From as far back as 1973, Corporation Tax was paid at varying rates depending on the level of profits, and over the years, these rates and profit thresholds have changed many times to suit the economic climate.
Corporation Tax was either paid at the Small Profits Rate for profits below a set amount or at the Main Rate for profits above a set amount. These limits were proportionately reduced for shorter accounting periods and where there are associated companies.
Profits falling in between these two set amounts were also paid at the Main Rate; however, a reduction by Marginal Relief was given on a sliding scale, providing a gradual increase in Corporation Tax. We will discuss this Marginal Rate in more detail later.
In 1994, these two limits were set at £300,000 for the Small Profits Rate and £1,500,000 for the Main Rate. These limits remained constant then until 2015.
From 1st April 2015, the Small Profits Rate and Main Rate were unified into a single rate of tax, set at 20%. As a result, Marginal Relief no longer applied.
Further changes were revealed in the summer Budget 2015, which reduced the charge to Corporation Tax to 19% from 1st April 2017.
As part of the latest Budget, the government has announced a return to the historical method of Corporation Tax calculating by reintroducing the Small Profits Rate, and with it, Marginal Relief. These changes will come into force from 1st April 2023.
Companies with profits of £50,000 or less will pay the Small Profits Rate of Corporation Tax at 19%, whereby 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.
The simplified calculation of Marginal Relief is given as (Upper Limit – Profits) x Standard Fraction (in this article, we have assumed there to be no Franked Investment Income).
The Standard Fraction has been calculated to be 3/200.
Example: Calculate the tax due on profits of £150,000.
£150,000 x 25% = £37,500
Less Marginal Relief: (£250,000 – £150,000) x 3/200 = (£1,500)
Tax Due = £36,000
Difference to Income Tax
When considering rates of Income Tax, it is worth noting that Higher Rate tax is only paid on income above the Basic Rate threshold.
Any income below this threshold is still paid at the Basic Rate. However, for Corporation Tax, a change in tax rate results in all tax paid at that new rate.
This gives rise to an Effective Marginal Rate of Corporation Tax for profits falling between the two limits.
Effective Marginal Rate
Corporation Tax on profits up to and including £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 raises to 25%.
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 the Benefit of Capital Allowances
The impact a change in the rate of Corporation Tax has on the benefit of Capital Allowances is best shown with 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 exact figures to a year ending 31st March 2024, 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%.
A rise in the Corporation Tax rate is never a welcome announcement for any company, especially when this rise applies to all profits and not just the profits that exceed the lower limit.
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.
So, it is more important than ever to maximise the tax relief available and potentially reduce the rate at which Corporation Tax is paid. One of the most effective means of achieving this remains to be the instruction of a Capital Allowances review to unlock the tax potential of a commercial property.