Rishi Sunak delivered the Budget in March 2021. All eyes were on COVID relief packages, reduced VAT, the furlough scheme etc.
I want to focus on what the budget means for Limited Company owners and investors going forward.
It feels like the government is going after limited companies this time. The most important change is that the corporation tax will increase from 19% to 25% starting in 2023. The full 25% will apply to companies showing a profit of over £250,000.
Read also the latest article on how corporation tax is calculated for 2023, with examples and a free calculator.
A “small profits rate” of 19% will be maintained for those with a profit of £50,000 or less, with a tapered approach between £50k and £250k.
So for instance, if your company is taxed on a £40,000 profit, you will keep paying 19% corporation tax. If your company makes £100k profit you will pay somewhere between 20-25% (yet to be announced).
This corporation tax rate will increase gradually up to the £250k level, above which everyone will pay 25% corporation tax.
So overall, more corporation tax coming our way. Ok.
However, I want to stress 2 negative changes that were small letters in the Budget and will have an impact on company investors. They were surfaced in the company investing academy community (thanks Stephen!) where we discuss all things related to LTD company investing.
Those making more than £250k annual profits in their limited companies can stop reading now. The rest of us, carry on!
Change #1: No corp tax ‘relief’ for investment companies
Companies operate in a particular trade or a set of similar trades as defined by their activities. So we have companies that trade commercially like recruitment agencies, marketing companies, IT contractors, plumbers, etc.
These are trading companies and they are slightly different to investment companies. Currently, there are some small differences between the two but nothing major. For example, closing down an investment company cannot offer the 10% tax option (Entrepreneur’s Relief) to the director.
From 2023 on, investment companies will not enjoy the “small profits rate” as trading companies do. However, companies that do property investing and let the properties out are exempt!
So a property landlord renting out a flat through a LTD company can still enjoy the starting 19% corp tax rate.
A pure holding company of a trading company (no investing, just holding) is also exempt.
The definition is a bit confusing though. Is my company a close investment holding company?
What makes a company a Close Investment Holding Company?
As per HMRC:
In broad terms, a company will be a close investment holding company if it does not exist wholly or mainly for the purpose of trading commercially or investing in land for (unconnected) letting or acting as a holding or service company within a group which exists wholly or mainly to trade or invest in land for lettingHMRC
So in other words, if I have a holding co just owning my trading co (no investing) then it qualifies for the small profit rate (19% corporation tax up to threshold). If I have an investment company mainly doing property investing to unconnected parties it should still qualify for low corporation tax. But if I have a company (regardless of ‘holding’ or not) of which the main purpose is to invest in shares (non-rental income) and the trading activity is a small part of the activities (~20%) then it is a close investment-holding company. Trying to define the main purpose really depends on the activities it undertakes and to what extend.
Therefore takeaway #1 is that unless your company is a trading company or does buy-to-let investing or is a pure holding co of a trading company (no investing), for all other purposes it is a close investment-holding company. That increases its corporation tax to 25%.
A few examples:
- My company is a trading company (IT contracting) and has a small stocks portfolio (10% of assets) – Is it a close investment holding company? No, the small profit rate applies (starting corp tax is 19%)
- My company has a property investment portfolio letting the properties out for a profit – Property is exempt so the ‘small profit rate’ still applies
- My company has half its assets in buy-and-hold investment funds, stocks, crypto, gold etc – It is a close investment company and the ‘small profit rate’ does NOT apply. Corp tax will be 25%
- My company is day-trading stocks for a profit – It is not a close investment company, the ‘small profit rate’ applies
I’m not sure why property has preferential treatment here, but I’m glad it does. Buy-to-let investors had seen their taxes increase by a lot in the past few years.
Michael’s Note: Although a 6% increase in corporation tax seems like a high number, I think its impact will be somewhat low for company investors. Why is that? Because typically investment companies hold investments for a number of years and trigger tax only when selling. When it’s time to sell, this can be typically combined with a salary, pension contributions or other expenses so that the company’s corporation tax is lower.
We also tend to prefer investments with better tax treatment for LTD companies, so corporation tax may not even apply in the first place. Have a look at the Tax, Investing pillars and the “Exit Strategy” sessions of the LTD company investing course.
Also, some company investors like property, of which rent is taxable the year it is received. But remember, property companies letting out to 3rd parties are exempt from being “Close investment holding companies”. So they can still get the small profits rate without having to pay the entire 25% tax on the first penny.
All things considered, yes nobody likes tax hikes but I think it’s not as bad as I initially thought.
Change #2: The more ‘associated’ companies you own the lower the corporation tax relief
What is an associated company in the UK?
Broadly, a company is associated with another company at a particular time if, at that time or at any other time within the preceding 12 months:
* one company has control of the otherHMRC
* both companies are under the control of the same person or group of persons
This is a more concerning change to me and others who operate more than one limited company.
