Corporation tax changes from 1 April 2023
For the financial year 2021-22 (which started on 1 April 2021), companies pay corporation tax on their profits at a rate of 19%, regardless of the level of those profits. This remains the case for the financial year 2022-23 (which runs from 1 April 2022 to 31 March 2023). However, new rules come into effect from 1 April 2023. Consequently, for some companies the rate of corporation tax will, from that date, rise to 25%.
Whilst this may seem some way off, there may be actions companies can take before 1 April 2023 to mitigate the impact of the new rules.
The new regime
From 1 April 2023, there is no longer a one-size-fits-all approach to corporation tax, and the rate at which companies pay corporation tax will depend on the level of their profits. This is similar to the system that applied for the financial year 2014 and previous years, with the resurrection of upper and lower profits limits (albeit at somewhat lower levels than applied in 2014) and marginal relief where profits fall between the two.
For the financial year 2023-24 (starting on 1 April 2023), the main rate of corporation tax will increase to 25% for companies whose profits exceed the ‘upper profits limit’, set at £250,000. Companies whose profits do not exceed the ‘lower profits limit’, set at £50,000, pay corporation tax at the ‘small profits rate’, which remains at the current corporation tax rate of 19%.
The lower and upper profit limits are reduced proportionately where the accounting period is less than 12 months and where a company has one or more associates.
Companies whose profits fall between the lower and upper profits limits (reduced where appropriate) will pay corporation tax at the main rate, as reduced by marginal relief. This provides a gradual increase in the rate of corporation tax as profits increase until the main rate of 25% is payable once profits reach the upper profits limit.
Calculating marginal relief
Marginal relief applies to reduce the corporation tax payable where the company’s profits fall between the lower and upper profits limit. The approach is to work out corporation tax on the profits at the main rate of 25% and to deduct the marginal relief. Marginal relief is calculated in accordance with the following formula:
F x (U – A) x N
- F is the standard marginal relief fraction (set at 3/200);
- U is the upper limit;
- A is the augmented profits; and
- N is the amount of the taxable total profits.
A company’s ‘augmented profits’ are the company’s total taxable profits plus exempt distributions from non-group companies (such as dividends, distribution of assets or amounts treated as a distribution on the transfer of assets or liabilities or the repayment of share capital). Where a company does not have any exempt distributions from non-group companies, augmented profits are the same as total taxable profits, and the fraction N/A is 1 (meaning that this part of the formula can be ignored for practical purposes).
Example 1: Marginal relief calculation
A Ltd prepares its accounts to 31 March each year. It has taxable profits (and augmented profits) of £190,000 for the year to 31 March 2024. The company has no associated companies.
The taxable profits for the year to 31 March 2024 fall between the lower and upper profits limits, so marginal relief is calculated in accordance with the above formula as follows.
3/200 (£250,000 – £190,000) x 1
= 3/200 (£60,000) = £900
The corporation tax payable by A limited is £46,600 ((£190,000 @ 25%) – £900). This is an effective rate of 24.52%.
The upper and lower profits limits are proportionately reduced to take account of the number of associated companies that the company has, with each limit being divided by N + 1, where N is the number of associated companies.
A company counts as an associated company if it is associated for any part of the accounting period – thus, the reduction applies even if the companies are only associated for a number of days in the accounting period. However, a company is ignored for the purposes of calculating the applicable limits if it has not traded in the accounting period or, where the company was associated for only part of the accounting period, it did not trade during that period.
Two companies are associated with each other if one is under the control of the other or both are under the control of the same person or persons. Here, ‘control’ means 51%. However, in determining whether a person has control of a company, the rights and powers of their associates (which includes their spouse or civil partner and business partners) are taken into account.
Example 2: One associated company
B Ltd has one associated company. It has taxable profits (and augmented profits) of £150,000 for the year to 31 March 2024.
For a company with one associated company, the lower profits limit is £25,000, and the upper profits limit is £125,000. This means B Ltd must pay corporation tax at 25% on its profits as they exceed the reduced upper profits limit of £125,000.
The associated company rules can have a distortive effect if profits between the companies are uneven.
Example 3: Associated companies: uneven profits
Company C and Company D are associated companies. For the year to 31 March 2023, Company C has taxable profits of £40,000 (which fall between the lower and upper profit limits where a company has one associate). The company pays corporation tax of £9,475.
Company D has profits of £2,000 and pays corporation tax of £380.
The combined tax on total profits of £42,000 is £9,855 – an effective rate of 23.46%. However, a single company with profits of £42,000 would pay corporation tax at 19%, a bill of £7,980 and a saving of £1,875.
Accounting period spans 1 April 2023
Where the accounting period spans 1 April 2023, the profits are apportioned to those falling within the financial year 2022-23, which are taxed at 19%, and those falling within the financial year 2023-24, taxed at the appropriate rate depending on the level of profits falling into that year, with the upper and lower profits limits being proportionately reduced.
Example 4: Apportionment of profits
E Ltd prepares accounts to 30 September each year. The company has taxable profits (and augmented profits) of £300,000 for the year to 30 September 2023.
Profits falling into the financial year 2022-23 are £150,000 (i.e. 6/12 x £300,000). These are taxed at 19%. The resulting corporation tax is £28,500.
For the financial year 2023-24, the lower and upper profit limits are proportionately reduced to reflect the fact that only six months of the accounting period falls in the financial year 2023. The lower profits limit is £25,000 (i.e. £50,000 x 6/12) and the upper profits limit is £125,000 (i.e. 6/12 x £250,000). Profits for the period are £150,000 (i.e. 6/12 x £300,000). As these exceed the upper profits limit for the period, they are taxed at 25%, and the associated corporation tax is £37,500.
Thus, the company must pay corporation tax of £66,000 on its profits of £300,000 for the year to 30 September 2023 – an effective rate of 22%.
There is time to plan ahead to mitigate the impact of the changes. For example:
- If possible, where profits exceed the lower profits limit, accelerate profits so that they are taxable in the financial year 2021-22 or the financial year 2022-23, rather than after 1 April 2023.
- Where the effective rate of corporation tax after 1 April 2023 is more than 19%, delay expenses to secure relief at a higher rate.
- Where losses are made, consider whether it would be more beneficial to carry them forward rather than carry them back. The trade-off is between later relief, potentially at a higher rate or earlier relief (or repayment), but at a lower rate.
- Consider the impact of associated companies and whether restructuring would be beneficial.