The concept of associated companies is crucial for tax purposes in the UK, particularly in determining applicable Corporation tax rates and reliefs. HMRC enforces specific rules to ensure fair taxation and prevent businesses from artificially splitting operations to benefit from lower tax rates. Understanding the associated company’s rule is essential for business operating in the UK, to structure their business in a tax-efficient and compliance manner.
This article explores what constitutes an associated company, how HMRC assesses control, recent changes to tax rules, and key implications for business.
What is an Associated Company?
According to HMRC, company is considered associated company of another company if one of the two has control of the other, or both are under the control of the same person or group.
Control, in this context, is defined by reference to:
- Shareholding (owning more than 50% of ordinary share capital).
- Voting rights (holding more than 50% of voting power).
- Rights to greater part of assets in a distribution on a winding-up.
- Control over income, assets and affairs of the company.
When determining control, the rights and powers of certain persons can be attributed to another. Specifically:
- Nominee Rights and Powers: Any rights or powers of a nominee (someone acting on behalf of another) are considered as if they belong to the person they represent.
- Attribution of Rights and Powers: The following rights and powers may also be attributed to a person (P):
- Any company that P controls, or that P and their Associates control.
- Any two or more companies within the scope of (a) above.
- Any associate of P.
- Any two or more associates of P.
Do Non-UK Resident Companies fall under Associated company rules?
A non-UK resident company can be treated as an associated company if:
- It directly or indirectly influences a UK company's operations, AND
- It meets the control test as defined in UK tax legislation.
A Dormant Company (a company that is not actively trading or carrying out any business activities) is not usually counted as an associated company for tax purposes.
Key Changes from April 1, 2023
HMRC’s definition of associated companies was updated with the reintroduction of marginal relief for Corporation Tax from April 1, 2023. Under the revised rules:
- The small profits rate (19%) applies to companies with profits up to £50,000.
- The main Corporation Tax rate (25%) applies to companies with profits over £250,000.
- Marginal Relief applies to companies with profits between £50,000 and £250,000, leading to a tapered tax rate.
- The profit thresholds are divided equally among associated companies, reducing the eligibility for lower tax rates and marginal relief.
Implications of Associated Company Rules
Being classified as an Associated Company can have various tax and regulatory consequences, including:
Corporation Tax Thresholds
The number of associated companies affects how Corporation Tax thresholds are allocated. Companies with multiple associated entities may have to split their tax thresholds, potentially leading to higher tax rates.
Small Profits Rate & Marginal Relief
The availability of the small profits rate and marginal relief depends on the number of associated companies.
Group Relief & Loss Relief
Associated companies may be eligible for group relief, allowing losses to be transferred between companies to optimise tax efficiency.
Eligibility Criteria for the Group Relief
The eligibility criteria for group relief under HMRC's rules are as follows:
- Group Relationship: To qualify for group relief, the companies involved must be part of the same group. The basic requirement is that one company must be a 75% subsidiary of another, or both companies must be 75% subsidiaries of a third company.
- 75% Subsidiary: One company must own at least 75% of the ordinary share capital of another company, either directly or indirectly. This means the parent company must hold at least 75% of the shares in the subsidiary company.
- Common Parent: If two companies are not directly related, they can still qualify if they are both 75% subsidiaries of a third company, which is the common parent.
- Eligibility of Loss Surrendering Company: The company surrendering the loss (the "surrendering company") must have a trading loss, interest expenses, or other tax attributes that can be transferred to another group company.
- Eligibility of Receiving Company: The company receiving the loss (the "claimant company") must have a taxable profit that can be offset by the surrendered loss. This helps reduce the group's overall tax liability.
- Continuity of Ownership: For group relief to be valid, there must be continuity of ownership during the relevant period. This means that the ownership structure of the companies involved in the relief must remain stable.
- Beneficial Ownership: The relationship must be based on beneficial ownership of shares, not just legal ownership. The parent company must have the right to control the economic benefits from the shares.
- Anti-Avoidance Provisions: Specific anti-avoidance rules apply to prevent tax avoidance, such as preventing companies from shifting losses to unrelated companies or artificially creating group structures to claim relief.
Example Covering all Implications
Company A owns two associated companies, B and C. The corporate tax threshold of £50,000 (small profits rate) and £250,000 (main rate threshold) must be split equally among the three companies.
Tax Threshold Allocation:
- Small profits threshold: £50,000 ÷ 3 = £16,667 per company
- Main rate threshold: £250,000 ÷ 3 = £83,333 per company
Taxable Profits:
- Company A: £10,000
- Company B: £60,000
- Company C: £100,000
Assuming no other allowable deduction.