Remember how the first threshold for lower corp tax is £50,000? Cut this in half if you own 2 limited companies.
So the 2 companies will have the lower band (19% corp tax) set to £25,000 and the highest band (25% corp tax) set to £125,000.
Each associated company will reduce the level at which the small profits rate applies. Both companies will have a 19% corporation tax rate only on the first £25,000, not £50,000.
Effectively in a situation where you have a Limited trading company and an ‘associated’ company with investment activities, this is what happens:
- The investment company would pay tax at 25% regardless of the levels of profit generated (that’s from change #1)
- The trading company’s small profits rate would reduce to £25k and the higher profits rate to £125k respectively
I think this rule will harm a lot of people owning multiple properties in SPVs (limited company special purpose vehicle). That’s because their relief limits will be cut further for each additional limited company they own. Some lenders have now started giving products to non-SPVs which is great (more info).
But how bad is change #2 overall?
What the new ‘associated’ rule means practice
Say you own one company, company A.
It has a £100k taxable profit. Without any other company in your name, company A would have to pay somewhere between 20% and 25% on the 2nd band. Remember, we don’t know yet.
Say it’s 21% corp tax for the £100k band.
21% corp tax on £100k profit = £21,000.
Now say you introduce another company, company B. Introducing company B on your name will probably move company A to the next tax band (lower threshold down to £25k, highest threshold down to 125k).
So assuming the corp tax now is 23% instead of 21% for company A, the new corporation tax is
23% corp tax (company A) = £23,000
An extra £2,000 to pay because of an ‘associated’ company.
It doesn’t matter if the companies are trading commercially or investing for this rule to apply. In fact, if the 2nd company is ALSO trading, it gets worse.
Because if it’s an investment company you pay 25% corp tax anyway so only your trading co is affected. But if you’re setting up different businesses, say you’re a plumber but you also operate a car driving school (don’t ask me why!) then both your trading companies will be paying more tax going forward just because they are owned by the same person.
Again defining what constitutes an ‘associated’ company is really important to decide if the rules apply.
A pure holding company is not ‘associated’. That’s if it’s just holding shares and receiving dividends from trading co – it’s not really carrying on a business or trade. As per HMRC CTM03580 an associated company which has not carried on any trade or business (see CTM03590) at any time during the accounting period is disregarded (source).
This holds true for dormant companies or ‘idle’ companies in the accounting period. For example, idle contractors who have their trading companies “open” but in a zombie state.
However, any other investment or business activity in a company which, let’s face it, this is what we are interested in, would make it an ‘associated’ company and therefore affect the trading co corp tax as well.
That’s not to say that nobody should open a new investment company anymore. If you plan to invest through a limited company there are some very good reasons why you should consider separating the investing activities from the trading ones (among many, see change #1!). Also, if the trading company invests to a substantial extent, it may be seen as a Close investment holding company and pay 25% on the first pound (even if most profits come from the commercial activity!).
Final notes and suggestions
Higher taxes may come our way. Having more companies in your name means it will reduce the small profit rate. In a basic example of one trading co and one investment company, this means about £2,000 more tax in the first £100,000 of profit.
Paying a high dividend tax (32.5% or 38.1%) to extract the money out before investing will probably still be the worst solution for many, including myself. And so will be investing directly through the trading company if it’s classified as a Close Investment Holding Company (25% tax from the first £1.00 of profit).
I think we have to accept there will be higher taxes to pay for the high debt the government took to fight COVID. I expect an upcoming capital gains tax hike for individuals too which unlike the rumours, did not happen.
This is why it is now even more important to look out for ways to reduce the taxable amount subject to corporation tax. For example:
- Consider pensions which not only will reduce your taxable profits, but may also place your company in a lower tax bracket
- Consider company investing in buy-to-let. Letting out property does NOT make a company a ‘close investment holding company’
- Buy-to-let investors should see if they can combine properties in one company to avoid seeing their tax relief reduced
- Focus on things you can control when investing such as platform fees and fund management fees. Keep these costs as low as possible
- Don’t let taxes paralyse you. Learn about making money in income-producing assets like stocks and property.
Overall, yes tax planning is good but remember, taxes are only on profits. We must have profits first, so don’t put the cart before the horse.
Making profits first by investing our money should be the first goal and definitely a good problem to have. It will hopefully pay off many times over the initial amount, regardless of higher taxes.
Finally, we really don’t know if these proposed measures will actually take place. There’s certainly some time before 2023. Perhaps it will happen in parallel with an election cancelling this. Clearly, all we have now is guidance and nothing concrete but it’s definitely worth planning with the above in mind.
If you want to learn how to invest your company profits, have a look at the Company Investing Academy. The above is one of the many topics we discuss and analyse. Next group: April 12th – May 10th. This is the last group before the end of summer. If you are really interested sign up now. Spaces are limited and almost sold out.