How do the changes to corporation tax affect my business?

You have probably heard about the rise in corporation tax. Let’s face it, it’s been in the news over the last year or so. First Rishi and Boris told us about the rise, then Kwasi and Liz scrapped the rise, and then Liz u-turned and said the rise would go ahead after all.
Lots of talk of a rise to 25%, but what does it actually mean for small business owners.
Corporation tax before the change
Since 1st April 2015, corporation tax has been simple. If you are a company, you pay tax at a straightforward % of your taxable profits. For the last 6 years this tax % has been 19%. Nice and simple for the majority of companies.
What is changing?
From 1st April 2023 corporation tax will become more complicated for a lot of companies. The one-size-fits-all approach we are used to disappears. Companies with year ends after 31st March 2023 will be affected by the change.
If you are a small owner managed business with a single company with taxable profits below £50,000 then there is no change. You will continue to pay corporation tax at 19%.
If you are a single company business with taxable profits over £250,000 then you will pay tax at the new 25% rate.
If you are a single company business and your taxable profits falls between £50,000 and £250,000 then you will be affected by a marginal rate of corporation tax. This essentially means that your profits up to £50,000 will be taxed at 19%, and your profits between £50,000 and £250,000 will be taxed at an effective rate of 26.5%.
The situation can get more complicated if you have involvement with more than one company. For example, if you are a director or shareholder of two companies then those companies may be considered to be ‘associated’. If there are associated companies the £50,000 and £250,000 thresholds get divided by the number of associated companies.
The impact of associated companies
A company is associated for corporation tax purposes if one company has control over the other, or if two companies are under control of the same person. Let’s look at some examples.
Small group of companies
ABC Ltd is a trading company selling toys. Several years ago it wanted to move into manufacturing toys. To keep that business separate from the established company, it decided to form a new company DEF Ltd. DEF Ltd is 100% owned by ABC Ltd.
ABC Ltd clearly has control over DEF Ltd and the two companies are associated for corporation tax.
Each company would see their corporation tax limits halved. This means if taxable profits exceeded £25,000 their corporation tax would rise from 19%. If taxable profits were higher than £125,000 the company would pay tax at the full 25%, with the 26.5% effective rate applying to taxable profits between the two thresholds.
Husband and wife companies
Mr Smith runs an IT consultancy company. He is the sole director and employee of the company but the structure of the company is that he only owns 75% of the shares, with the other 25% being owned by his wife, Mrs Smith.
Mrs Smith runs a company providing counselling services. She is the sole director and herself and an assistant are employed by the company. The shares in this company are owned 75% by Mrs Smith and 25% by Mr Smith.
The companies are run as two separate businesses. The only involvement each person has in their spouse’s business is to receive dividends and, occasionally, one company may lend the other company money on a short-term basis.
For corporation tax purposes, these two companies are not associated merely due to the fact that one spouse owns shares in the other spouse’s business. Mr Smith’s business is clearly controlled by him, as sole director and majority shareholder, and the same applies to Mrs Smith’s business.
However, even though their companies aren’t automatically associated, Mr Smith and Mrs Smith are deemed to be associates, as this term includes spouses. What this means is that if there is a ‘substantial commercial interdependence’ between the two companies then the companies will both be caught by the associated companies rules for corporation tax.
So what is a substantial commercial interdependence? There are three factors that might mean two companies are substantially commercially interdependent.
Financial interdependence: one company has given the other company direct or indirect financial support. In our Mr and Mrs Smith example, the loans between the two companies would fall into this category.
Economic interdependence: both companies are trying to achieve the same economic objective, they have common customers or the activity of one of the companies benefits the other company.
Organisational interdependence: if two companies have common staff, premises or equipment then they will fall into this category. This may often be seen in situations where the owners of one company have formed another company to pursue a different type of business and they run both businesses side by side, with staff being employed through one company and the second company being charged a management fee to cover the company staff/resources used.
In our Mr and Mrs Smith example, the question would then become when did they last make a loan between companies. The associated companies test is based on a year-by-year basis. This means a loan three years ago would have no impact now. However, a loan in the current year, even if it was repaid before the year end, would mean that the companies of Mr and Mrs Smith would be associated companies for corporation tax.
As you can see, corporation tax has become a lot more complicated! Day to day decisions made in running your business could have an impact on the size of your tax bill. Tax planning has become more important. A good accountant will help you navigate the new system and ensure you aren’t paying unnecessary tax, keeping your money in your hands.