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2023 Corporation Tax Changes

In Budget 2021 it was announced that Corporation Tax will increase from 1 April 2023.

Whats Changing?

Currently, there is a flat rate of Corporation Tax of 19%.

From April 2023:

  • The main rate of Corporation Tax will be 25% for Companies with profits of £250,000 or more
  • A Small Profits Rate of 19% will exist for Companies with profits of £50,000 or less
  • The main rate will taper in between £50,000 and £250,000

However there are some important twists in these rules, and the detail merits attention.

Of course, Corporation Tax doesn’t exist in isolation, so in this article we will look at the impact of the change in the wider context of overall tax liabilities for a small business.

One caveat – we don’t know the detailed rules yet, only the Governments 2021 Budget Announcement.  However a similar regime existed up to 2014/15 so we can assume the 2023 rules will be substantially the same; however historically the thresholds were a lot higher, so many companies never dealt with these complexities.

 

Understanding the Taper – Marginal Rates and Effective Rates

The taper takes a little bit of understanding.

The official expression of the rates are:

  • If profits are over £250,000 the Main Rate of 25% applies to all profits
  • If profits are £50,000 or below the Small Company Rate of 19% applies to all profits
  • If profits are between these thresholds then the main rate of 25% applies and the company is entitled to Marginal Small Companies Relief (MSCR)

MSCR tapers the effect of the increased rate in.

The MSCR calculation is:

(Upper Limit – Profits) x Basic profits/Profits x MSCR fraction

where

    • Upper Limit is £250,000
    • Basic profits are the companies trading profits / gains
    • Profits are Basic Profits plus Franked Investment Income (FII is generally Dividends from other companies)
    • MSCR Fraction is 3/200ths

There is however a simpler expression on a slab basis, where there is no FII:

Profit Band Marginal Rate
£0 to £50,000 19%
£50,000 to £249,000 26.5%
£250,000 plus 25%

These bands give the same result as the full formula and are easier to use, but maybe not as politically friendly as far as the Treasury is concerned.

Bear in mind these are Marginal Rates not Average Rates, for example:

Example, Profits £100,000
Slice £ Rate % Tax £
   £50,000 19.0%    £9,500
   £50,000 26.5%  £13,250
Effective Rate and Total Tax
 £100,000 22.75%  £22,750
So we see an Effective Rate of 22.75% and a Marginal Rate of 26.5%.

The £22,750 is the same result as charging the whole profits at 25% and applying MSCR as legislation suggests.

 

The Effective Corporation Tax rate at various profit levels will be:

 Profits  £50,000  £75,000  £100,000  £150,000  £200,000  £250,000
Effective CT % 19.00% 21.50% 22.75% 24.00% 24.63% 25.00%

This Effective Rate applies to the whole of the profits.

 

How Does This Effective Rate Impact Dividends?

Dividends from Companies are paid from profits after Corporation Tax – so more Corporation Tax means less Profit to distribute, but the personal Dividend Tax (a form of Income Tax) on dividends will decrease.

So lets look at Dividend Marginal Rates.  The easiest way to do this is to consider the combined Corporation Tax and Dividend Tax on a notional £1,000 of company profit.  We can consider the scenarios at the three Marginal Corporation Tax Rates outlined above – 19%,  26.5% and 25%.  Remember Dividend Tax has three rates – 7.5% for Basic Rate taxpayers, and then 32.5% and 38.1% for Higher Rate and Additional Rate taxpayers, but these amounts apply on the net after Corporation Tax (the previous grossing up of dividends was abolished in 2016).

Dividend Marginal Rates – 19% Corporation Tax Marginal Rate
£1,000 pre tax profit Corporation Tax Dividend Dividend Tax Rate Dividend Tax £ Total Tax £ Effective Marginal Rate
£1,000 £190 £810 7.5% £61 £251 25.08%
£1,000 £190 £810 32.5% £263 £453 45.33%
£1,000 £190 £810 38.1% £309 £499 49.86%
Dividend Marginal Rates – 26.5% Corporation Tax Marginal Rate
£1,000 pre tax profit Corporation Tax Dividend Dividend Tax Rate Dividend Tax £ Total Tax £ Effective Marginal Rate
£1,000 £265 £735 7.5% £55 £320 32.01%
£1,000 £265 £735 32.5% £239 £504 50.39%
£1,000 £265 £735 38.1% £280 £545 54.50%
Dividend Marginal Rates – 25% Corporation Tax Marginal Rate
 
£1,000 pre tax profit Corporation Tax Dividend Dividend Tax Rate Dividend Tax £ Total Tax £ Effective Marginal Rate
£1,000 £250 £750 7.5% £56 £306 30.63%
£1,000 £250 £750 32.5% £244 £494 49.38%
£1,000 £250 £750 38.1% £286 £536 53.58%

The first part of this table, 19% Corporation Tax Rate, is, of course, as things stand at present.

With the increase in Corporation Tax rates unsurprisingly the Effective Marginal Rate increases, although by slightly less than the increase in Corporation Tax rates.

The Dividend Tax rates are the current ones; of course they could increase or decrease in a future budget.

However all other things being equal Dividends, even with the increased Corporation Tax rates, are still cheaper than salary:

 Comparison to Salary 
£1,000 pre tax profit Employers NI Net Salary after Ers NI Income Tax Rate  Income Tax Employees NI Total Tax £ Effective Marginal Rate
£1,000 £121 £879 20.0% £176 £105 £402 40.25%
£1,000 £121 £879 40.0% £351 £105 £578 57.82%
£1,000 £121 £879 45.0% £395 £105 £622 62.21%

To see how much extra tax you may be paying overall, see Table 1 at the end of this document.

 

Multiple Companies

Multiple companies present some traps with the new Corporation Tax rates.

Briefly, the £50,000 and £250,000 thresholds are apportioned where there are Associated Companies.   This means the Main Rate cuts in at a lower level.  The apportionment is on a strict arithmetic basis so for situations where aggregate profits are below £250,000 care will be needed to make sure each company is as close as possible to its peers in terms of profit levels – we will look at this below.

Associated Companies are Companies under common control.  The rules around this are complex, but generally they look at different groupings of individuals who control a company, and commonality within those groupings.  In practical terms Companies will be associated where:

  • They are controlled by the same individual, eg:
    • Mrs X owns 100% of A Limited and 100% of B Limited – the companies will be Associated
    • Mr Y owns 100% of A Limited and 80% of B Limited – the companies will be Associated
    • Mr Z owns 100% of A Limited and 20% of B Limited –  the companies will be not be Associated
  • They are controlled by the same group of individuals, albeit with differing shareholdings,eg:
    • Company A is owned 80% by Mr X and 20% by Miss Y; Company B 45% each by Mr X and Miss Y, and 10% by Mrs Z.  A and B will be connected by virtue of Mr X and Mrs Y despite the shareholdings differing
  • In some circumstances the rights of family members (spouse and blood relations) are included, where there is a commercial interdependence between two companies.  Eg:
    • Mr F owns 100% of A Limited, Mrs F 100% of B Limited – If A Limited and B Limited have no commercial interdependence the companies will not be Associated – if there is a commercial interdependence they will be associated.

HMRC looks at commercial interdependence on the following basis:

    • Financially, eg one company supports the other
    • Economically, eg the companies serve the same market, share common customers or benefit each other
    • Organisationally, eg common management, premises or equipment

Where companies are Associated the £50,000 and £250,000 thresholds are strictly apportioned, eg if two connected companies, then each has a £25,000 Small Profit Rate threshold.

The strict apportionment can cause an anomaly if profits are not equal:

eg 1 – Companies A and B are under common control and hence Associated. A makes an annual profit of £22,000 and B £28,000.  Both will pay Corporation Tax at Small Profits Rate, 19%, so £4,180 and £5,320 respectively, total £9,500

eg 2 – Companies A and B are under common control and hence Associated. A makes an annual profit of £48,000 and B £2,000.   Company A will only have a £25,000 Small Profits threshold, so will pay Corporation Tax at an Effective Rate of 22.59*% after MSCR.  The Corporation Tax bills will be £10,845 and £380 respectively, total £11,225.  This is £1,725 than the preceding example despite profits being the same.

The take aways here are:

  • Be cautious around the number of companies under common control.  As a firm we have noticed a trend in recent years for clients to set up multiple companies – this could cause difficulties with Corporation Tax rates.
  • Where there are companies under common control, try and match profits as equally as possible.
  • If multiple companies are needed, consider a LLP instead
  • Be aware of the business activities of family members if there is a mutual interdependency, or the same markets are served.

 

Companies v Sole Traders and Partnerships

Table 2 looks at the comparison of tax liabilities as a Sole Trader or Partnership versus a company – in the case of Sole Trader, the table compares to a company with a single shareholder, and in the case of a Partnership, to a company with two shareholders.

Interestingly the Corporation Tax increase doesn’t really change the overall balance of company v unincorporated business, but it does reduce the differentials.  The days of “tax motivated incorporation” are ebbing away, leaving issues like image, separation and limited liability being more prominent in decisions; anyone considering the pros and cons of incorporation would be best advised to talk these variables through with an accountant.

 

Tables

Table 1 – examples of change in overall tax liabilities at different profit levels, arising from the new Corporation Tax rates.  An assumed Director(s) salary of £12,000 is used, and the table reflects Income Tax, Dividend Tax, NI and Corporation Tax.

2023CorporationTaxChangesTable1

 

Table 2 – Comparison of Company to Sole Trader or Partnership at different profit levels

2023CorporationTaxChangesTable2

Tables 3 and 4 Give a more detailed break down of the figures in Table 2.  Table 3 for Sole Trader to Single Shareholder company, Table 4 for Partnership to dual shareholder company

 

Table 3 – Sole Trader to Single Shareholder company

2023CorporationTaxChangesTable3-1

 

Table 4 – Partnership to dual shareholder company

2023CorporationTaxChangesTable4-1