What are associated companies and why do they matter?
Back in the halcyon days of 2015, before Brexit, before Covid, before the war in Ukraine, when mortgages were still affordable and anything higher than a ‘nul points’ score for the UK at Eurovision was considered to be a resounding success, we were happily bestowed with a rare gift from the Chancellor. The tax rules were to be simplified.
It was hard to believe. You see, for many years we had constantly been told the tax laws were being ‘simplified’ but simplification almost always revealed itself to be a smoke screen for a labyrinth of complex new rules. In reality, ‘simplification’ has resulted in the UK tax legislation being the longest in the world with over 10 million words, being more than five times longer than the complete works of Shakespeare and the Harry Potter series combined.
But this time it was true. The complicated ‘associated company rules’ were to be replaced with the straightforward and clear ‘51% related group company rules’, alongside a single corporation tax rate. Overnight, it became much easier for businesses to work out how much corporation tax they needed to pay and when they had to pay it. A company was a 51% related group company if it was more than 50% owned by another company. Simples.
But, of course, all good things must come to an end. The reintroduction of the full and lower corporation tax rates this year has meant the return of an old foe. The associated company rules are back.
But not to fear, the rules are tricky but I hope I can help to ease some of the pain by explaining some of the key points.
Why do the associated companies rules matter?
They matter because they determine the rate at which corporation tax is payable and the speed at which those payments must be made.
The rules are complicated and companies may be pushed into the higher rates of tax and quarterly instalments regime unexpectedly.
With interest rates for late payment of corporation tax rising to 6.75% in April (5.25% for quarterly instalments), compared with only 2.6% three years ago (1.1% for quarterly instalments) the cost for companies getting the number of associates wrong can be significant.
What are the associated companies rules?
Companies under the control of the same person or persons are ‘associated’. When working out the corporation tax rate and the quarterly instalment limits, it is necessary to divide the relevant threshold by the number of “associated companies” to decide which tax rate/ tax payment regime applies.
For example, in terms of the corporation tax rate, from April 2023 companies will pay an effective rate of 19% on taxable profits of up to £50,000, 26.5% on the slice of profits between £50,000 and £250,000 and 25% on profits of £250,000 and over. However, when there are two associated companies we divide each profit threshold by two, so that the 25% rate kicks in for each company when its profits exceed £125,000, instead of £250,000. The more associated companies there are, the lower the profit threshold will be for each tax rate band.
In terms of the timing of tax payments, companies with taxable profits of less than £1.5m normally pay their corporation tax in one lump sum 9 months after the company’s year end. When profits exceed £1.5m for two consecutive accounting periods, the entire corporation tax liability for the second period has to be estimated before that year-end and paid in quarterly instalments, starting 7 months into the second year. But where there are two associated companies, the threshold is reduced to £750K for both companies.
Very large companies with profits of £20m or more have to pay their corporation tax even earlier. They must pay quarterly instalments during the first year they expect profits to reach this level and starting in month 3, rather than in month 7 of year 2. The £20m threshold is also similarly reduced when there are associated companies.
Depending on where profits fall, one group company could be paying corporation tax at 25% and in quarterly instalments, while another pays at 19% 9 months after the year end. If so, the directors may wish to consider whether management charges between the companies are appropriate.
The more associated companies there are, the sooner the higher tax rates apply and the earlier the quarterly instalment regime kicks in for each company. The only saving grace is that if the corporation tax liability is less than £10,000 the quarterly instalment rules do not apply, so this protects companies with low profits but which happen to have a very large number of associates.
What are associated companies?
Associated companies are those under control of the same person or persons. This includes group companies (as with the 51% related company test) but it also includes the situation where an individual owns companies which are not in the same group.
For example: Mrs A is the sole shareholder of both company 1 and company 2. Until April 2023 there had been no 51% related group companies, but afterwards there are two associated companies because Mrs A controls them both. This means that she will need to divide her profit thresholds by two to determine the corporation tax rate and the quarterly instalment limit. So if either company has taxable profits of over £750K for two consecutive periods it will come into the quarterly instalments regime.
It does not matter which country a company is resident, any worldwide companies can be associated. However dormant and inactive companies are excluded.
