Associated companies and corporation tax

As if the increase in the primary corporation tax rate, from 19% to 25%, wasn't enough, on 1 April 2023, HMRC changed the associated company status rules.

Clients and accountants regularly discuss the subjects of associated companies and corporation tax rates. Over the years, we have seen changes in the definition of “associated companies”, with the most recent adjustments coming into force on 1 April 2023. This occurred simultaneously with an increase in the primary corporation tax rate from 19% to 25%.

On the surface, the associated company changes may seem pretty innocuous, but as ever, the devil is always in the details. Let’s look at the changes brought in by the government and the potential impact on company profits and cash flow.

What is an associated company?

In the past, there were opportunities to split business operations into different companies owned/controlled by the same individuals/groups to reduce corporation tax. Then, we saw the introduction of the associated company rules, which were significantly revamped on 1 April 2023.

As part of these changes, the previous 51% group company test was removed and replaced by associated company rules (similar to the situation before the 51% rule was introduced). Broadly speaking, companies are associated if:-

One company has control of the other
Both companies are under the control of one person/group of people

Before we look at the new rules of practice, it is essential to recognise the consequences of the second condition. In this scenario, a company your spouse owns or controls could fall under the associated company rules. As we will discuss later in this article, this can impact corporation tax rates and cash flow.

There is also another vital factor to consider; companies in different tax jurisdictions that the same person/group of people control. Under HMRC regulations, it does not matter where the company is registered; therefore, companies from other countries may unwittingly find themselves associated.

Exclusions to the associated company rules

There are some situations where what may look like an associated company will not fall under the current rules. Exclusions include:-

Dormant companies
Passive holding companies
Lack of substantial commercial interdependence

The third exclusion is important, highlighting the difference between companies owned by the same person/group of people and their commercial interdependence. Consequently, not all companies owned by one person or a group will be deemed associated.

How might this impact corporation tax?

When looking at company profitability, you will notice that the authorities refer to augmented profits. These are defined as:-

Total taxable company profits
Plus, any exempt dividends from non-group companies

We will now look at the impact of associated company status on corporation tax and how this may impact cash flow. At the moment, there are three primary thresholds:-

Companies with profits less than £50,000 a year will be charged corporation tax at 19%
Companies with profits over £250,000 will be charged at 25%
Companies with profits between £50,000 and £250,000 will be charged at 25%, but can also claim marginal relief

Where there are associated companies, the thresholds are reduced, potentially increasing the tax liabilities of each company.

Case study

It is probably better to show the consequences of associated company status in practical terms rather than focusing on the technical aspect.

Scenario

Number of companies: 5

Corporate relationship: Associated

Augmented profits for each company: £25,000

Where there are associated companies, the above thresholds are divided by the number of companies. In this situation, the thresholds would be rewritten as follows:-

Profits of less than £10,000 would be charged corporation tax at 19%
Profits of more than £50,000 would be charged at 25%
Those with profits between £10,000 and £50,000 would attract a 25% charge but can claim marginal relief

If we ignore the associated company status for a moment, on a stand-alone basis, each company would be charged corporation tax at 19%:-

19% x £25,000 = £4750
Combined corporation tax liability £23,750

However, in this case study, the companies are associated, so there will be an adjustment to their corporation tax rate. As profits are greater than the adjusted maximum rate for 19% corporation tax, the rate is increased to 25%, as you can see below:-

25% x £25,000 = £6250
Combined corporation tax liability £31,250

Calculating marginal relief

In this instance, individual company profits are above the adjusted lower tax band but below the higher rate where there is no relief. Using the HMRC adjustment of 3/200^th, the profits of each company will be liable to corporation tax as follows:-

£25,000 profits at 25% corporation tax = £6250 (combined associated companies £31,250)

Adjustment calculation:-

3/200 x (adjusted higher band – individual company profit) = marginal relief

3/200 x (£50,000 – £25,000) = £375 marginal relief

Adjusted corporation tax liability:-

£6250 – £375 = £5875

Compare and contrast

If the five companies did not fall under the associated company status, their corporation tax would have been:-

£4750 individually or a combined figure of £23,750

Taking into account the associated company status and ignoring corporation tax relief, the situation would have been as follows:-

£6250 individually or a combined figure of £31,250

This equates to an extra £1500 per company or an additional combined corporation tax figure of £7500.

If we take into account the tax relief available, the situation is a little more palatable:-

£5875 individually or a combined figure of £29,375

Even after the tax relief adjustment, the corporation tax liability still equates to an additional £1125 per company or a combined figure of £5625.

As you can imagine, the more associated companies there are, the more significant the reduction in the corporation tax thresholds and the higher the potential corporation tax liability.

Large and very large companies

Where augmented profits are greater than £1.5 million, and there are several associated companies, this can significantly impact company cash flow.

Currently, if a company earns augmented profits of between £1.5 million and £20 million per annum, it is deemed large. Therefore, rather than paying corporation tax nine months after the company’s year-end, the company would be liable to pay quarterly instalments on the seventh, 10^th, 13^th, and 16^th months following the start of the accounting period.

Consider the following scenario:-

Number of associated companies: 2

Augmented annual profits: £1 million each

As stand-alone companies, they would not be deemed large by HMRC. However, if they were associated, they would, as this would halve the £1.5 million minimum definition of a large company down to £750,000 in annual profits. In this scenario, each company would need to pay quarterly instalments as detailed above, which could have a potentially significant impact on cash flow.

Companies with profits exceeding £20 million, deemed very large companies by HMRC, are also expected to pay tax every quarter. However, this begins four months earlier than those companies deemed large. The £20 million minimum profit to qualify for very large company status would be halved to £10 million with two associated companies and down to £2 million with ten associated companies.

It is not difficult to see how the combined effect of several associated companies might impact individual company tax payment plans.

Corporation tax – Planning ahead

Before you start building your business empire, it is vital to appreciate the structure and the potential impact this could have on corporation tax rates and tax payment timetables. It is also crucial to consider businesses owned by spouses and connected parties or the same group of people. The impact can be significant even on relatively modest profits, but this will multiply where profits are in the hundreds of thousands or even millions of pounds.