companies that are associated.
It may, therefore, be appropriate to consider whether any companies can be merged, eliminated, or disposed of in order to minimise the impact of these rules.
Groups or companies under common or associated ownership will also need to ensure, so far as possible, that the level of profits in each associated company does not result in losing out on part of the small company’s rate.
This number of associated companies also needs to be considered for the timing of upcoming tax payments because the thresholds for the instalment payment regime may begin to impact where, under the new rules, more companies become associated than had been the case under to 51% subsidiary test.