In his Budget of 3 March 2021, Chancellor of the Exchequer Rishi Sunak introduced several measures intended to provide cash-strapped businesses with support as we emerge from the pandemic and raise additional tax revenues in the medium term.

The measures include:

• an increase in the main rate of corporation tax from 19% to 25% from 2023; and
• a temporary extension to the trading loss carry-back rules for companies and unincorporated businesses.

These measures may cause business owners to reconsider some of the approaches and decisions they have taken over the past few years. This article sets out details of these measures and indicates some of the implications they will have for decision making in the future.

Corporation tax rate change

From 1 April 2023, there will be two rates of corporation tax:

• the main rate of 25%; and
• the small profits rate of 19%.

The small profits rate will apply where ‘augmented profits’ are no more than £50,000. The main rate will apply otherwise, although marginal relief will be available where augmented profits are between £50,000 and £250,000.

Augmented profits are essentially taxable total profits plus tax exempt distributions (which includes most dividends), except those received from within a 51% group. 

Where marginal relief is available, it is calculated using the formula:

F x (U – A) x (N/A)

Where:

F = standard marginal relief fraction [3/200]

U = upper limit [£250,000]

A = augmented profits

N = taxable total profits

Where augmented profits are the same as taxable total profits (ie, there are no non-group dividends), companies eligible for marginal relief will pay tax at 19% on their first £50,000 of profits per annum and 26.5% on any profits in excess of this.

The limits of £50,000 and £250,000 are each reduced for periods of less than 12 months and divided by the total number of associated companies. An associated company is defined in the same way as it was when there were the last two rates of corporation tax. Essentially, companies are associated where one has control of the other or where they are both under the control of the same person or persons. All worldwide companies must be considered, but dormant companies and certain ‘passive’ holdings companies are excluded from the definition.

Close investment holding companies (ie, close companies that do not exist for a ‘permitted purpose’, such as trading or the commercial letting of property) will always be subject to the main rate of corporation tax and unable to use marginal relief.

Implications of increased corporation tax rate

One of the decisions that business owners often face is when, or if, to incorporate their existing self-employed business. Clearly, any increase in the rate of corporation tax will – considered on its own – make incorporation a less attractive option. A self-employed individual who pays tax at the additional rate will currently have a marginal rate of 47% on additional profits. Were those profits made in a company, and therefore subject to corporation tax (at the current rate) at 19%, and then extracted by way of dividend, the marginal effective tax rate would be slightly higher at 49.9%. Where the corporation tax rate of 25% applies in the future, this effective tax rate will increase to 53.6% – approximately equal to the effective rate that would apply if the profits were taken out as salary.

Of course, few business owners extract all their profits each year. The ability to store up profits without suffering income tax remains an attractive feature of a corporate vehicle. Each case will depend on its own circumstances, but the change in rates will move the focus away from incorporation to some degree.

Taking things slightly further, some company owners may, in the wake of the rate change, consider disincorporating their business. In doing so, however, they would need to bear in mind the potential tax costs involved. In particular, the company might trigger gains on the disposal of tangible and intangible assets to its owners. In addition, tax could arise in the hands of the owners depending on what they received from the company. A limited disincorporation relief was in place for a while, but this has now been removed.

Companies affected by the rate change may consider what they can do to ensure profits fall the ‘right side’ of the date of the change. Commercial factors, and the fact that the starting point for a company’s calculation of taxable profits is a set of accounts prepared under the accruals basis, will limit the extent to which this is possible. But there may, for example, be some scope to defer expenditure to ensure it attracts relief at 25%.

For companies with annual plant and machinery expenditure within the annual investment allowance (AIA), the introduction of the capital allowances ‘super deduction’ means there is no real incentive to defer qualifying capital expenditure beyond 1 April 2023. The reason for this is that the company should either benefit from the 130% upfront deduction at a corporation tax rate of 19% or make use of the 100% AIA at a corporation tax rate of 25% and achieve broadly the same outcome.

Companies may be reassured that if they make losses in the next couple of years, they can carry them forward into 2023 and beyond, and utilise them against profits otherwise chargeable to tax at the higher 25% rate. However, this will need to be weighed up against the possibilities created by the extension of the trade loss carry-back provisions.

Extension of trading loss carry-back provisions for companies

Generally, companies can make claims under s37, Corporation Tax Act 2010 (CTA 2010) to offset trading losses against total profits of the same accounting period and then against total profits of the preceding 12 months.

