A Guide to Corporation Tax

Most companies will generally pay corporation tax on both their income as well as their capital gains tax.

For the financial year beginning on 1^st April 2021, all companies (except for those in the oil and gas sector) will pay the same flat rate of 19% corporation tax. This rate will also continue into the financial year of 2022.

In 2023, the corporation tax rate will increase to 25% which was announced during March 2021.

You must pay Corporation Tax on profits form doing business as:

• A limited company
• A club, co-operative, or any unincorporated association
• Any foreign company with a UK office or branch

Profits you pay Corporation Tax on

Taxable profits for Corporation Tax include the money your company makes from:

• Investments
• Doing business (trading profits)
• Selling assets for a profit

Calculating Your Company’s Effective Tax Rate

From April 2023 corporation tax will not only get increased, but it will also become a bit more complicated. There will be two official corporation tax rates:

• Small profits rate: 19%
• Main rate 25%

Companies with taxable profits of £50,000 or less will continue to pay 19% tax on all their profits. Companies with taxable profits of more than £250,000 will pay 25% tax on all their profits.

If profits are between £50,000 or £250,000 a ‘marginal relief’ calculation will be made. The practice effect of this is that there will effective be three different corporation tax rates:

First £50,000: 19%

Between £50,000 and £250,000: 26.5%

Over £250,000: 25%

Multiple Companies

There are many company owners who think about setting up a second company which is separate from their existing business. Often there are a few commercial reasons for using more than one company including:

• Reducing risk and limiting liability
• Involve different shareholders
• Enable a stand-alone sale of each business

With corporation tax increasing in the near future, it is possible for multiple companies with one owner, enjoying up to £50,0000 of profit taxed at 19%. However, in order to achieve this the companies must not be associated companies.

Associated Company Rules

When the new corporation tax rates come into operation within the next couple of years, to prevent people artificially spreading their business activities across multiple companies, the £50,000 lower limit and £250,000 upper limit will be divided up if there are any associated companies.

A company will only be associated with another company if:

• One company controls the other company
• Both are under the control of the same person / people

Family Members and Business Partners

When deciding who controls a company, your associates interests are treated as your own if there is substantial commercial interdependence between the companies.

Business associates include:

• Your spouse or civil partner
• Close relatives
• Legal business partners

Trading Companies vs Investment Companies

A trading company is essentially a company that is involved in regular business activities such as a company that sells goods online or a catering company or a firm. Common types of non-trading companies include those that hold substantial investments in financial securities or property or earn substantial royalty income.

Corporation Tax

If your company is mainly engaged in non-trading activities, in 2021 it will be paying corporation tax at the same rate as most other companies (19%). However, when the new corporation tax rates come into effect, a lot of these investment companies will have to pay the main rate of corporation tax which will be a rate of 25% on all their profits.

This is because any company classed as a close investment holding company (CIC) will not be able to benefit from the small profits rate of 19%. The company will be forced to pay corporation tax at the main rate on all profits.

Companies that mainly derive their profits from renting properties to unconnected third parties (not to family members, etc) are excluded from the CIC provisions. Hence, the majority of property investment companies will be allowed to enjoy the small profits rate.

If a company has too many non-trading activities (including most property investment and property letting) it may lose its trading status for capital gains tax purposes. This will result in the loss of two important CGT reliefs:

• Business Asset Disposal Relief
• Holdover Relief

Business Asset Disposal Relief

Business Asset Disposal Relief allows you to pay capital gains tax at just 10% (instead of 20%) when you sell your company.

Holdover Relief allows you to give shares in the business to your children, common-law unmarried partner, or other individuals and postpone CGT. You do not need Holdover Relief to transfer shares to your spouse because such transfers are always exempt.

A company will only lose its trading status for CGT purposes if it has ‘substantial’ non-trading activities. Unfortunately to HMRC ‘substantial’ usually means as little as 20% of various measures such as:

• Expenses
• Assets
• Profits
• Turnover
• Directors’ and employees’ time

HMRC may attempt to apply the 20% rule to any of the above measures.

Inheritance Tax Shares in trading companies usually qualify for business property relief. This means they can be passed on free from inheritance tax. However, if the company holds investments (including any rental properties), this could result in the loss of business property relief.

The qualification criteria are more generous than for CGT purposes and a company generally only loses its trading status for inheritance tax purposes if it is either wholly or mainly involved in investment related activities. To be on the safe side you will want to ensure that the company’s qualifying activities exceed 50% of each of the measures listed above (e.g. turnover, time, profits etc).

Companies registered as Tax Shelters Corporation tax is often a lot lower than the income tax and national insurance paid by sole traders and partnerships. Companies don’t always pay less tax than self-employed business owners but, as profits increase, the tax savings also naturally increase.

A business owner will therefore potentially have a lot more after-tax profit left to reinvest. Companies are normally most powerful as tax shelters when profits are reinvested. Most company owners need to extract money for their own personal use. At this point additional tax may be payable. The income tax payable on dividends reduces the tax benefits of using a company in many cases.