Marginal Corporation Tax Relief: How It Works and How to Save Tax

Understanding corporation tax is essential for businesses looking to manage their finances and reduce unnecessary tax costs. While marginal relief is designed to make the transition between the small profits rate and the main corporation tax rate smoother, it can sometimes result in a higher effective tax rate on profits within a particular band.

However, with careful tax planning, businesses may also be able to use this higher effective rate to their advantage and secure valuable tax savings.

Understanding Corporation Tax and Marginal Relief

Under the current UK corporation tax rules, companies with taxable profits of £50,000 or less generally pay corporation tax at the small profits rate of 19%. Companies with profits exceeding £250,000 are subject to the main corporation tax rate of 25%.

For companies with profits between these two thresholds, marginal relief applies.

The purpose of marginal relief is to gradually increase the corporation tax liability rather than allowing the tax rate to jump immediately from 19% to 25%.

However, there is an important point that businesses should understand. Although marginal relief reduces the overall corporation tax bill, the effective tax rate on each additional pound of profit within this band can reach 26.5%. This is higher than the main corporation tax rate of 25%.

How Is Marginal Relief Calculated?

Marginal relief is calculated by first applying the main corporation tax rate of 25% to the company’s taxable total profits. The marginal relief amount is then deducted from the resulting tax liability.

The calculation uses the following formula:

F × (U – A) × (N ÷ A)

Where:

• F = Marginal relief fraction (3/200).
• U = Upper profits limit.
• A = Augmented profits.
• N = Taxable total profits.

Augmented profits include certain exempt distributions received from companies that are not members of the same group. Where no such distributions arise, augmented profits will generally be equal to taxable total profits.

The way this calculation works means that marginal relief gradually decreases as company profits increase. Consequently, every additional £1 of profit within the marginal relief band can result in 25p of corporation tax and a further 1.5p through reduced marginal relief.

This produces an effective marginal tax rate of 26.5% on profits within the band.

It is important to remember that this does not mean the company’s entire profit is taxed at 26.5%. Its overall average corporation tax rate remains between 19% and 25%. The 26.5% rate applies only to the additional profits falling within the marginal relief band.

Worked Example: Calculating Marginal Relief

Consider a company with taxable profits of £60,000 for the accounting period ending 31 March 2027.

Its corporation tax liability would be calculated as follows:

Step 1: Calculate corporation tax at the main rate

£60,000 × 25% = £15,000

Step 2: Calculate marginal relief

3/200 × (£250,000 – £60,000) × (£60,000 ÷ £60,000)

= £2,850

Step 3: Deduct marginal relief

£15,000 – £2,850 = £12,150

To understand the impact, compare this with the tax payable on the first £50,000 of profits:

£50,000 × 19% = £9,500

The company has made an additional £10,000 in taxable profits. The additional corporation tax payable is therefore:

£12,150 – £9,500 = £2,650

This means the additional £10,000 of profits is effectively taxed at 26.5%.

How Associated Companies Can Increase Your Corporation Tax Liability

Businesses with associated companies need to pay particular attention to marginal relief, as having associated companies can bring the higher effective tax rate into effect at a much lower level of profits.

Companies are generally considered associated where one company controls another, or where both companies are controlled by the same person or group of people.

Control can include having the right to more than 50% of a company’s share capital, voting rights, distributable profits or assets available on a winding-up.

In certain circumstances, family ownership may also be relevant. The rules consider substantial commercial interdependence between companies, including financial, economic and organisational connections.

Where a company has associated companies, the £50,000 lower profits limit and £250,000 upper profits limit are divided by the total number of associated companies, including the company itself.

For example, if a company has two other associated companies, there are three companies in total. Its corporation tax thresholds would therefore be reduced as follows:

• Lower profits limit: £50,000 ÷ 3 = approximately £16,667.
• Upper profits limit: £250,000 ÷ 3 = approximately £83,333.

As a result, marginal relief may apply at considerably lower profit levels.

It is also worth remembering that a company can count as an associated company even if the association exists for just one day during the relevant accounting period.

The corporation tax thresholds are also reduced proportionately where the accounting period is shorter than 12 months.

Can the 26.5% Marginal Rate Create Tax-Saving Opportunities?

Although an effective tax rate of 26.5% may initially appear unfavourable, it can create opportunities for businesses to obtain greater tax relief on qualifying expenditure.

For every £1 of allowable tax-deductible expenditure that reduces profits within the marginal relief band, a company could save 26.5p in corporation tax rather than 19p or 25p.

This makes the timing of certain business expenses particularly important.

1. Bringing Forward Qualifying Business Expenditure

Where a company expects its taxable profits to fall within the marginal relief band, bringing forward commercially justified expenditure could help maximise available tax relief.

For example, qualifying assets that benefit from 100% capital allowances may provide tax relief at an effective rate of 26.5%, depending on the company’s circumstances and the relevant capital allowance rules.

If a business is approaching its accounting year-end, it may be worth reviewing planned purchases and considering whether making an eligible purchase before or after the year-end would produce a better tax outcome.

2. Making Employer Pension Contributions

Employer pension contributions can also be an effective way of reducing a company’s taxable profits.

For example, a qualifying employer pension contribution of £1,000 could generate a corporation tax saving of up to £265 where the full deduction reduces profits within the 26.5% marginal relief band.

However, pension contributions must meet the relevant tax rules, and businesses should consider the wider financial implications before making payments.

3. Considering Bonus Payments

Paying bonuses to directors or employees may also reduce a company’s taxable profits. However, this needs careful consideration.

Although a bonus may provide corporation tax relief, employer National Insurance contributions and the recipient’s personal income tax position could affect whether it is worthwhile.

There are also timing rules to consider. Generally, a bonus accrued at the accounting year-end must be paid within nine months of the end of the accounting period to obtain a deduction in that period. Otherwise, tax relief is normally deferred until the period in which the bonus is actually paid.

Practical Considerations for Business Owners

Marginal relief can make corporation tax planning more complicated, particularly for businesses with profits close to the £50,000 or £250,000 thresholds.

Before the end of each accounting period, businesses should review their expected taxable profits, associated company position and planned expenditure.

Bringing forward qualifying purchases or making employer pension contributions could help secure tax relief at an effective rate of 26.5%. However, expenditure should always be commercially justified rather than incurred purely to obtain a tax deduction.

The most effective approach is to understand how marginal relief affects your company’s tax position and plan ahead.

Need Help With Corporation Tax Planning?

At Makesworth Accountants, our team helps businesses understand their corporation tax obligations, identify tax-planning opportunities and make informed financial decisions.

If your company’s profits are approaching the marginal relief thresholds, professional advice can help you understand the potential impact and plan accordingly.

                                              For more information, Book a Free Consultation