Despite several tumultuous weeks towards the end of 2022, the Corporation Tax increase will be going ahead in April 2023 as announced back in 2021.
Small companies should already be aware of the incoming tax rate changes, but it’s important to take the associated company rule changes into account, too.
The rate of Corporation Tax applied and when it needs to be paid will depend on the company’s profits and how many associated companies it has. This will affect more companies than just the rate change, so company owners shouldn’t let themselves be caught off guard.
This blog explains the basics of the rule changes and how they could affect your company.
How is Corporation Tax changing?
Effective as of 1st April 2023, there are two rates of Corporation Tax according to company profits:
- Small profits rate – 19% for profits below £50,000
- Main rate – 25% for profits exceeding £250,000
Companies whose profits fall between £50,000–£250,000
will also be taxed at 25%, but may be entitled to marginal relief, where the rate would be progressive between 19% and 25%.
Some companies might split activities between multiple associated companies in order to benefit from the small profits rate or marginal relief. To prevent this, the new rules will ensure that the tax rate is calculated by dividing profit thresholds by the number of associated companies.
What counts as an associated company?
Determining whether companies are associated or not can quickly become complicated. The basic rules are that a business can be an associated company of another if one has control over the other, or if both are controlled by the same person or people.
Companies are generally considered to be associated if they’re under common control – having a shareholding of over 50%. As an example, if two people both had shareholdings of 30% in two different companies, the companies would then be associated.
Even companies only temporarily associated for part of the accounting period will be considered associated for the entirety of the accounting period, including overseas resident companies. However, dormant companies not carrying out any business during the accounting period would not be counted as associated companies.
Company control can be determined via a series of tests, considering ownership of shares, voting power, or asset entitlements. In some cases, ‘substantial commercial interdependence’ may lead to companies being associated through business partners, relatives, or trustees of controlling shareholders where their commercial activities are interconnected.
The aim of the associated company rules is to prevent owners or shareholders from splitting profits with companies controlled by relatives, for example, in order to apply the higher profit thresholds separately and benefit from lower Corporation Tax.
How will the changes affect associated companies?
When companies have one or more associated companies, the owners will not be able to apply the profit thresholds individually to each company to reduce their tax liability.
Instead, the threshold will be divided by the number of companies. For example, if a company has one associated company, the £50,000
threshold for the small profits rate will be divided by two – only allowing each company to benefit from the 19% rate on profits up to £25,000.
When this happens, both primary and associated companies will end up paying more in annual Corporation Tax individually than if they had simply been one company using the full £50,000 limit. In cases like this, it would be better for the owner to run just one small company.
The number of associated companies will also affect whether a company is considered to be ‘large’ or ‘very large’ and will have to pay Corporation Tax in instalments. This could accelerate tax payment due dates and impact financial plans for the accounting period.
With the changing definition of an associated company taking individuals into account, this could also make companies that were previously not considered to be associated now fall under the new rules for applying Corporation Tax profit thresholds.
For example, an individual with shares in four different companies would lead to HMRC treating each company as an associated company and charging Corporation Tax accordingly.
Preparing for Corporation Tax changes
When associated company rules were last applied before the introduction of a flat Corporation Tax rate back in 2015, they applied when one company was a 51% subsidiary of another, and the profit thresholds were much higher. Now, the lower thresholds and broader associated company rules will affect the tax liabilities of far more companies than the previous rules would have.
This is why businesses with associated companies must take stock of their current arrangements to calculate how these changes will affect their tax liabilities. Some may find that it’s in their best interests to consolidate associated companies or dissolve smaller companies.
You can find more information about the newer associated company rules here. If you would benefit from professional accounting, corporate finance, or tax consultancy services, our accountants in Barnsley and Leeds could be of assistance.