UK: Associated Companies Rules For The Small Profits Rate Of Corporation Tax

Introduction

Finance Bill 2011amends s27 of CTA2010 so that where there is no substantial commercial interdependence between two companies, they will only be under common control for the purposes of the small profits rate by assessing control under CTA10 s451 ignoring the interests of any associate of a person or company (i.e. ignoring attribution according to CTA10 s451(4) and s451(5). This has effect for accounting periods ending on or after 1 April 2011. However a company may elect that this new rule does not take effect in relation to an accounting period beginning before 1 April 2011, the election having to be made within one year of the end of that accounting period (i.e. a 12m deadline rather than a two year deadline).

The draft regulations issued on 31 March 2011 (and effective for accounting periods ending on or after 1 April 2011) set out the factors to be considered when determining whether there is substantial commercial interdependence. HMRCs draft guidance on how these regulations work in practice has also been issued. As a reminder companies are associated if they are associated for any part of the accounting period (CTA10 s25); it is not sufficient to only consider the position at the year end. Thus the new rules will already apply to any company with a 12 month accounting period commencing on or after 1 April 2010, unless an election to disapply them is made. Companies that could be disadvantaged by the new rules could include those which are associated through the interests of partners, but where there are no tax planning arrangements, and where the companies would be regarded as being substantially commercially interdependent.

Existing rules - accounting periods ending on or before 31 March 2011

By way of reminder, companies are associated if they are under the common control of a person (or persons together). The thresholds for small profit rate of corporation tax (£300,000 and £1,500,000) are reduced where there are associated companies, resulting in less profit being taxed at the small profits rate and more at the marginal and main rates. The test for whether companies are associated is based on the rules governing 'control' of a company set out in s450 of the Corporation Tax Act 2010.

To determine a person's control, you have to attribute the rights of their associates to them. 'Associates' include relatives (spouse/civil partner, parents and remoter forebear, children and remoter issue, siblings) and certain trustees. By concession (ESC C9), HMRC will not attribute the rights of parents (or remoter forebear), children who are not minors (or remoter issue) or siblings to a person when determining control of companies as long as there is no 'substantial commercial interdependence' between the companies in question. Where a person's associates include a partner, the interests of the partner are only attributed to that person if tax planning arrangements exist between the person and the partner that secure a reduction in the taxpayer company's liability to corporation tax.

New rules - accounting periods ending on or after 1 April 2011

Two or more companies will continue to be associated if a person (or persons together) control them. However, the rights of his/her associates will only be attributed to that person for determining control for this purpose if there is 'substantial commercial interdependence' between the companies. There are two important points to note.

The factors used to determine substantial commercial interdependence between companies are any of the following:

• financial interdependence - where one company gives financial support to the other or they share financial interests in the same business;
• economic interdependence – in particular where companies seek the same economic objective, the activities of one company benefits the other or the companies have common customers; or
• organisational interdependence – in particular where companies share common management, common employees, common premises or common equipment.

The draft guidance covers various scenarios in each of these three categories. These tests are clearly subjective and a view will need to be taken on each case, bearing in mind HMRC guidance at the time if appropriate. An example given of substantial financial interdependence includes a loan between two companies that could be associated through common control. No mention is made of the impact of the existence or otherwise of arms length terms for this situation, though from other examples in the guidance it is doubtful whether this would influence the outcome.

One of the characteristics specified in the Statutory Instrument denoting 'organisational interdependence', is the sharing of common premises. The draft guidance includes an example of a husband and wife each operating separate companies from the family home owned by the wife, which apart from operating from the same premises and sharing the domestic phone line, have no other financial, economic or organisational links. The guidance indicates the companies in this example would not be regarded as substantially interdependent, despite the fact that husband's company could not afford to operate from other premises.

The guidance does not cover every situation and comments that each situation would depend on its own specific facts and circumstances. One example demonstrating organisational interdependence in HMRC's view is of two companies with a common director, all transactions between related parties being on arms length terms, one involved in wholesale activity for the building trade, and one concerned with retail building trade activity, both operating from the same premises owned by one of the directors. However no example was given of two companies with no links apart from having common directors (it is likely each situation will depend on specific facts).

For the avoidance of doubt, there is no need to consider substantial commercial interdependence where a person or persons control two or more companies outright (whether by shares, rights to more than 50% of assets on a winding up, or other means of control). These companies remain associated even if there are no other links between the companies.

Planning opportunity

According to the Treasury, the policy intention behind the new rules is to stop companies being associated by 'accident of circumstance'. In some family situations, e.g. husband controls one company and wife controls another, and there are no other links (as defined above) between the two companies. These companies are currently associated companies but should cease to be so under the proposed rules.

This may be an opportunity to review potentially associated corporate clients to see if the association between companies can be broken in time for the implementation of these new rules, and indeed whether a change of accounting date would be effective. For example, if there are two companies with no financial/economic/organisational links, both currently owned 51% by the husband, one possibility might be to move shares (subject to any IHT considerations!) to break the association by giving control of one company to the wife.

Consideration would need to be given to HMRC's guidance on what substantial commercial interdependence means. It may also be beneficial to ensure that husband and wife are not each directors of both companies, but it will be necessary to consider the Entrepreneurs' Relief condition that requires a person disposing of shares to be an employee or officer (director or company secretary) of the company to enable the disposal to qualify for the beneficial rate of CGT (subject to the other conditions).

With all planning it is necessary to bear in mind the cost of any restructuring compared to the actual benefit. Assuming a main corporation tax rate of 26% and a small profit rate of corporation tax of 20%, and if one company has a profit of £10,000 while the other has a profit of £290,000, the annual corporation tax saving from not being regarded as associated is £10,500. For two companies each with profits of £600,000, the potential annual corporation tax saving from not being associated is £22,500. Any potential savings from this planning will diminish as the main rate and small profit rate come closer together.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.