Tax Planning

Capital allowances have gotten extra necessary for corporate tax planning

Marginal Relief and Small Profits Rates are back. In the penultimate budget, the government reintroduced both and announced a return to the historical method of calculating corporation tax.

These changes will go into effect on April 1, 2023, but it’s worth thinking about now because the capital allowances will become much more important to your corporate tax planning.

What changes?

Corporate income tax has adapted to the economic climate, but in the past it was always paid at different rates depending on the level of profit.

This included paying corporation tax at the small profit rate for profits below a specified amount or at the main rate for profits above a certain level. Profits between these two amounts were paid out at the main rate; however, a gradual reduction was granted through border relief, which allowed for a gradual increase in corporate income tax.

In 2015, the Small Profits Rate and the Main Rate were combined into a single tax rate of 20% (later 19%), eliminating the need for border relief. But eight years later, in 2023, those two rates will be back and with them border relief.

In reality, the changes mean that companies with a profit of £ 50,000 or less will pay the small profit corporation tax rate of 19%, while companies with a profit above £ 250,000 will pay corporation tax at the main rate of 25%. Profit levels between these amounts also pay main rate taxes, but with marginal relief.

What does that mean?

Corporate tax on profits up to £ 50,000 is paid at 19%, but if the profits exceed this amount and the tax rate is increased to 25%, the tax on that first £ 50,000 is also increased to 25%.

This is different from income tax, where the higher rate is only paid on income above the threshold of the base rate. So at what rate are profits between £ 50,000 and £ 250,000 actually taxed? Let’s look at an invoice:

The profit of £ 50,000 will be taxed at the Small Profits Rate of 19% which equates to a tax liability of £ 9,500.

The profit of £ 250,000 is taxed at the main rate of 25%, which equates to a tax liability of £ 62,500.

This means that the £ 200,000 gain between the two limits resulted in a tax liability of £ 53,000 (£ 62,500 – £ 9,500). Therefore all profits between £ 50,000 and £ 250,000 will be effectively taxed at 26.5% (£ 53,000 / £ 200,000).

Effects on capital allowances

This change requires that in the future, any company with profits between £ 50,000 and £ 250,000 will effectively be required to pay 26.5% tax on those profits above the floor.

A corporate tax hike is never welcome and it is important to maximize the tax break available in order to potentially lower the rate at which corporate tax is paid. One of the most effective ways to accomplish this is to determine the significant capital injections available from owning a commercial property. The higher the tax liability, the more worthwhile they are.

Let’s look at an example:

A company with a 12 month fiscal year ended March 31, 2021 has a profit of £ 150,000 and annualized capital additions of £ 75,000. These capital additions translate into 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 the tax saving increases to £ 19,875 (£ 75,000 x 26.5%). That’s an additional £ 5,625 in tax savings – an increase of nearly 40%.

Capital bonuses are becoming increasingly valuable to the most profitable companies, so accountants need to provide proper advice and ensure thorough tax planning in order to optimize the tax breaks available. Will the savings on this proposed 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 Allowances Analyst at tax consultancy Catax

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