For accounting periods ending between 1 April 2020 and 31 March 2022, the 12-month period is extended to a three-year period, giving a much greater ability to take immediate advantage of trading losses (but not property business or other losses). Where a loss carry-back claim is made under these extended provisions, losses are set against profits of more recent years first.

The legislation here refers to ‘2020 claims’ and ‘2021 claims’. A 2020 claim is essentially a s37 claim relating to a loss incurred in an accounting period ending between 1 April 2020 and 31 March 2021 that could not have been made without the extended provisions. An equivalent definition exists for 2021 claims.

The legislation also refers to ‘de minimis 2020 claims’, and ‘de minimis 2021 claims’. These are claims that, along with claims for the relevant year that have already been made by the company, do not exceed £200,000.

These definitions then feed into the following detailed rules.

• For companies that are not members of groups, neither the total of any 2020 claims, nor the total of any 2021 claims, can exceed £2m.
• Companies that are members of groups may make de minimis 2020 claims, or de minimis 2021 claims, up to £200,000, without reference to the group as a whole. Non-de minimis claims can then be made such that total group claims for each year do not exceed £2m.
• A loss carry-back allocation statement is required where a group member is making a non-de minimis claim.
• In general, 2020 claims cannot be made at any time before 31 March 2021, and 2021 claims cannot be made at any time before 31 March 2022. Claims must be made in the company tax returns of the loss-making periods and this will be treated as an amendment to the earlier years to which the loss is carried back.

Claims should not have been made before the Finance Bill received Royal Assent on 10 June 2021, but they must be made within two years of the end of the loss-making period.

The following example shows these rules in practice. Sentry Limited makes the following trading profits/(losses):

Year ended 30 September 2017         £1,500,000

Year ended 30 September 2018         £3,500,000

Year ended 30 September 2019         £2,000,000

Year ended 30 September 2020         (£5,500,000)

Year ended 30 September 2021         (£4,500,000)

The trading losses for the year ended 30 September 2020 can be carried back against profits of the year ended 30 September 2019. The unused losses can then be carried back against profits of the year ended 30 September 2018, but subject to the cap of £2m (leaving profits of £1,500,000 for the year ended 30 September 2018, and unused losses for the year ended 30 September 2020 of £1,500,000).

The trading losses for the year ended 30 September 2021 can be carried back against the remaining £1,500,000 profits of the year ended 30 September 2018. Although the £2m cap has not been reached, the losses cannot be carried back any further.

What about income tax trading losses?

Sole traders and members of partnerships can typically make claims under s64, Income Tax Act 2007 (ITA 2007) to offset trading losses against other income of the tax year of the loss, or of the previous tax year (or of both tax years).

The provisions of s64, ITA 2007 are not being extended (in the way that s37, CTA 2010 is), but new carry-back provisions are being introduced that can be used where a claim under s64, ITA 2007 has been made (or where it could have been if there were sufficient profits). Under these rules, 2020/21 trading losses can be set against trading profits of 2018/19 and 2017/18, subject to a £2m cap. Similarly, 2021/22 trading losses can be set against trading profits of 2019/20 and 2018/19, again subject to a £2m cap.

Claims under these provisions must be made by the anniversary of the usual tax return filing deadline for the year of the loss (and again should not have been made before the Finance Bill received Royal Assent).

It is worth stating here that where a business owner receives a payment under the Self-Employment Income Support Scheme, this will form part of the trading result of the business to which it relates in the tax year it is received. If this payment turns a trading loss into a profit, then the business owner will be taxed on this profit and will not have a loss to carry back against profits of earlier periods.

The benefits of a loss carry back

Many businesses will want to make the greatest possible use of the extended loss carry-back rules to generate tax repayments and interest, which will be incredibly useful in the recovery, growth or even survival of the business.

In some cases, however, it may not be possible for group companies to make full use of the loss carry-back provisions because losses are in the ‘wrong’ company (possibly as a result of past group relief claims that cannot now be amended).

Some companies may be inclined to carry forward their losses to save tax at the increased corporation tax rate. Even if the company does not need cash now, it might still want to take full advantage of the loss carry-back provisions because being able to use the losses in the future relies on factors such as the trade continuing to be carried on, and the use of the losses not being restricted (for example, under the changes made to the loss carry-forward rules made in 2017), which may not be guaranteed.

About the authors

Andrew Constable, Partner, Moore Kingston Smith LLP and member of the Tax Faculty’s SME Business Tax Committee

Richard Jones, Business Tax Manager, Tax Faculty