Contractors’ Questions: How can my corporation tax rate leap to 26.5% from April 6th 2023?

Contractor’s Question: The government’s corporation tax page fails to mention the 26.5% rate on contractor profits which some advisers are warning about. Barring a U-turn at Spring Budget 2023, is this new 26.5% rate really a thing, and how does it come about?

Expert’s Answer: You sound aware that corporation tax rates for limited companies are changing, notably for those companies with taxable profit in excess of £50,000. 

And it’s good you’re asking this question about the rate-changes now. Given that many contractors take a small salary and the rest of their income as dividend (which comes out of taxed profits), this change is likely to affect a significant number of limited company contractors when it is introduced on April 6th 2023.

Good-ish news

The good news (sort of) is that the new tax rate of 25% only applies if the profit is over £250,000. 

Between £50,000 and £250,000, the overall rate will be between 19% and 25%. Profits falling within these two thresholds will be taxed at 25% minus a relief calculated at 1.5% of the difference between £250,000 and your profits.

Limited company profits example of £100,000

For example, if the profits are £100,000, they are taxed at 25% (£25,000), and then relief is given at 1.5% x (£250,000 - £100,000) = £2,250. So, the tax due to HMRC would be £22,750. This compares to the less swingeing £19,000 tax bill if the corporation tax rate had remained unchanged at 19%. And remember, that 19% will apply to your limited company assuming its profits stay below £50,000.

But you are correct to say the effective tax rate is higher than 25%. Us accountants get very excited about ‘effective’ tax rates!

Limited company profits example of £60,000

The effective rate on profits over £50,000 under the new corporation tax regime from April 6th 2023 is calculated in the following breakdown, where I’ve used profits of £60,000 as an example:

Profit: £60,000  

Corporation Tax: £60,000 x 25% - 1.5% x (£250,000 – £60,000) = £15,000 - £2,850 = £12,150 in HMRC liabilities.

Tax had profit been £50,000: £50,000 x 19% = £9,500.

Where the 26.5% corporate tax rate bites

The addition corporation tax due as a result of profits if £10,000 over the threshold: (£12,150 - £9,500) = £2,650.

So, the effective tax rate on the additional £10,000 profit is 26.5% (2,650/10,000).

Therefore tax of £12,150 is payable on profits of £60,000; equating to 20.25% which, as expected, is between 19% and 25%.

But the £10,000 has indeed suffered tax at 26.5%. That is higher than the 25% rate and as you say, isn’t being expressly pointed out by the government in its official guidance.

The expert was chartered accountant Graham Jenner, founder of contractor accountancy firm Jenner & Co.

Wednesday 1st Mar 2023
Profile picture for user Graham Jenner

Written by Graham Jenner

Graham is a Chartered Accountant and has run his own accountancy practice, Jenner Accountants Ltd, for over 20 years and is the MD of Nopalaver Group, which provides Umbrella company and other services to contractors. He specialises in dealing with family run businesses and contractors, supported by a strong team including 5 qualified accountants.

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