Corporation Tax Changes from 1st April 2023

Contractors who carry out their business activities through their own Personal Service Company (PSC) should be aware that the main rate of Corporation Tax (CT) jumps from 19% to 25% from 1st April 2023.

These changes mark a departure from the one size fits all approach introduced back in 2014. It includes the re-introduction of upper and lower profit limits and marginal relief where company profits fall between the two.

Firstly, a 19% small companies rate will be in place for companies with annual profits below £50,000 (lower limit). Companies with annual profits over £250,000 (upper limit) will pay the main rate of 25%, companies with profits between the upper and lower limit will be entitled to marginal relief which will mean they will pay corporation tax a rate between 19% and 25% depending on the level of annual profits generated.

Despite the headline rise in the CT rate, the Government still expects that around 70% of all companies will continue to be taxed at 19%.

In this article we highlight some of the background to the changes and look in detail at how limited contractors may be affected.

What is Corporation Tax?

Corporation Tax (CT) is a charge on the annual profits, other income, and gains of an incorporated business entity, most commonly a limited company. It is not charged on the business profits of a sole trader or partnership (a non-incorporated business).

The tax itself has been around since 1965 and is subject to review by the Government of the time as it prepares the nation’s annual budget. The rates are often increased to raise additional revenue for the Exchequer and sometimes reduced as an incentive to international business to invest in the UK.

CT is charged on a company’s profits realised in its accounting period (usually an annual period). In general terms profits are calculated by deducting allowable business expenditure from taxable business income.

The tax regime also allows other deductions from taxable profits in the form of certain qualifying capital expenditure, research and development expenditure and trading losses from other accounting periods.

PSC directors should be aware that salaries and bonuses paid to them as employees by their limited company reduce their company’s profits but that dividends to shareholders do not.

Does the Corporation Tax rate rise apply to every company?

The main rate of tax rises from 19% to 25%. However, smaller companies will not have to pay the full rate. What tax is payable will depend on each company’s profits for each financial year.

The current 19% rate will apply if the company’s profits are at or below a £50,000 threshold. The full 25% rate of CT will apply to companies with annual profits of £250,000 or more.

If a company’s profits fall between these upper and lower thresholds a ‘marginal relief’ is available to prevent a ‘cliff face’ transition between the two rates of 19% and 25%. This ‘marginal relief’ fraction has been set at 3/200.

Here are some simple examples of how the changes will apply:

1. Company A has profits for 12 months to 31st March 2024 of £300,000
   Profits exceed upper threshold of £250,000 so all are chargeable at 25%. Tax payable £300,000 x 25% = £75,000
2. Company B has profits for 12 months to 31st March 2024 of £20,000.
   Profits less than lower threshold of £50,000 so all are chargeable at 19%. Tax payable £20,000 x 19% = £3,800
3. Company C has profits for 12 months to 31st March 2024 of £100,000.
   Because the profits fall between the lower and upper threshold, marginal relief is due:
   A. Tax on profits of £100,000 x 25% = £25,000
   B. Difference between profits and upper threshold: £250,000 - £100,000 = £150,000.
   C. Apply marginal fraction 3/200 x £150,000 = £2,250
   D. Tax payable (A) £25,000 less marginal relief (C) £2,250 = £22,500

An important thing to bear in mind when looking at marginal relief is that its availability will be reduced if there are ‘associated companies’. A company is associated with another company if both are under the control of the same person or persons.

The rules around ‘control’ are complex and any limited company contractors who have more than one company are advised to speak with their accountant to see whether the associated company restrictions may apply.

How do the changes affect a company whose accounting period is less than 12 months?

If this is the case the lower (£50,000) and upper £250,000 thresholds are reduced proportionately to calculate the rate to be applied.

If the accounting period is, say, for 6 months from 1st April 2023 to 30th September 2023 here’s how it would work:

1. Company A has profits for this 6-month period of £300,000.
   The upper threshold is £250,000 x 6/12 = £125,000 so all the profits are taxed at the main rate of 25%.
2. Company B has profits for this 6-month period of £20,000.
   The lower threshold is £50,000 x 6/12 = £25,000. As the profits fall under this reduced threshold, they are all taxed at 19%.
3. Company C has profits for this 6-month period of £100,000.
   The lower threshold is £50,000 x 6/12= £25,000 and the upper threshold £250,000 x 6/12= £125,000 so marginal relief is available. The calculation is as follows:
   A. Tax on profits of £100,000 x 25% = £25,000
   B. Difference between actual profits and reduced upper threshold: £125,000 - £100,000 = £25,000
   C. Apply marginal fraction 3/200 x £25,000 = £375
   D. Tax payable (A) £25,000 less marginal relief (C) £375 = £24,625

What if the company’s accounting period straddles 1st April 2023?

Many small PSCs will have accounting periods which begin before 1st April 2023 when the new rate and rules come into effect.

The basic calculation principle is to first apportion the profits between the pre-1st April 2023 and the post–1st April 2023 periods.

Here is an example of how such a calculation would proceed showing the CT payable under both the ‘old’ and the ‘new’ rules:

Company A has an accounting period ending 30th September 2023 and profits of £300,000

Profits falling into the financial year pre 1st April 2023 (ending 31st March 2023) £300,000 x 6/12 = £150,000. These profits fall to be taxed under the ‘old’ regime at 19%.

The remaining apportioned profits for this accounting period, £150,000 fall in the post 1st April 2023 financial year and are taxed on the ‘new’ basis.

The lower and upper thresholds are proportionately reduced to reflect the fact that only 6 months of the accounting period fall in the period subject to the new rules.

The lower profit threshold is reduced to £25,000 (£50,000 x 6/12) and the upper profits threshold is £125,000 (£250,000 x 6/12).

As the apportioned profits (£150,000) exceed the upper threshold, they fall to be taxed at 25%.

The same method of calculating marginal relief on the apportioned profits is applied as it would for a ‘short’ accounting period described earlier.

Tax planning to mitigate the impact of the increased CT rate

There are some basic planning actions and options which can be considered if there is sufficient time left before 1st April. Some of them may be relevant only if there is a risk of a main rate charge post 1st April 2023:

• Ensure that all the company’s expenses are recorded and identified. This will help to reduce the company’s net taxable profits irrespective of the rate of CT;
• If you have more than one active company please let your accountant know so that the possibility of associated companies can be considered;
• If possible, accelerate business activity to ensure that income can be recognised in your pre-April 2023 taxing period;
• If your company has chargeable assets (such as property) scheduled for disposal try to bring forward the sale contract into the pre 1st April period;
• Consider deferring significant expenditure until periods where the tax deduction would be at 25% rather than 19% or where your effective rate of CT would be higher;
• If you have any CT loss reliefs for earlier periods consult your accountant to discuss their best use.