The United Kingdom’s Budget 2021 initially stated that the Corporation Tax rate would increase from the 1st of April 2023. Although this decision was later reversed and re-instated twice in the two budgets of autumn 2023. However, starting from April 2023, there will be significant changes to the Corporation Tax rate that will impact companies. Historically, there was a flat rate of Corporation Tax of 19%, but from April 2023, the new regulations will be implemented as follows:
- The main corporation tax rate will rise from 19% to 25% for companies with profits of £250,000 or more. This applies to all profits.
- A Small Profits Rate of 19% would apply to companies with profits of £50,000 or less.
- Companies with profits between £50,000 and £250,000 would have a tapered main rate that would entitle them to Marginal Small Companies Relief (MSCR) as a deduction from their calculated liability.
While there are some important twists in these new regulations, it is necessary to understand the impact of the change in the context of overall tax liabilities for a small business. Therefore, this article aims to provide a comprehensive analysis of the Corporation Tax regulations, including marginal rates, effective rates, multiple companies, and how the effective rate impacts dividends.
Marginal rates and Effective rates
The taper is an essential aspect of the new Corporation Tax regulations that takes a little bit of understanding. Marginal Small Companies Relief (MSCR) is a deduction from the calculated liability that tapers the effect of the increased rate. MSCR applies when profits are between the thresholds of £50,000 and £250,000. This calculation is (Upper Limit – Profits) x Basic profits/Profits x MSCR fraction. The upper limit is £250,000, and the MSCR fraction is 3/200ths. It is important to note that these are Marginal Rates, not Average Rates.
A simpler expression on a slab basis without Franked Investment Income (FII) applies, where there are no FII profits:
£0 to £50,000
£50,000 to £249,000
Above £250,000 applies to all profits – including those below £250,000
These bands give the same result as the full formula but are easier to use. The Effective Corporation Tax rate at various profit levels can be calculated using the same formulas.
- A business with a taxable profit of £85,000 will pay 19% up to the first £50,000, then 26.5% up to £250,000 = £18,775. Therefore effective rate is 22.1%.
- If the profit were to increase to £249,000, the same calculation would apply, giving rise to a corporation tax liability of £62,235. Effective rate is 24.99%
- A larger company with a profit of £300,000 would pay their full tax bill based on a 25% rate = £75,000.
How the effective rate impacts dividends?
The changes to Corporation Tax rates will also have an impact on the dividends paid out by businesses. Dividends are paid out of profits after Corporation Tax, which means that a higher tax rate will result in less profit available for distribution.
However, the changes to Corporation Tax rates may also lead to a decrease in personal dividend tax, which is a form of Income Tax paid on dividends. Therefore, it is crucial to consider the overall impact of the changes on small businesses’ dividend tax rates. The new Corporation Tax regulations also present some traps for multiple companies. The £50,000 and £250,000 thresholds are apportioned where there are Associated Companies, which means the Main Rate cuts in at a lower level. The apportionment is on a strict arithmetical basis. For situations where aggregate profits are below £250,000, it is crucial to ensure that each company is
as close as possible to its peers in terms of profit levels. Follow our articles to know more about Limited Company Taxation.
New associated company rules will replace the previous group company test. The determination test is the same regardless of the size of the company and applies equally to large or very large organisations and whether or not they are subject to quarterly instalment payments.
In determining whether companies are associated with each other, the usual criterion is if, at any point during the previous year or at the present time, one company has exercised control over the other, or if the same individual or group has controlled both companies. If a company has one or more associated businesses within the same accounting period, the thresholds relevant to corporation tax are divided by the number of associate companies.
Consequently, the £50,000 small profits rate and the £250,000 standard corporation tax threshold are reduced based on the number of associate companies involved within the same control or subsidiary structure.
The associated companies rule includes non-UK resident businesses but excludes dormant companies and certain passive entities. The tax residency location of a company does not affect its classification as an associated company.
Associate companies are counted even if they were associated for only part of the accounting period. However, companies that have not engaged in any trading activity during the reporting year are disregarded.
According to the guidelines in the Company Taxation Manual, the calculation operates as follows:
The upper and lower corporation tax thresholds are divided by the total number of associated companies, including the subject company.
For instance, if a company has four associate companies, the lower limit of £50,000 would be divided by five, resulting in a threshold of £10,000, and the upper limit of £250,000 would also be divided by five, resulting in a threshold of £50,000.
In conclusion, these new Corporation Tax regulations will have a significant impact on UK companies, especially small businesses. It is crucial to understand the details and nuances of these regulations to ensure that businesses remain compliant and plan their finances accordingly.
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