Holding companies which only receive and pay out dividends are also specifically excluded, provided that they have no assets other than shares in their 51% subsidiaries. This means that holding companies with inter- group assets and liabilities on their balance sheet, for example, may be less likely to qualify for the exclusion.
In the past HMRC seems to have taken a fairly relaxed view as to whether a company is ‘inactive’ or not, but it is possible they may pursue this more keenly in the future. Now that late payment interest rates are rising, there is potentially more for HMRC to gain from enquiring into this area.
For group companies, it is not necessary to multiply down through the group shareholding structure to determine ‘control’. For example where a parent company has a 51% subsidiary which in turn has its own 51% subsidiary, all 3 companies will be associated.
When does a person have control of a company?
‘Control’ means having the power to dictate the company’s affairs. It covers a wide range of situations such as holding the majority of the ordinary share capital, the voting rights, or the rights to capital and profits on winding up. It also includes the position where a person is able to exercise control, even if they do not actually do so in practice, or where they are entitled to acquire control at some future date. A ‘person’ can be a company, an individual or a trustee.
So far, so straightforward. However, the associated companies test can be complicated because it is also necessary to attribute the rights and powers of any ‘associates’ when determining whether a person has control.
What are ‘associates’ for associated company purposes?
An associate includes a relative, such as a sibling, spouse, parent or grandparent (but not aunts/ uncles/ in-laws) a business partner (in a partnership) or a trustee of a trust connected with you or your close family.
So, for example, if Mrs A controls company 1 and her husband Mr A controls company 2, the rights of Mr A are attributed to Mrs A and the companies are associated (subject to the ‘commercial interdependence test’ explained below).
Only the rights of a person’s associates are attributed to them for these purposes. There is no need to attribute the rights of associates of associates.
However there is no need to attribute the rights of associates if there is no ‘substantial commercial interdependence’ between the companies.
What does substantial commercial interdependence mean?
It means that the companies are in some way dependent on one another, whether that be financial (e.g. supporting loans between the companies), economic (for example where one company’s activities support/ benefit the other) or organisational (such as operating from the same premises with the same management team). It is not necessary for all three types of dependency to exist, one alone may be sufficient. Each case must be considered in the round and will depend on its specific circumstances.
Where there is interdependence, the rights of associates need to be attributed. Where there is no interdependence, the rights of associates can be ignored.
Nevertheless, even if there is no substantial commercial interdependence between the companies, two companies can still be associated if they are directly controlled by the same person (whether by virtue of share capital or one of the other ‘control’ tests referred to above). It is not always straightforward.
How do you establish the number of associated companies where more than one person has control?
Unfortunately that is not the end of the story. Where no single person alone controls the company, we have to consider whether the control test is met by a group of persons. This is known as the ‘minimum controlling combination’ test.
The test is met where a group of persons have control of a company when taken together, but would not have control if any of them were excluded from the group.
For example, if company 1 is jointly owned by Mrs A, Mr Y and Miss Z, there are 3 possible minimum controlling combinations, being either A and Y, or Y and Z or A and Z. If any of those three parings also control another company (for example A and Z also jointly owning company 2 together) the companies will be associated.
When do the associated company rules start?
For quarterly instalment purposes, the new rules apply for accounting periods starting on or after 1 April 2023. So, for example, companies with a year ending 31 December will need to apply the rules from 1 January 2024 onwards. If a company is associated at any point during the accounting period, it will be treated as associated for the entire year.
For the purposes of working out the applicable rate of corporation tax, it is necessary to look at the number of associated companies from 1 April 2023 onwards. Profits arising in an accounting period straddling 1 April 2023 will be split into 2 notional periods. The first notional period will be for profits arising in the period to 31 March 2023, and will be subject to corporation tax at 19%. The second notional period will be for profits arising from 1 April 2023 onwards, and will be subject to the new corporation tax rates noted above and the associated companies rules.
The ‘associated companies’ rules will clearly act as a wider net to bring more companies into the higher rates of tax and earlier tax payments. They will also undoubtedly catch situations where there was no intention to establish a link between companies and may catch some shareholders by surprise, with a large late interest payment charge if they get it wrong. Unfortunately the truth is that the tax code shows no sign of simplification yet. But I am still hopeful!
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