A level playing field
Andrew Harrington discusses marginal relief on corporation tax for companies whose accounting periods straddle two financial years, and how it makes the tax liability fair for those with high profits
UK resident companies pay corporation tax on all of their income and chargeable gains (unless exempt – for example, dividends from UK companies), wherever in the world those profits or gains arise. Taxable income and gains for an accounting period are aggregated; this total is called profits chargeable to corporation tax (PCTCT). Accounting periods are usually the same as periods of account (i.e. the periods for which the company prepares accounts), but are not allowed to be more than 12 months’ long. If a company has a longer period of account, it is split into two accounting periods for corporation tax purposes: one of 12 months, and one of the remainder.
The rate of corporation tax charged depends on the level of profits. For the financial year 2007 (1 April 2007–31 March 2008), there are two rates of corporation tax:
• 20 per cent (small companies rate) if profits do not exceed £300,000; and
• 30 per cent (main rate) if profits exceed £300,000.
Applying these rates with no amendment may lead to unfairness: if profits are £300,000, they will be taxed at 20 per cent; but if they are £300,001, they will all be taxed at 30 per cent – thus increasing the tax liability by over £30,000 for a profit increase of £1. To combat this, marginal relief is available for companies whose profits exceed £300,000 but are less than £1.5 million. Tax is calculated at 30 per cent, but the resulting liability is reduced by an amount calculated using the following formula:
Here, Mis the upper limit (£1.5 million for a 12-month accounting period), I is PCTCT, and Pis profits. Profits are calculated as PCTCT plus franked investment income (dividends received from UK companies plus the related tax credit). For the financial year 2007, the fraction is 1/40 – prior to this year, it was 11/400.
A further issue may arise if a company has an accounting date other than 31 March, because its accounting period will then fall partly in one financial year and partly in another. If the rates of corporation tax, or the limits, or the marginal relief fraction have changed, then corporation tax must be calculated for each financial year (and then summed to get the overall liability).
For example, consider a company that has the following results (adjusted for tax purposes) for the year ended 31 December 2007:
PCTCT is calculated as £320,000 + £130,000 + £80,000 = £530,000. Note that the dividends from UK companies have been omitted – as mentioned above, they are exempt from corporation tax because they have been paid out of profits that have already been taxed. However, they must be grossed up to get franked investment income (£180,000 x 100/90 = £200,000), and added to PCTCT to get profits:
An important distinction must be made here. The company will be taxed on PCTCT of £530,000, but the profits of £730,000 are used to determine which rate of tax is applicable.
The upper and lower limits of £1.5 million and £300,000 have not changed from the financial year 2006, and the profits of £730,000 fall between these limits, so the company will pay corporation tax at 30 per cent less marginal relief.
Because the marginal relief fraction has changed, it is necessary to timeapportion the PCTCT and profits between financial years 2006 and 2007:
The corporation tax liability is then calculated as follows:
Total corporation tax liability for the year ended 31 December 2007:
Note that the upper limits in the marginal relief calculations have been scaled down. Only three months of profit fall in FY 2006, so the upper limit is £1,500,000 x 3/12 = £375,000. The remaining nine months fall in FY 2007, so the upper limit is £1,500,000 x 9/12 = £1,125,000.
Note also that the tax rate applied was 30 per cent in both years, so a small shortcut could have been used – the rate could have been applied to the total PCTCT and then the two amounts of marginal relief calculated as above:
