Updated on: Jan 28, 2024
New corporation tax rates are taking effect from 01 April 2023 and there are several different elements to these changes. The majority of our limited company contractor clients will not be affected by these changes because their taxable profit for the year tends to be below £50,000.
However, that is not the end of the story. There are changes in the way corporation tax is calculated that may unexpectedly affect a number of our clients. In this article we look into the detail around this corporation tax rise including how you may unexpectedly be caught by them.
If you are wanting to see how your company tax might change this year, take a look at our Corporation Tax calculator. Corporation tax is paid by our limited company contractor clients, but does not apply to sole traders. See Limited company vs Sole trader for more.
Changing the corporation tax rate
The corporation tax rate is changing for some businesses on 01 April 2023. At the moment the corporation tax rate is 19% and this same rate applies to all businesses regardless of their size. From April onwards the corporation tax rate for businesses with annual profits below £50,000 remains the same at 19%.
For businesses with annual profits in excess of £250,000 the corporation tax rate on those profits will be 25%. And finally for businesses where profits fall between these two numbers the corporation tax rate is calculated on a sliding scale between 19% and 25%.
Let’s take a quick look at this corporation tax increase calculation.
Where your taxable profit falls between 50,000 and 250,000, a new element is introduced to the corporation tax calculation called Marginal Relief. The corporation tax is first calculated using the 25% tax rate and then marginal relief is used to reduce the corporation tax calculation.
For example, let’s say Jim & Co Contractor Ltd Has a taxable profit of £65,000 and he wants to see how the tax changes will affect his business. Because the profit is between the £50,000 and £250,000 thresholds, we need to use marginal relief in our calculation. Corporation tax at a rate of 25% is 65,000 x 25% = £16,250. Now we need to apply the marginal relief. This is calculated using, (Upper Limit – Profit) x Marginal Relief fraction, so adding our figures above, the calculation becomes (250,000 – 65,000) x (3/200) [this a fixed fraction that never changes] = £2,775.
So after allowing for marginal relief the corporation tax bill for Jim & Co Contractor Ltd will be 16,250 – 2,775 = £13,475.
Overall for Jim & Co Contractor Ltd, the effective corporation tax rate for the year was 13,475 / 65,000 = 20.7%.
Does the Accounting Year Make a Difference?
We’re so glad you asked! Yes the accounting period for your business will also have a significant impact on how your corporation tax is calculated. These new tax changes take effect from 01 April 2023, and if your accounting year straddles this date the calculation becomes a bit more complex.
To save ourselves from the complexity and to ensure you keep reading this article, I will sum this up with a few words.
Where your accounting year straddles 01 April 2023, some of your corporation tax liability will be calculated using the existing method and some of it will be calculated using the new method. the calculation is fairly pro-rated and does an effective job of ensuring the taxes are fairly calculated across the accounting year. What it does is takes your taxable profit across the entire year and then splits it. For example if your accounting year end is 31 Oct 2023 and you had a taxanle profit of £80,000, then £40,000 will be taxed using the pre-April 2023 calculation, and £40,000 will be taxed using the post-April 2023 calculation. Since only 6 months of trading is used for the post-April 2023 calculation, the lower limit of £50,000 is halved to £25,000, and the upper limit is halved to £125,000. So you see your post-April 2023 earnings will still be taxed at a higher rate than 19%.
The deadline that you must pay corporation tax by remains unchanged.
Looking at the Marginal Tax rate
When these sorts of tax calculations are introduced, I always like to take a look at the marginal rates to see how much it will cost in tax for our clients if their business were to earn another ְ£1 in profit.
If a client has a taxable profit of up to £50,000 the marginal tax rate is 19%. That means, the tax paid on any profits up to this amount remains the same at 19%.
For any taxable profit above £50,000 (and below £250,000) this will be taxed at 26.5% (after the first £50,000 has been taxed at 19%).
And any taxable profit above £250,000 will it be taxed at 25%.
This is a shortcoming of the marginal tax rate calculation and the highest rate of corporation tax is actually 26.5% Which applies to the band of taxable profit between £50,000 and £250,000.
Although this section has been left to the end of this article it is absolutely critical that all of our contractor clients understand the implications of this. Associated companies are companies that are under common control. There are several rules around this but essentially companies will be associated where they are controlled by the same individual or a controlled by the same group of individuals. Time to focus on the associated company rules helps explain this is more detail.
The impact is significant. If you are a contractor working through your own limited company, and are involved in a side project that also has its own limited companies, its quite probable in this scenario that you will have two associated companies.
Under the new company tax calculation, the calculation thresholds are divided by three. So the lower limit (above which a higher company tax rate kicks in) drops from £50,000 to £25,000, and the upper limit drops from £250,000 to £125,000.
So you can quickly see that if your contracting company has a taxable profit of £40,000 then it faces a tax bill higher from 19% just because of the associated company. In this case, just by having a second ltd company, the tax paid by your contracting company would increase from £7,600 (19%) to £8,725.
If you do have a side hustle business and want to avoid these associated company rules, you could consider (a) closing the business and operate it as a sole trader (b) make the business dormant if it is truly doing nothing (c) if the business is making money try to equalise profits across the two businesses as much as you can to minimise the impact of this issue.