Budget 2021: the Small Profits Rate, as welcome as it seems for contractors?

Despite being broadly welcomed initially by the FSB and other business cheerleaders, the Small Profits Rate announced at Budget 2021 might not go down so well with contractor limited companies, writes Chris James, director of accounting services at JSA Services.

Profits, not turnover

First and foremost, the new measure will affect many contractors working through a PSC on an outside IR35 basis. But these contractors should remember that sensible tax planning, such as using pension contributions where appropriate to reduce taxable profits, could significantly help them remain in the 19% tax band. After all, when it arrives in April 2023, the Small Profits Rate (SPR) is concerned only with taxable profits, not turnover. So a company with £50k or less in profits will remain on the 19% rate that they pay to HMRC today.

However due to the complex way corporation tax is calculated when more than one rate applies, the impact for a contractor limited company will be that for each pound of taxable profit the company makes over £50,000, an effective marginal rate of 26.5% will apply. 

Your 26.5% rate (cont.)

Above £250,000, the overall rate, and effective marginal rate settles at 25%. The overall impact is that the overall rate of corporation tax grows from 19% to 25%, as you move from £50k of profits to £250k. But the marginal rate of 26.5% is of course steeper than those headline rates, so it certainly pays to look beyond the figures which the government is ‘selling’ this incoming tax change on.

All that said, corporation tax rates have been flat for some years now -- since the end of financial year 2014 in fact. The political backdrop is equally interesting – it means chancellor Sunak is the first chancellor to increase taxes on businesses since Dennis Healey in 1974.

Punishment for outside IR35 contractors

But back to 2014. At that time, the rate of tax started to increase at a hefty £300,000 of profits, not the £50,000 we see coming down the pipe now. In addition, the top rate of tax was much less than the 25% being introduced to bite from April 2023. So it’s therefore understandable that contrary to the applause the SPR got coming out the blocks on March 3rd, successful outside IR35 contractors feel that yet again, they are being singled out for punishment.

It should also be noted that with the reintroduction of starting rates for corporation tax (the ‘old’ 19% rate becomes the starting rate, with the full 25% being the ‘main’ rate thereafter), comes sharing the starting rate band among the companies owned by a single owner or group of owners. 

A further sting

Known as the ‘associated company rules’, this means that if a contractor owns two companies, each will only have to reach a modest £25,000 of profits before the 26.5% marginal rate stings. The rate continues up to £125,000 each.

So tidying up corporate groups, or getting rid of spare companies if you were an ambitious contractor who overextended themselves by setting up an extra PSC, will be worth looking at for the next two years. It also means that contractors who want to concentrate on their ‘Plan A’ might need to look at making their largely unused ‘Plan B’ fully dormant. Another reason, then, that in the contractor sector at least, this small profits rate might have a smaller band of followers than first thought.

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Written by Chris James

Chris James BFP FCA is a Chartered Accountant who regularly speaks on taxation matters affecting Limited Company contractors, umbrella workers and the recruitment supply chain. He is is head of limited company solutions at Workwell.
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