Tax Rates:
- Small profits rate (19%) applies up to £16,667.
- Marginal relief applies between £16,667 and £83,333.
- Main rate (25%) applies above £83,333.
Tax Calculation:
- Company A (£10,000 profit)
This profit falls below the reduced threshold as well. So, tax liability would be £1,900 (£10,000*19%).
- Company B (£60,000 profit)
Here, the marginal relief would apply as it falls between the reduced lower and upper threshold.
Tax due at 25% | £60,000*25% = £15,000 |
Less: Marginal Relief [(U-A) *F*N/A] | (£83,333-£60,000) *3/200 = (£350) |
Tax Due | £14,650 |
Here,
F = Standard Marginal relief fraction (3/200)
U = Upper limit
A = Augmented Profits
N = Taxable Total Profit
Augmented Profits = Total Taxable Profit + Exempt distribution from non-associated company.
In simpler terms, augmented profits are the total profits of the company plus certain types of income or distributions from companies that are not part of the same group but are still considered for tax purposes. These exempt distributions can include things like dividends, asset distributions, or situations where assets or liabilities are transferred or share capital is repaid, which are treated as distributions.
- Company C (£100,000 profit)
This profit of C has exceeded the reduced Upper Threshold. So, it will be taxed on higher main rate (25%)
Tax due = £100,000 *25% = £25,000
Total Tax Liability Across Companies:
£1,900 + £14,650 + £25,000 = £41,550
Impact of Group Relief & Loss Relief:
If Company A had a loss of £10,000, it could offset against Company C’s profit, reducing its taxable amount to £90,000, lowering the overall tax liability.
This example illustrates how associated companies split tax thresholds, qualify for marginal relief, and benefit from group relief.
Implication of Company not Associated
If the Companies were not associated, then the threshold would not be reduced, and the small rate would still apply to Company A as it is below the small profit threshold of £50,000. Company A would be liable for the same tax due.
For Company B
The marginal relief would still apply as it falls between the lower (£50,000) and upper threshold (£250,000).
Tax due at 25% | £60,000*25% = £15,000 |
Less: Marginal Relief [(U-A) *F*N/A] | (£250,000-£60,000) *3/200 = (£2,850) |
Tax Due | £12,150 |
For Company C
This would now fall between the small rate threshold and upper threshold. So, the marginal rate relief would apply to company C.
Tax due at 25% | £100,000*25% = £25,000 |
Less: Marginal Relief [(U-A) *F*N/A] | (£250,000-£100,000) *3/200 = (£2,250) |
Tax Due | £22,750 |
Total Tax Liability Across Companies:
£1,900+£12,150+£22,750 = £36,800.
From these two results, the tax due under associated company is more than companies which are not associated by £4,750 (£41,550 - £36,800).
Key Exemptions Under Associated Company Rules
Passive Holding Companies Exclusion
A company is not considered an associate if it is a passive holding company, meaning it only receives dividends from subsidiaries and distributes them to shareholders without engaging in other financial activities.
Substantial Commercial Interdependence Criteria
Companies owned by the same person(s) are not automatically associated unless they exhibit substantial commercial interdependence based on the following factors:
- Financial Interdependence: If one company provides financial support or has a financial interest in another.
- Economic Interdependence: If companies share common economic objectives, benefit from each other’s activities, or have common customers.
- Organisational Interdependence: If businesses share management, employees, premises, or equipment.
Special Cases in Determining Control
Best Practices for Compliance and Risk Mitigation
Business should take proactive steps to remain compliant with HMRC’s associated company rules:
- Regularly Review Corporate Structure: Companies should periodically assess their ownership and control structures to identify associated entities.
- Document Intercompany Transactions: Maintain records to justify financial relationships and avoid scrutiny.
- Seek Professional Advice: Tax professionals and legal advisors can provide guidance on structuring business entities to optimise tax efficiency while ensuring compliance with HMRC regulations.
Conclusion
Understanding associated company rules is vital for businesses in the UK to manage their tax liabilities effectively. With the recent changes in Corporation Tax rules, businesses should carefully assess their structures and seek professional guidance to navigate these regulations. Staying informed and compliant will help businesses avoid unnecessary tax burdens and penalties from HMRC.
Moreover, by proactively monitoring corporate structures and financial interdependencies, businesses can identify potential tax-saving opportunities and mitigate risks associated with non-compliance. A well-structured approach to associated company rules can ensure long-term financial sustainability and improved tax efficiency. Keeping up with HMRC guidelines and industry best practices will enable businesses to operate smoothly while maximising their financial benefits. Ultimately, a strong understanding of these regulations not only ensures compliance but also positions businesses for future growth and stability.
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