The new corporation tax rate
The new corporation tax rate was announced in the 2022 Autumn statement to the dismay of many business owners. Despite a great deal of lobbying from the business community the chancellor has refused to capitulate and the new rate therefore takes effect from 1 April 2023.
In this article, we discuss how this will operate in practice and the steps you can take to potentially mitigate the increase.
The increase in corporation tax
From 1 April 2023, the corporation tax rate increases from 19% to 25% for companies with taxable profits over £250,000. Where your company has taxable profits of less than £50,000 will continue to pay tax at 19%.
However, that's not the full story as typically with taxes, the devil is in the detail. If your company has taxable profits between £50,000 and £250,000 it will be eligible for marginal relief. Unfortunately, the effective rate of corporation tax becomes 26.5% due to the way the calculation works as you'll see later on in this article.
Your company's profits that are subject to corporation tax are those after various tax adjustments have been made. For example after deductions for equipment and additions for non-allowable expenses - for example client entertaining.
Just by way of a reminder, those payments for salaries are tax deductible although dividends paid out are not tax deductible.
What is the marginal rate of corporation tax?
Put simply, when your company's taxable profits exceed £50,000 the marginal rate of corporation tax applies. This ensures that the excess over £50,000 and up to £250,000 your will be taxed gradually at an effective rate of 26.5%. This is illustrated in the example we've shown below.
Cam Ltd has taxable profits of £75,000 these will be taxed as follows:
£50,000 @ 19% + £25,000 @ 26.5% = a total tax charge of £16,125 meaning an overall effective rate of 21.5%
Mitchell Ltd has taxable profits of £225,000 these will be taxed as follows:
£50,000 @ 19% + £175,000 @ 26.5% = a total tax charge of £55,875 meaning an overall effective rate of 24.8%
As you can see, the closer to the £250,000 threshold your company's profits are, the higher the effective rate is accordingly.
Unfortunately matters become more complex when companies are associated. Broadly speaking companies are associated where one company has control of another or both companies are under the control of the same people.
These rules apply regardless of whether or not a company is UK resident, or was only associated for part of the accounting period. The one main exception where these rules don't apply is where a company is dormant
Essentially the thresholds are divided by the total number of associated companies as set out below:
Gloria, a director owns 100% of Manny Ltd which made a taxable profit of £125,000 in the year to 31 March 2024. She is also the holder of 51% of the ordinary shares of Jay Ltd which made a taxable profit of £45,000 in the same period.
In this case, Manny Ltd and Jay Ltd will be associated companies for tax purposes meaning the thresholds where each rate of tax begins is divided by 2. The tax calculations for each company would be as follows:
£25,000 @ 19% + £100,000 @ 26.5% = a total tax charge of £31,250. If there were no associated companies the tax charge of £29,375 if the company had no associates.
£25,000 @ 19% + £20,000 @ 26.5% = a total tax charge of £10,050 .However if Manny Ltd and Jay Ltd were not associated the tax liability would be £8,550.
Clearly the effect of these companies being associated has led to an increase in the overall corporation tax liability.
Mitigating the effects of the corporation tax increase
So what steps should be considering in order to reduce the impact of the increased rate of corporation tax from 1 April 2023?
Changing your company's year end
It could be worth considering changing your company's year end if your business has profits which fluctuate year on year or realises a large profit in an accounting period that straddles 1 April 2023.
So for example assuming your profits are in excess of £250,000 and you have an accounting period ended 31 October 2023, your effective tax rate across the whole year will be as follows:
However, if your company changed its year end to 31 March 2023 it would pay tax at 19%.
Impact of changing your company's year end
Your company can shorten it's accounting period end more frequently than extending the year-end date. Generally speaking there are limitations as to how often companies can lengthen their accounting periods and this can only be done once every five years.
Additionally, this will change the filing date of the accounts and tax computation/return. In the example above, the deadline dates become as follows:
Increase or make company pension contributions
If you haven't previously considered getting your company to make pension contributions to your pension scheme it might be worth considering doing this going forward.
Given the changes announced in the 2023 Spring Budget, this might be an attractive way of reducing your company's tax liability especially if you are approaching retirement age.
Consider alternative methods of profit extraction from your company
Whereas extracting profits as dividends from your company may have previously been considered more tax effective than paying yourself an increased salary bearing in mind the marginal rate of corporation tax and associated companies rules referred to above this may no longer be the case. This could be particularly relevant if you're a profitable company in the technology sector and are working on a project that qualifies for R&D tax reliefs.
There's still time to take action to mitigate the effects of the increased corporation tax rate, though ideally you should be considering this before the end of your company's current accounting period.
For more useful information, check out our Ebooks here.
And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at [email protected].
Alternatively, please feel free to complete our Business Questionnaire here.