How having too many companies can cost you in tax
It can be tempting to set up a new company whenever you have a new business idea – like a joint venture with another author. But, you need to be aware of the associate company rules, which can significantly affect the amount of tax you pay.
What are Associate Company Rules?
As soon as you introduce different tax rates for different sizes of company then there’s a temptation to split a big business up into a few little businesses in order to pay less tax. Associate company rules are part of the UK’s tax legislation to stop this happening+. Essentially, if one company has control over another, or if both are under the control of the same person or persons, they are considered associated companies.
How Do These Rules Affect Corporation Tax?
From 1 April 2023, the UK introduced a tiered corporation tax system:
- 19% for companies with profits of £50,000 or less.
- 25% for companies with profits over £250,000.
- A gradual increase from 19% to 25% for profits between £50,000 and £250,000, through marginal relief.
The catch is, if a company has associated companies, these thresholds are divided by the total number of associated companies. This means that having associated companies can lead to a higher effective tax rate.
Example
Let’s say we have a small UK company, Fabulous Writer Ltd, with a taxable profit of £100,000 for the year. Normally, it would expect to pay tax at a rate of 19% on the first £50,000 and 26.5% on the next £50,000. In total that’s £22,750 or a rate of 22.75%. However, Fabulous Writer Ltd has two associated companies.
Here’s how the associate company rules affect its tax calculation:
- The £50,000 lower threshold and the £250,000 upper threshold are divided by three (Fabulous Writer Ltd + 2 associates), resulting in new thresholds of approximately £16,667 and £83,333, respectively.
- Since Fabulous Writer Ltd’s profits of £100,000 exceed the new upper threshold of £83,333, it must pay tax at the main rate of 25% instead of benefiting from marginal relief.
So, instead of paying a reduced rate, Fabulous Writer Ltd will pay 25% of £100,000, which amounts to £25,000 in corporation tax – a difference of £2,250.
Conclusion
The associate company rules can have a substantial impact on the amount of corporation tax a small UK company pays so think before setting up additional companies whether you really need them.
