After some political to-ing and fro-ing the increase of the corporation tax (CT) rate to 25% was finally confirmed in October 2022. The increased rate was no great surprise given the government’s need to re-coup funds following the support offered during the Covid pandemic, and whilst we are pleased that the 19% rate was retained for the smallest of companies, a return to a two-rate system does bring additional complications that companies (and advisers!) could do without.
The basics
Those of you who have been in business for many years may remember the old two-rate system, and I’m pleased to report that the mechanics of the new system are the same, just with different rates and thresholds. However, as we’ve had one rate of CT for 8 years now there will be plenty of people who either have no experience, or no memory, of the two-rate system and how it works.
There are two thresholds to be aware of:
- The “marginal relief lower limit” of £50,000 – companies with profits equal to or below this will continue to pay at the small profits rate, currently set at 19%
- The “marginal relief upper limit” of £250,000 – companies with profits above this will pay tax at the main rate, currently set at 25%
Companies with profits between £50,000 and £250,000 will pay tax at an effective rate somewhere between 19% and 25% – see “Marginal Relief” below.
The profit figure used when deciding what rate applies is their augmented profits, which is the taxable profits plus any exempt dividends received from non-group companies. To clarify, the dividends are not taxable, they just impact the rate at which CT is paid on the company’s taxable profits.
It is important to note that the thresholds above have to be divided between associated companies, and this is widely drawn and may include more companies than expected (see below for details). They also apply to 12 month periods so will need to be pro-rated for long or short accounting periods.
Marginal relief
Marginal relief is HMRC’s way of smoothing out the jump from 19% to 25% and the idea is that the closer a company’s profits are to the marginal relief upper limit the closer their effective rate of CT will be to 25%.
In practice it works by taxing the total profits at 25% and then deducting marginal relief. Marginal relief is calculated by this scary looking formula:
(Upper limit – profits) x profits/augmented profits x 3/200
This is best seen in an example:
Marginal Limited has profits of £200k and received exempt non-group dividends of £10k, it has no associated companies.
CT at main rate on total profits: £200k x 25% = £50,000
Less Marginal relief: (£250k – £200k) x (£200k/£210k) x 3/200 = £714
Final liability = £49,286, giving an effective rate of 24.6%.
Whilst this means that no company will have an effective rate in excess of 25%, it does mean that profits between the lower and upper limits are taxed at a rate of 26.5% – this is a difficult concept to understand and is again best seen through an example.
Returning to Marginal Limited; if they had only made £50k of profit they would have had a liability of £9,500 (19% of £50k), so the additional £150k of profits have increased the CT liability by £39,786, an effective rate of 26.5%.
Associated companies
As mentioned above the marginal relief lower and upper limits must be divided by the number of associated companies. This is different from the number of 51% group companies which you may currently see on your CT returns.
A company is associated with another company if one has control of the other, or both companies are under the control of the same person or group of persons. If a company is only associated for part of the period it is counted, and companies are included even if incorporated and/or resident outside the UK. However, dormant companies and passive holding companies (who simply pass dividends from subsidiaries to the shareholders) can be excluded.
When considering who controls a company we also look at any rights held by their associates. A person’s associates are:
- their relatives – spouse/civil partner, parents and remoter forebears, children and remoter issue, and siblings
- any partners in partnerships of which they are members
- any Trustees of settlements in which they are the settlor or a beneficiary
As you can see this could include a significant number of companies, particularly where family members have lots of different business interests. You will need to provide details of all such companies to your accountant for the first accounting period ending after 1 April 2023, but we would advise you to collate the list as soon as possible so that the expected rate of CT can be estimated for each company and you can plan accordingly. Having a substantial number of associated companies could also impact when CT liabilities are due (see Quarterly Instalment Payments below).
Close Investment Holding Companies
The small profits rate and marginal relief are not available to Close Investment Holding Companies (CIHCs), so these companies will pay tax at the main rate of 25% from April 2023.
A CIHC is a close company which is not trading or letting property to unconnected parties. A close company is a company controlled by 5 or fewer shareholders, or any number of shareholders who are also directors. Group holding or service companies are excluded.
This means that family-owned investment companies will be CIHCs and will pay tax at 25% regardless of their level of profits from April 2023.
Other implications
Allocation of Annual Investment Allowance
After years of ups and downs with the level of the Annual Investment Allowance (AIA) we are pleased that the government have not only retained the current £1m but confirmed this will become permanent. Whilst this should have simplified capital expenditure planning, the move to a two-rate CT system will complicate this again. Groups of companies will need to think carefully about how to allocate their AIA to maximise the tax relief across the group, and even standalone companies will need to consider which rate they expect to be incurring in different years to ensure they get the most benefit from the relief.
Quarterly Instalment Payments (QIPs)
Companies with taxable profits of £1.5m or more are expected to pay their corporation tax in quarterly instalments, starting in the seventh month of the relevant accounting period. Under the current rules this £1.5m limit is divided by the number of companies in the same group, but from April 2023 it will be divided by the number of associated companies (see above). Therefore, individuals owning several standalone companies could find themselves within the QIP regime.
Such individuals may want to move their companies into a group; from April 2023 they will be suffering the higher tax rates and accelerated payment dates but without the benefit of being able to group relieve any losses. There will be lots to consider before this is implemented, and the tax implications will depend on the ownership and types of companies involved.
Group relief
As with AIA allocation, deciding how to allocate losses between group members has been relatively simple whilst we had one rate of CT, but will become a much more complex decision from April 2023. The group will need to allocate losses to eliminate profits being taxed at the highest rate first, i.e. bringing any companies out of marginal relief, then to companies paying at the main rate and finally to companies paying at the small company rate.
If you want to discuss any of what is written here please don’t hesitate to get in touch.
