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.