Marginal Relief and Small Profits Rates are back. In the penultimate Budget, the Government reintroduced them both and announced a return to the historic method of Corporation Tax calculation.
These changes will come into force from 1st April 2023, but it is worth thinking about it now because Capital Allowances are about to become much more important to your Corporation Tax planning.
What is changing?
Corporation Tax has changed many times to suit the economic climate, but historically it was always paid at varying rates depending on the level of profits.
This involved paying Corporation Tax at the Small Profits Rate for profits below a set amount or at the Main Rate for profits above a certain level. Profits falling in between these two amounts were paid at the Main Rate; however, a reduction by Marginal Relief was given on a sliding scale, providing a gradual increase in Corporation Tax.
In 2015, the Small Profits Rate and Main Rate were unified into a single rate of tax, set at 20% (later 19%), thus removing the need for Marginal Relief. But eight years later, in 2023, these two rates will be back and, with them, Marginal Relief.
In real terms, the changes mean companies with profits of £50,000 or less will pay the Small Profits Rate of Corporation Tax at the existing 19%, while companies with profits over £250,000 will pay Corporation Tax at the Main Rate of 25%. Profit levels in between these amounts will also pay tax at the Main Rate, but with Marginal Relief.
What does this mean?
Corporation Tax on profits up to £50,000 is paid at 19%, but when profits exceed this amount, and the tax rate increases to 25%, the tax due on this first £50,000 also rises to 25%.
This is different to Income Tax, where the Higher Rate is only paid on income above the Basic Rate threshold. So, at what rate are profits between £50,000 and £250,000 actually taxed? Well, let us look at a calculation:
£50,000 of profit is taxed at the Small Profits Rate of 19%, giving a tax liability of £9,500.
£250,000 of profit is taxed at the Main Rate of 25%, giving a tax liability of £62,500.
This means that the £200,000 of profit between the two limits generated a tax liability of £53,000 (£62,500 – £9,500). Therefore, any profits between £50,000 and £250,000 are effectively taxed at 26.5% (£53,000 / £200,000).
Impact on Capital Allowances
This change dictates that, in the future, any company with profits between £50,000 and £250,000 will effectively be paying tax at 26.5% on those profits above the lower limit.
A rise in Corporation Tax is never welcome and it’s important to maximise the tax relief available to potentially reduce the rate at which Corporation Tax is paid. One of the most effective means of achieving this is by identifying the significant Capital Allowances available from owning a commercial property. The higher the tax liability, the more worthwhile these become.
Let’s look at an example:
A company with a 12-month accounting period ended 31st March 2021, has profits of £150,000 and Capital Allowances written down in the year of £75,000. These Capital Allowances will generate a tax saving of £14,250 (£75,000 x 19%) at the current rate of Corporation Tax.
However, applying the same scenario to a year ending 31st March 2024 means the tax saving rises to £19,875 (£75,000 x 26.5%). That is an additional £5,625 in tax savings — an increase of almost 40%.
Capital Allowances are becoming more valuable for the most profitable companies, so accountants will need to advise properly and ensure thorough tax planning to optimise the tax relief available. Will the savings on that planned capital investment be more beneficial now with a £1,000,000 Annual Investment Allowance and Super-Deduction or later with a higher rate of Corporation Tax?
Mark Anthistle is senior capital allowances analyst at specialist tax consultancy Catax