Capital allocations are becoming increasingly important for corporate tax planning

Marginal relief rates and small profits are back. In the penultimate budget, the government reintroduced them both and announced a return to the historical method of calculating corporate income tax.

These changes will take effect from April 1, 2023, but it’s worth thinking about now as capital deductions are set to become much more important to your corporate tax planning.

What is changing?

Corporate tax has changed several times to suit the economic climate, but historically it has always been paid at varying rates depending on the level of profits.

This involved paying corporate tax at the small profit rate for profits below a certain amount or at the prime rate for profits above a certain level. Profits between these two amounts were paid at the main rate; however, a reduction by marginal relief was granted on a sliding scale, offering a gradual increase in corporate tax.

In 2015, the small profit rate and the main rate were unified into a single tax rate, set at 20% (later 19%), thus removing the need for marginal relief. But eight years later, in 2023, those two tariffs will be back and, with them, Marginal Relief.

In real terms, the changes mean that companies with profits of £ 50,000 or less will pay the corporation tax rate for small profits at the current rate of 19%, while companies with profits over £ 250,000. £ will pay corporation tax at the main rate of 25%. Profit levels between these amounts will also pay taxes at the prime rate, but with marginal relief.

What does it 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%, tax due on those first £ 50,000 also drops to 25%.

This is different from income tax, where the highest rate is only paid on income above the base rate threshold. So what rate are profits between £ 50,000 and £ 250,000 actually taxed? Well, let’s look at a calculation:

£ 50,000 of profit is taxed at the small profit rate of 19%, resulting in a tax liability of £ 9,500.

£ 250,000 of profit is taxed at the 25% prime rate, resulting in a tax liability of £ 62,500.

This means that the £ 200,000 profit between the two limits generated a tax liability of £ 53,000 (£ 62,500 – £ 9,500). Therefore, any profit between £ 50,000 and £ 250,000 is effectively taxed at 26.5% (£ 53,000 / £ 200,000).

Impact on capital provisions

This change dictates that in the future any business with profits between £ 50,000 and £ 250,000 will effectively pay a 26.5% tax on profits above the lower limit.

An increase in corporate tax is never welcome and it is important to maximize the tax relief available to potentially reduce the rate at which corporate tax is paid. One of the most effective ways to do this is to identify the large capital deductions available when owning commercial property. The higher the tax payable, the more attractive they become.

Let’s look at an example:

A business with a 12 month accounting period ending March 31, 2021, has profits of £ 150,000 and capital allowances amortized over the year of £ 75,000. These capital allocations will generate a tax saving of £ 14,250 (£ 75,000 x 19%) at the current corporate tax rate.

However, applying the same scenario to a year ending March 31, 2024 means that the tax savings amount to £ 19,875 (£ 75,000 x 26.5%). This represents an additional £ 5,625 in tax savings, an increase of almost 40%.

Capital allocations are becoming increasingly valuable for the most profitable businesses, so accountants will need to properly advise and undertake in-depth tax planning to maximize the available tax breaks. Will the savings on this planned capital investment be more beneficial now with an annual investment allowance of £ 1,000,000 and a super-deduction or later with a higher corporate tax rate?

Mark Anthistle is a senior capital allocation analyst at the specialist tax consultancy firm Catax

Luisa D. Fuller