Last April, changes to both the corporation tax rate and the rules for determining associated companies came into effect. This had a significant impact on the majority of limited companies. It’s become more apparent that businesses which fall under the updated rules for associated companies face more challenges. Given the recent political changes and upcoming Autumn Budget, it's crucial to understand the impact these changes have had on limited companies to get ahead of further potential tax changes. This article will explore how these changes have impacted UK businesses and what our recommendations are going forward
Overview of Corporation Tax Rate Changes
As of April 2023, the corporation tax rate increased to 25% for companies with profits over £50,000. With marginal relief available for those with profits up to £250,000. For companies with profits between £50,000 and £250,000, the tax rate gradually increases from 19% to 25%. The rate will remain at 19% for companies with profits less than £50k. The new rules have introduced a complex calculation for determining a company’s tax liability, especially when associated companies are involved.
The calculation is:
This has already created complications for businesses. They are no longer able to apply a straightforward percentage to profits and instead need to use the above formula.
Understanding Associated Company Rules
Alongside the above corporation tax rate changes, the concept of an associated company, as defined by HMRC, refers to companies that have control over one another or are under common control. Control can mean having significant influence over the company’s affairs, voting power, share capital, income, or assets. For many businesses, especially those in complex ownership structures or with multiple family-owned businesses, determining whether they have associated companies isn't a simple yes-or-no answer.
Broadly speaking, if Company A owns Company B, these are considered associated. Similarly, if the same individuals control two separate companies, those companies could also be associated, even if they operate independently in different sectors. This association is not limited to direct ownership or control either but also includes indirect relationships, such as companies owned by spouses or other family members.
In the latter case, whether a company is considered associated depends on the relationship between the two companies whether there is substantial commercial independence.
Dormant or ‘passive’ holding companies are exceptions.
The Impact of These Changes on Limited Companies
Complexities and Challenges for Limited Companies
The complexities introduced by the new corporation tax rules are significant. Businesses now face a much more difficult and extensive process when calculating their tax liabilities. These complications represent an additional administrative burden and a potential increase in costs due to more detailed forecasting.
For businesses with associated companies in particular, the profit thresholds for lower tax rates are reduced which adds an additional level of difficulty. If a company has one associated company, the thresholds drop from £50,000 and £250,000 to £25,000 and £125,000, respectively.
Over the last year, I’ve seen both of the above lead to unexpected cash flow issues when tax calculations were based on incorrect assumptions. Resulting, more often than not, in a higher tax burden than anticipated. The reduced profit thresholds also mean there is less room for error so there is now a greater need for more accurate tax planning.
Impact on Marginal Relief and Investor Decisions
The rules around associated companies also affect the availability of marginal relief. It could be reduced or eliminated entirely if there are multiple associated companies. This is particularly challenging for family-owned businesses or companies with complex ownership structures, where there may be financial, economic and organisational connections between companies even when there isn’t a direct association by way of shareholding. For example, if one company supports another financially or there are significant loans between multiple companies. Another typical example is if the companies have common management or premises.
When companies are associated due to financial, economic, or organisational ties, this has the same effect on their tax rate and marginal tax relief as it would if they were associated otherwise.
This reduction in profit thresholds due to the associated company status may have deterred potential investors. Especially, if they were deemed to have control over multiple businesses. The lower thresholds lead to higher tax liabilities and, therefore, less after-tax profits available to reinvest in growth which would negatively affect long term growth. This is especially frustrating for businesses whose only relationship with the associated company is the investor.
Risks for New Business Ventures
If a company is considered associated with another for even a single day within an accounting period, this association must be reflected in the tax calculations. The lack of a minimum period for association adds another layer of complexity and potential risk for business owners. Especially those who are looking to expand into other industries or consider new business ventures. I think that business owners might have been discouraged by the potential tax implications if their new business didn’t go as planned since the tax rate of their existing business and cash flow would be further affected, even if the association was brief and the new venture was unsuccessful. In my opinion, there should be something in place to encourage new businesses without it affecting their current business.
Changes to the Large Company Threshold
The definition of what is considered a "large company" has changed to align with the new marginal corporation tax rules. This now considers associated companies rather than just group companies. A company is classified as "large" if its profits exceed £1.5 million for the relevant accounting period, but this threshold is reduced according to the number of associated companies. For example, if a company has four associated companies, the threshold reduces to just £300,000. This means that more companies have fallen into the definition of a large company. They have had to consider quarterly tax instalments alongside the increase in corporation tax rates.
This will have had a significant effect on cash flow and requires businesses to manage their finances more carefully. Businesses should be looking at how the change in associated company rules affect them and whether their threshold has reduced further than what it would have been prior to change, taking special consideration of companies that may be associated by way of financial, economic, or organisational ties.
Strategic Considerations Moving Forward
Over the last year, we’ve seen how these changes have affected limited companies. Not only have they seen a corporation tax rate increase. They've also seen an added degree of complexity to their financial planning. With Labour recently coming to power, there could be even more changes to follow which means it is crucial that businesses are well prepared.
A bookkeeping system allows for monitoring of day-to-day activities and allows businesses to assess their finances on a regular basis. This establishes a solid foundation for preparing cashflow forecasts so you can effectively plan ahead and avoid unnecessary tax charges. It’s important for businesses to consider how associated company rules affect their tax and the impact for their group structure.
How MJ Kane Can Assist
MJ Kane and Co can help ease the burden by assisting with tax calculation and forecasting. Ensuring accurate bookkeeping, and advising on potential restructuring to improve overall tax positions. This allows you to focus on your business whilst we ensure you’re financially prepared.
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