With the corporation tax rate increasing from 19% to 25% from 1 April 2023, there are some potential pitfalls for companies to look out for.
The first pitfall is for companies where their accounting period ends on anything other than 31 March. Corporation tax is charged per Government ‘financial year’ which runs from 1 April to 31 March. Where a company has an accounting period which straddles two ‘financial years’, it is necessary to apportion the profits on a strict time basis between the two years and charge the corporation tax rate set for that year on the profits apportioned to that year.
This has little practical implication where the corporation tax rate is the same for the two years in question, however, where the accounting period straddles a rate change, this could result in additional tax being paid due to the strict time apportionment of profits.
Take for example a company with a 12-month accounting period ending 31 December 2023 - Three months fall into one financial year where the corporation tax rate is 19% and nine months into the financial year where the corporation tax rate is 25%.
In anticipation of the rate change the directors of the company decided to dispose of investment properties in February 2023, thinking that profits from these disposals would be charged solely at the rate of 19%. Unfortunately, due to the way corporation tax is charged, these profits are apportioned across the entire year. Three months at 19% and nine months at 25% resulting in a blended rate of 23.5% applying to profits of the entire year.
If it is appropriate to do so, the directors of a company may wish to consider changing a year end or shortening an accounting period where there might be an unusually large transaction in the year to avoid the higher blended rate of corporation tax applying.
The other pitfall with a rate change can apply even to companies with a year end of 31 March. This is where the date on which a transaction is taken into account for tax might differ to the date on which, for example, the contract is signed.
One example is where a company disposes of a capital asset. The disposal date for a company's chargeable gain is the date on which the contract for sale becomes unconditional. For some contracts it is easy to identify, it is simply the date the contract is signed if there are no conditions within the contract to fulfil.
An example where the date of disposal for tax purposes diverges from the date of signing would be land being sold subject to planning permission. If a contract was signed on 1 January 2022 and it was conditional on planning permission being granted, no contract comes into existence until that planning permission is granted.
If permission was granted on 1 June 2023 the disposal date for that asset for tax purposes would be 1 June 2023. If the company had a 31 March year end, the disposal should be reflected in the tax return for the financial year ending 31 March 2024 rather than the return for the financial year ended 31 March 2022. This is two tax returns later than the period in which the contract was originally signed. Any profits from the disposal would also be taxed at 25% rather than 19%.
It is very important that company directors and shareholders pay close attention to the dates on which any large transactions may potentially take place so they can identify the potential period and tax rate which might apply, as well as any possible advance planning to mitigate the tax charge.