Practical impacts of changes to the Corporation Tax regime

By Michael Williams, Knill James Tax Manager

Regime change

Our earlier blog in May 2021 flagged some computational issues in anticipation of the Corporation Tax (CT) regime change from 1 April 2023. This article builds on that commentary and takes a closer look at the implications of these changes which may have gone under the radar, and which may impact sooner than expected. In particular, the change in the rules around the definition of associated companies could have a significant impact on both the quantum and the date of payment of CT.

Associated, not just group, companies

From 1 April 2023, the concept of associated companies returns. Companies are associated with one another when one has control of the other, or both are under the control of the same person or persons.

The definition of associated company will clearly still capture companies in the same group. However, consider the following scenario:

Example

Mr A owns 100% of the shares in A Holdings Limited (“A”). A owns 100% of B Trading Limited and C Trading Limited, providing management services to the two trading subsidiaries.

Mr A also owns 100% of the shares in X Holdings Limited (“X”). X owns 100% of Y Property Investment Limited and Z Investments Limited, which are property and share investment companies respectively, held in their own group to be isolated from the trading activities.

Mr A is therefore in control of 2 groups of companies.

The impact on Quarterly Instalment Payments (QIPs)

Previously, the rules on QIPs required the large company and very large company profit limits of £1.5m and £20m respectively to be divided between 51% group companies – ie companies in the same group. In the example above, this would divide the limits by three for each group and require QIPs to be made only where profits in any company exceed £500k. The very large QIP limit, which accelerates the due date of the instalments by four months compared to large company QIPs, would then be £6.67m.

The new rules require these profit limits to be divided by the number of associated companies. All companies in both groups above are now associated and results in there being 6 associated companies, significantly reducing both profit limits to £250k and £3.33m.

Late payment risks and cash flow

With a halving of the profit limits, it is far more likely that one of the companies has exceeded a QIPs threshold which will accelerate the date when CT is paid. This will impact cash flow and increase the chances of QIPs being late. With interest rates currently rising to significant levels, late payment of tax could result in a material cost to a company.

There thankfully remains the one-year grace period, under which it is only in the second consecutive accounting period when the limits are breached that results in QIPs being payable, so long as profits do not exceed £10m.

Is your CT rate increasing?

The May 2021 blog described the introduction of lower (19%) and main (25%) rates of corporation tax applying when profits are less than £50k or greater than £250k, respectively. For profits falling between the two limits, there is an effective marginal CT rate of 26.5% on profits.

As with the QIPs limits, these CT rate thresholds are also divided by the number of associated companies. With six associated companies in our example, this reduces the lower limit to £8.3k and the upper limit to £41.7k. The limits themselves are not large so it doesn't take much to reduce them further so that even the smallest entities can be suffering an increase in their CT rate.

What planning can be undertaken?

Optimise loss relief

Companies need to be included in the determination of the number of associates, regardless of profitability. Associated loss-making companies will also reduce the limits and potentially increase the CT rates of profitable associates.

If the loss-making entities are not part of a group, then no surrender of losses is possible to reduce the profits and CT liabilities of associated companies. Consideration could therefore be given to creating a group of companies to access group relief and achieve a lower overall tax burden.

However, there are factors apart from tax to consider when creating a group, including commercial, accounting and legal issues so such a decision should not be taken lightly.

For companies within a group, the allocation of losses between group members can be very important in reducing the group global tax cost. As a rule of thumb, losses should first be surrendered to take companies out of the marginal rate, then to reduce profits of companies taxed at the main rate and lastly against the 19% band.

Ensuring that profits are as low as possible will also benefit group cash flow, either by reducing the number of companies under the QIPs regime altogether or postponing payment if entities are brought below the very large QIP limit.

Exclude non-associates

Companies that do not have a trade or business in the accounting period do not have to be associated. It will be important to ensure that all inactive companies are identified as such.

Likewise, if a company meets the definition of a passive holding company, then it can also be excluded from being an associate. The definition is quite detailed, but broadly, if the company is purely a holding company acting as a conduit for dividends received from its subsidiary companies, then it is likely to be a passive holding company.

It will also be important to review and correctly identify whether companies owned by connected persons (say husband & wife) need to be included as associated companies. In broad terms they are not associated unless there is 'substantial commercial interdependence' between such companies.

Consider a change in year-end

In certain circumstances, there is a one-off opportunity to secure the previous 19% rate if there have been exceptional profits arising before 31 March 2023.

Where a company's year-end is not currently 31 March, it may be possible to secure a lower rate of tax by changing the year-end to 31 March 2023 so that an accounting period ends on that date. This should capture all profits realised before that date and subject them all to the 19% rate, irrespective of the number of associated companies.

Here to help

We'd be delighted to see what we can do to assist you in ensuring your compliance with the new rules, as well as taking advantage of opportunities to reduce your exposure. Please contact Michael Williams at michaelw@knilljames.co.uk.